CGW flags ‘largest trap’ with Section 99B and trust distributions
The timing that applies with Section 99B and distributions from foreign trusts can leave clients with a nasty surprise, warns Cooper Grace Ward Lawyers.
Where section 99B applies to tax distributions of capital from foreign trusts, it can result in taxpayers being hit with substantial tax liabilities, Cooper Grace Ward Lawyers has cautioned in a recent podcast.
Section 99B of the Income Tax Assessment Act 1936 applies where money or another asset of a foreign trust is paid to a person or applied for their benefit and they are the beneficiary of the foreign trust.
Cooper Grace Ward partner Fletch Heinemann said issues can often arise with Section 99B for clients with things like New Zealand-based trusts.
“We tend to see a lot of New Zealand trusts and typically how it works is that there’s property in New Zealand that has been transferred into a New Zealand trust. The trustees are in New Zealand and it’s operated in New Zealand,” said Mr Heinemann.
“A lot of these properties were transferred into these trusts around 20 to 30 years ago so the value of those properties have gone up significantly during that time. Some of the kids who are beneficiaries of those trusts have then become Australian tax residents. Unfortunately we’re getting to the stage where Mum and Dad who are the original controllers of the trust are starting to pass away and so an issue arises with how we’re distributing the proceeds of the trust.”
Mr Heinemann said the main problem that occurs is that if the trust then sells the property in New Zealand, it's going to be a significant capital gain and the capital gain will be distributed to the Australian tax residents.
“Section 99B is basically going to tax the capital gain component of that of that distribution. So, the full amount would be subject to tax under Section 99B. There are some amounts that are then excluded, but for purposes [of this example], really, we’re only looking at the cost base of the property when it was transferred in. Sometimes that's pretty marginal,” he said.
“We also need to be mindful that there’s no general 50 per cent discount so it’s taxed at marginal rates. It can be a very significant tax liability.”
Cooper Grace Ward partner Sarah Lancaster said the biggest trap that tends to arise with Section 99B and trust distributions is with timing.
Ms Lancaster stated that Section 99B can apply for any resident beneficiary who is an Australian resident at any time during the income year.
Mr Heinemann said this often causes confusion among tax advisers and their clients because it differs from the other rules concerning timing.
“You would ordinarily think that if somebody immigrates to Australia on a particular date, that their tax presence starts from that date and that any income that they derive from that date they become a resident will be subject to tax in Australia,” he said.
“For example, the CGT assets that they hold when they become a resident. Assuming they're not a temporary resident, the market value of those assets will form the cost base for those assets. So we’re all geared into thinking of the residency start date as the date that you jump into the Australian tax net.”
However, Section 99B tax can apply to distributions received at any point during the income year in which someone has become a resident, he warned.
“Let’s say that you immigrate to Australia on today's date and you received a distribution from your Nan's trust in New Zealand of $3 million. You receive it on 1 December so you received it while you're a non-resident.
[However], you've received that distribution during the income year in which you've become an Australian tax resident. So suddenly, that $3 million is now subject to tax in Australia under 99B, which is a horrendous result.”
Mr Heinemann said where the adviser or their client is aware of the issue beforehand, they can deal with the assets overseas appropriately before immigrating to Australia to avoid such significant tax liabilities.
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