Assessability of distribution of interest income received by resident beneficiary of deceased estate from Canada

Is a distribution of interest income received by a resident taxpayer as a beneficiary of a deceased estate from Canada, assessable under subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. A distribution of interest income received by a resident taxpayer as a beneficiary of a deceased estate from Canada is assessable under subsection 6-10(4) of the ITAA 1997.

The taxpayer is an Australian resident for income tax purposes.

The taxpayer is a beneficiary of a deceased estate.

The taxpayer receives distributions of income from the trustee of the deceased estate.

The income consists of interest derived from a Canadian bank account by the trustee of the deceased estate.

Canadian tax at the rate of 15% has been deducted from the distribution made to the taxpayer.

Subsection 6-10(4) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes statutory income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Section 10-5 of the ITAA 1997 lists those provisions about statutory income. Included in this list is section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with present entitlement to the net income of a trust estate.

Subsection 97(1) of the ITAA 1936 provides that where a beneficiary of a trust estate who is not under any legal disability and is presently entitled to a share of the net income of the trust estate, the assessable income of the beneficiary shall include: (a) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident, and (b) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia.

Section 96B of the ITAA 1936 provides special rules for calculating the share of the net income where a taxpayer had an interest (including an interest that is to arise at a future time or is contingent on the happening of an event) in a non-resident trust in relation to the 1992-93 or later year of income.

Subsection 96B(2) of the ITAA 1936 deems the taxpayer to be a beneficiary who is presently entitled to a share of the income of the trust estate and who is not under a legal disability.

Subsection 96B(3) of the ITAA 1936 further provides that the taxpayer's share of the net income of the trust estate is calculated in accordance with section 96C of the ITAA 1936. The amount calculated under section 96C is then included in the beneficiary's assessable income under section 97 of the ITAA 1936.

For Australian tax purposes, an amount of trust income distributed by a trustee to a beneficiary retains the character it had when it was derived by the trustee, unless a provision of the trust deed or of any relevant statute provides otherwise (see Syme v. Commissioner of Taxation (Vic ) (1914) 18 CLR 519 and FC of T v. Tadcaster Pty. Ltd. 82 ATC 4316; (1982) 13 ATR 245).

Accordingly, for Australian tax purposes, the distribution consisting of interest derived by the deceased estate retains its character as interest when distributed to the taxpayer.

In determining liability to Australian tax on foreign sourced income received by a resident, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1997 so that those Acts are read as one.

Schedule 3 to the Agreements Act contains the double tax agreement between Australia and Canada (Canadian Convention). Schedule 3A to the Agreements Act contains the Protocol amending the Canadian Convention (Canadian Protocol). The Canadian Convention and the Canadian Protocol operate to avoid the double taxation of income received by Australian and Canadian residents.

Article 11(1) of the Canadian Convention provides that interest arising in Canada, being interest to which a resident of Australia is beneficially entitled, may be taxed in Australia.

Article 11(2) of the Canadian Convention (as amended by Article 9 of the Canadian Protocol) provides that the interest may also be taxed in Canada, according to the law of Canada, but the tax so charged shall not exceed 10% of the gross amount of the interest.

However, under Canadian law, where a non-resident of Canada is beneficially entitled to a share of interest income derived by a Canadian trust estate, Canada taxes the non-resident beneficially on the distribution as an item of income generally rather than as a share of the interest income derived by the trust estate.

Accordingly, for Canadian tax purposes, the trust distribution will be considered under Article 21 of the Canadian Convention, rather than Article 11.

Article 21 of the Canadian Convention deals with income not expressly mentioned, including trust distributions.

Article 21(1) of the Canadian Convention provides that, subject to Article 21(2), items of income not expressly mentioned of a resident of Australia shall be taxable only in Australia.

Article 21(2) of the Canadian Convention provides that where such income is derived by an Australian resident from sources in Canada, that income may also be taxed in Canada. The Canadian tax payable under Article 21(2) shall be not exceed 15% of the gross amount of the income if it is subject to tax in Australia (Article 21(3) of the Canadian Convention).

Article 23(1) of the Canadian Convention (as amended by Article 14 of the Canadian Protocol) provides that, subject to the provisions of the law of Australia, a credit for tax paid in Canada under the law of Canada and in accordance with the Canadian Convention will be allowed against Australian tax paid on income from Canadian sources.

Taxation Ruling TR 2001/13 discusses the Commissioner's views about interpreting double tax agreements. At paragraph 104, it says that the OECD Model Tax Convention and Commentary may be considered in interpreting double tax agreements.

The Commentary regarding Article 23 of the OECD Model Convention discusses the interpretation of the phrase 'in accordance with the provisions of the Convention' in the context of providing relief from double taxation.

Paragraph 32.3 of the Commentary provides that where, due to differences in the domestic law between the country of source and the country of residence, the source country applies provisions of the relevant Convention that are different from those that the State of residence would have applied to the same item of income, the income is still being taxed in accordance with the provisions of the Convention, as interpreted and applied by the State of source. In such a case, therefore, the two Articles require that relief from double taxation be granted by the State of residence notwithstanding the conflict of qualification resulting from these differences in domestic law.

Accordingly, subject to the laws of Australia, a tax credit for Canadian tax paid at the rate of 15% in accordance with Article 21(3) of the Canadian Convention (and not at the rate of 10% in accordance with Article 11(2) of the Canadian Convention) will be allowed against the Australian tax payable on the distribution.

As the taxpayer is a resident of Australia, the taxpayer's share of the net income of the deceased estate, calculated in accordance with section 96C of the ITAA 1936, is included in their assessable income under subsection 6-10(4) of the ITAA 1997. As Canadian tax has been paid in relation to the distribution, a foreign tax credit will be allowed.

Where the Canadian tax paid on the interest is less than the Australian tax payable, the taxpayer will be entitled to a full credit for the Canadian tax paid. Where the Canadian tax paid is greater than the Australian tax payable, the taxpayer is only entitled to a credit equal to the value of the Australian tax payable and cannot recover any excess Canadian tax paid.

Note: the Foreign Investment Fund measures do not apply to an Australian resident beneficiary of a foreign trust arising in relation to the estate of deceased persons (paragraph 481(3)(b) of the ITAA 1936).