Discretionary trusts: be wary of distribution to foreign residents

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In a recent Federal Court case, Peter Greensill Family Co Pty Ltd v Commissioner of Taxation, the Federal Court found that a distribution from a resident discretionary trust to a foreign resident beneficiary was taxable in the hands of the foreign resident.

There are specific tax provisions that cover two situations involving foreign residents and foreign capital gains: one excluding foreign gains received directly by foreign residents and another excluding foreign gains distributed by fixed trusts to foreign beneficiaries.

However, the legal question in this case was whether the capital gain from that sale of foreign property should be taxable in Australia to that foreign beneficiary because they received it as a distribution from a discretionary (i.e. non-fixed) trust.

In Australia, trustees are generally taxed on income to which non-residents are presently entitled at the end of an income year, while foreign beneficiaries get a credit for such tax paid by the trustee when they are assessed on that income.

The Commissioner argued that the trustee should be assessed on these gains, while the corporate trustee argued that the capital gains had been distributed to the foreign resident beneficiary – who would have been exempt from Australian tax on the sale of the foreign property if they had held it directly.

Surprising many, the Court upheld the Commissioner’s position, reading the relevant provisions quite strictly, rather than treating the transaction as a flow-through to the foreign beneficiary.

This decision has significant implications for any Australian discretionary trust used as an investment vehicle to hold foreign assets on behalf of potential beneficiaries that include foreign residents.

Any affected taxpayers should consider seeking advice now on how to manage these newly emerging risks.

Category: Tax Residency