Assessability of trust distributions to non-resident beneficiaries

Is the trustee of a widely held Australian resident unit trust which carries on a business of funds management in Australia through a permanent establishment (PE) in Australia, assessed and liable to pay tax under subsection 98(3) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the income of the trust estate which is not attributable to sources in Australia and to which the trust's New Zealand resident beneficiaries are presently entitled?

No. Subsection 98(3) of the ITAA 1936 do not apply to the income of the trust estate to which the trust's New Zealand resident beneficiaries are presently entitled and which is not attributable to sources in Australia. Furthermore, section 3AA of the International Tax Agreements Act 1953 (Agreements Act) ensures that the source of the trust estate's funds management income remains attributable to sources outside Australia.

The trust estate is an Australian resident trust estate for the purposes of subsection 95(2) of the ITAA 1936.

The resident trust estate is a 'widely held unit trust' as defined in section 272-105 in Schedule 2F of the ITAA 1936 and is also a 'managed investment scheme' as defined in section 9 of the Corporations Act 2001 .

The trustee of the widely held Australian resident unit trust carries on a business of funds management activities in Australia by investing in shares in overseas listed entities, units in an Australian unit trust deriving income from overseas commodity funds, overseas currency swap contracts and overseas exchange rate contracts.

The income derived by the trustee of the trust estate from conducting its funds management activities in Australia is income attributable to sources outside of Australia.

The management and administration of the trust estate is undertaken at a place in Australia by personnel employed by the trust estate. The place of management and administration in Australia constitutes a PE in accordance with the principles of Article 5 of the tax treaty between Australia and New Zealand (New Zealand Agreement) contained in Schedule 4 of the Agreements Act.

All the beneficiaries of the trust estate are New Zealand resident individuals or companies. Each beneficiary is presently entitled for the purposes of subsection 98(2A) of the ITAA 1936 and beneficially entitled for the purposes of Article 7(7) of the New Zealand Agreement to their respective share of the net income of the trust estate.

For the purposes of this case, subsection 98(2A) of the ITAA 1936 provides that where a non-resident beneficiary is presently entitled to a share of the income of the trust estate, the trustee is assessed and liable to pay tax under subsection 98(3) of the ITAA 1936 in respect of 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.

Accordingly, as the beneficiaries' share of the income of the trust is from sources outside Australia, subsections 98(2A) and 98(3) of the ITAA 1936 do not apply.

In determining the New Zealand resident beneficiaries' liability to Australian tax, it is necessary to consider not only the Australian income tax laws but also the New Zealand Agreement.

Section 4 of the Agreements Act incorporates the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) into the Agreements Act so that all those Acts are read as one. The Agreements Act effectively prevails over the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except for limited situations not relevant for present purposes).

Article 7(1) of the New Zealand Agreement provides that the profits of an enterprise of New Zealand may be taxed in Australia if the enterprise carries on business in Australia through a PE in Australia, but only the profits attributable to that PE.

Article 7(7) of the New Zealand Agreement states: Where: (a) a resident of a Contracting State is beneficially entitled... to a share of the business profits of an enterprise carried on in the other Contracting State by the trustee of a trust...; and (b) in relation to that enterprise, that trustee would, in accordance with the principles of Article 5, have a permanent establishment in that other State,

the enterprise carried on by the trustee shall be deemed to be a business carried on in the other State by that resident through a permanent establishment situated in that other State and that share of business profits shall be attributed to that permanent establishment.

As the beneficiaries are beneficially entitled to their share of the income of the trust estate and the trustee has a PE in Australia, Article 7(7) of the New Zealand Agreement is satisfied. Accordingly, the enterprise carried on by the trustee in Australia is deemed to be a business carried on in Australia by the New Zealand resident beneficiaries through a PE in Australia and their share of the income of the trust estate is attributable to that PE.

Where Australia has a right to tax the profits of an enterprise of New Zealand under Article 7(1) of the New Zealand Agreement, Article 23(1) of the New Zealand Agreement (the source of income article) provides that income, profits or gains derived by a resident of New Zealand which, under certain Articles including Article 7 of the New Zealand Agreement, may be taxed in Australia shall, for the purposes of the law in Australia relating to its tax, be deemed to be income from sources in Australia.

However, subsection 3AA(2) of the Agreements Act provides that the source of income Articles in Australia's tax treaties including for present purposes Article 23(1) of the New Zealand Agreement do not apply to a beneficiary of a widely held unit trust in determining whether the funds management income of the beneficiary is attributable to sources in Australia for the purposes of the ITAA 1936 and ITAA 1997 if: • a beneficiary of a widely held trust is a resident of a treaty country (other than Australia) (paragraph 3AA(1)(a) of the Agreements Act), and • the beneficiary is presently entitled either directly or indirectly to a share of the income of a widely held unit trust which is derived from funds management activities carried on by the trustee through a PE in Australia, being the funds management income (paragraph 3AA(1)(b) of the Agreements Act).

Paragraph 3AA(4)(a) of the Agreements Act defines funds management activities as activities carried on by a 'managed investment scheme' (as defined by section 9 of the Corporations Act) that is a widely held unit trust. The trustee's activities constitute funds management activities as paragraph 3AA(4)(a) is satisfied in the present case.

Subsection 3AA(1) of the Agreements Act applies as the beneficiaries are residents of New Zealand, a country with which Australia has a double tax agreement (paragraph 3AA(1)(a) of the Agreements Act) and they are presently entitled to a share of the income of a widely held unit trust derived from the carrying on by the trustee of funds management activities through a PE in Australia (subparagraph 3AA(1)(b)(i) of the Agreements Act).

Accordingly, as subsection 3AA(1) of the Agreements Act applies, Article 23(1) of the New Zealand Agreement does not apply to the funds management activities income of the New Zealand resident beneficiaries (subsection 3AA(2) of the Agreements Act). Consequently, the funds management income that is derived by the trustee from sources outside Australia continues to be income from sources outside Australia for the purposes of the ITAA 1936 and the ITAA 1997.

Therefore, although Australia has a taxing right under Article 7(1) of the New Zealand Agreement to tax the funds management income derived by the trustee from sources outside Australia, subsection 98(3) of the ITAA 1936 does not apply to assess the trustee on the funds management income of the trust; in this case, all of the net income of the trust estate.