Capital gains tax: foreign source income made by a resident trust

Is an Australian resident trustee assessable under subsection 98(4) of the Income Tax Assessment Act 1936 (ITAA 1936) on any resulting net capital gain on the vesting of the trust and registration of the trust assets, being shares in a foreign company, in the names of the non-resident beneficiaries?

No. The trustee is not assessable under subsection 98(4) of the ITAA 1936 because any resulting net capital gain is not attributable to sources in Australia.

An Australian resident trust (the Trust) was established before 20 September 1985 (pre-CGT) and vested on the death in late 2002 of an individual, a non-resident for taxation purposes. The trustee remained at all times an Australian resident for taxation purposes. The only assets of the Trust were post-CGT shares in a foreign company that is listed on foreign stock exchanges. The shares could only be physically sold via an overseas broker. The shares have increased in value and the trustee has an unrealised capital gain. The trustee currently holds the shares in a nominee capacity and proposes to transfer the shares to the non-resident beneficiaries in their individual names.

Upon the vesting of the Trust, the individual's two children, who are both non-residents for Australian taxation purposes, became presently entitled to 50% each of the trust estate's net income (including the net capital gain). There is no net income (including the net capital gain) to which no beneficiary is presently entitled.

A resident trust, for CGT purposes, must include in the calculation of its net capital gain, capital gains and capital losses from CGT events happening to its worldwide assets. The net capital gain is then included in the net income of the trust in accordance with subsection 95(1) of the ITAA 1936.

Broadly, subsection 98(4) of the ITAA 1936 provides that the trustee of a trust may be assessed where there is an individual beneficiary who is a non-resident at the end of a year of income and that beneficiary is presently entitled to income of the trust. If the beneficiary has not been a resident of Australia at any time during the income year, the trustee is assessed on so much of the share of the net income of the trust estate as is attributable to sources in Australia.

As a consequence of the vesting of the trust on the death of the individual, the two non-resident beneficiaries became presently entitled to the net income of the trust.

The fundamental issue to be resolved is whether any capital gain made by the trustee in respect of the shares, is sourced in Australia.

The capital gains tax provisions do not contain any provision that expressly determines the source of a capital gain, or net capital gain, for the purposes of Division 6 of Part III of the ITAA 1936. The 'taxable Australia property' tests in section 855-15 of the Income Tax Assessment Act 1997 (ITAA 1997) are not relevant for this purpose.

In the absence of a statutory source rule for capital gains for the purposes of Division 6 of Part III of the ITAA 1936, reliance is appropriately placed on the common law source rules as they relate to income notwithstanding that net capital gains are a form of statutory income.

The leading Australian authority on the source of profits from the sale of shares is Australian Machinery and Investments Company Ltd v. Deputy Commissioner of Taxation (WA) (1946) 180 CLR 9; 3 AITR 359; (1946) 8 ATD 81 where it was held that where shares are situated outside Australia and sold outside Australia, the profit on sale is derived wholly from a source outside Australia.

Thus, where shares are sold using an offshore broker, the buying and selling is undertaken and thus sourced, where the contract is concluded.

Therefore, in applying the common law rules, the source of the capital gain made by the trustee will be outside Australia. This is because the shares in the foreign company are only traded on foreign stock exchanges and can only be bought and sold via an overseas broker and, as the company is trading overseas, from a practical viewpoint, the increase in the economic value of the shares would occur outside Australia.

Accordingly, as the source of the capital gain is outside Australia, the trustee is not assessable under subsection 98(4) of the ITAA 1936 on any resulting net capital gain from the vesting of the trust and registration of the shares in the names of the non-resident beneficiaries. Note 1: Subsection 98(4) of the ITAA 1936 has been amended by the Tax Laws Amendment (2007 Measures No 3) Act 2007 by extending a trustee's liability to pay tax to cases where a non-resident beneficiary is a trustee of another trust and is presently entitled to income of the first trust. However, this change does not affect the decision in this interpretative decision. Note 2: Section 136-25 of the ITAA 1997 is no longer relevant because Division 136 of the ITAA 1997 was repealed by the Tax Laws Amendment (2006 Measures No 4) Act 2006, with effect from 12 December 2006, applicable to CGT events that happen on or after 12 December 2006. Division 136 has been replaced by Division 855 in the ITAA 1997, and the reference to 'necessary connection with Australia' is replaced by the reference to 'taxable Australian property'. However, this change does not affect the decision in this interpretative decision.