Capital Gains Tax: foreign source capital gains made by a resident trust for CGT purposes

Is the trustee of a trust that is a 'resident trust for CGT purposes', assessable under paragraph 98(3)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to an individual non-resident beneficiary's share of the net income of the trust that is attributable to capital gains arising from the disposal of shares in foreign companies transacted in foreign jurisdictions, if the beneficiary is presently entitled to a share of the income of the trust for that year?

No. The trustee is not assessable under paragraph 98(3)(a) of the ITAA 1936 because the capital gains are not attributable to sources in Australia. As the contracts for the acquisition and disposal of the shares were concluded in foreign jurisdictions, any capital gains from the disposal of the shares are taken to have a source outside Australia for the purpose of Division 6 of Part III of the ITAA 1936.

The taxpayer is the trustee of a resident trust for CGT purposes. The trust is not a fixed trust as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

A beneficiary of the trust is an individual who was a non-resident throughout the income year. The beneficiary was presently entitled to a share of the income of the trust for the income year.

The trustee owns shares in foreign companies that are listed on stock exchanges located in foreign jurisdictions. The shares are all traded on foreign stock exchanges. The trustee engages the services of an overseas broker for all trades. Different overseas brokers are used for different trades on particular stock exchanges. No retainer was paid to any overseas broker.

The trustee decides which investments to buy and sell. Overseas brokers act only under the orders of the trustee. No overseas broker has a power of attorney to conclude contracts without the approval of the trustee.

During the year the trustee made capital gains from the sale of some of the shares. The shares are not taxable Australian property for the purposes of section 855-15 of the ITAA 1997 because they do not pass the non-portfolio interest or the principal asset tests referred to in subsection 855-25(1) of the ITAA 1997.

The trustee made no other capital gains or losses and did not have any net capital losses from earlier years to be carried forward.

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 calculated in accordance with subsection 95(1) of the ITAA 1936.

Broadly, the trustee of a trust may be assessed on a share of the trust's net income where there is a beneficiary who is a non-resident at the end of a year of income and that beneficiary is presently entitled to a share of the income of the trust. If the beneficiary is an individual who has not been a resident of Australia at any time during the income year, the trustee is assessed under paragraph 98(3)(a) of the ITAA 1936 on so much of the share of the net income of the trust as is attributable to sources in Australia - paragraph 98(2A)(d) of the ITAA 1936.

The issue in this case is whether capital gains from the disposal of the shares by the trustee are 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 Australian property' tests in section 855-15 of the 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.

In Nathan v. Federal Commissioner of Taxation (1918) 25 CLR 183 at 189-190, Isaacs J said: The Legislature in using the word "source" meant, not a legal concept, but something which a practical man would regard as a real source of income. Legal concepts must, or course, enter into the question when we have to consider to whom a given source belongs. But, the ascertainment of the actual source of a given income is a practical, hard matter of fact. The Act on examination so treats it.

In Federal Commissioner of Taxation v. Efstathakis (1979) 38 FLR 276 at 280; 79 ATC 4256 at 4259; 9 ATR 867 at 870 Bowen CJ stated 'the answer is not to be found in the cases, but in the weighting of the relative importance of the various factors which the cases have shown to be relevant.' Also, Kennedy J in Cliffs International Inc v. Commissioner of Taxation (Cth) (1985) 80 FLR 12; 85 ATC 4374; (1985) 16 ATR 601 stated 'there is no simple universal rule which can be applied to identify the source of any particular income. In some cases, particular features may be determinative. In others, they may not.'

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. Starke J said that the relevant source rule is where a business habitually enters into and carries out those contracts with a view to profit.

In Lovell & Christmas Ltd v. Commissioner of Taxes (Vict.) [1908] AC 46 at 52-53, Sir Arthur Wilson said: In the present case their Lordships are of opinion that the business which yields the profit is the business of selling goods on commission in London. The commission is the consideration for effecting such sales. The moneys received by the appellants out of which they deduct their commission, and from which, therefore, their profits come, are paid to them under the contract of sale effected in London. The earlier arrangements entered into in New Zealand appear to their Lordships to be transactions the object and effect of which is to bring goods from New Zealand within the net of the business which is to yield a profit. To make those transactions a ground for taxing, in New Zealand, the profits actually realized in London would, in their Lordships opinion, be to extend the area of taxation further than the authorities warrant. [Emphasis added]

Although these cases relate to profits that are ordinary income, we consider that similar principles apply in determining the source of a capital gain included in the calculation of a net capital gain. Thus, where shares are sold using an offshore broker, the buying and selling is undertaken and thus sourced, where the contract is concluded. We consider that the decisions by the trustee to sell the shares are incidental to the activities that actually realise the profits.

Accordingly, the trustee will not be assessed under paragraph 98(3)(a) of the ITAA 1936 in relation to the non-resident beneficiary's share of the trust net capital gain because the capital gains are sourced outside of Australia.