Will Section 99B Apply to Your Trust Distribution? - Takeaways from TD 2024/D2 and PCG 2024/D1

The Latest on Section 99B

In recent years, tax advisors and the ATO have observed an increase in resident taxpayers who receive an amount of trust property (being a payment or a benefit) from non-resident trusts.

Commonly, we see this take the form of distributions from foreign discretionary trusts or foreign deceased estates.

The application of section 99B of the Income Tax Assessment Act 1936 (ITAA36) to those amounts in the hands of resident taxpayers is often misunderstood, and therefore leads to unexpected effects for taxpayers.

On 31 July 2024, the ATO released two important publications on section 99B:

• Draft Taxation Determination TD 2024/D2 (Draft TD); and
• Draft Practical Compliance Guideline PCG 2024/D1 (Draft PCG).

This article considers the Draft TD and Draft PCG, and the key takeaways for resident beneficiaries of non-resident trusts, and their advisors.

What is Section 99B?

Section 99B was introduced in direct response to Union Fidelity Trustee Co of Australia Ltd v FCT [1969] HCA 36. That case held that existing trust taxation rules did not capture foreign sourced income.

To address this issue, section 99B was introduced. Much like section 100A, section 99B is drafted in very wide terms – terms arguably far wider than the stated purpose of the provision. Those wide terms mean section 99B captures any situation where property of a trust estate is applied for the benefit of an Australian resident beneficiary. The wide net covers loans, use of trust property and indirect benefits.

Where section 99B applies, the ‘amount’ will be included in the beneficiaries assessable income (as well as a punitive interest charge, calculated back to the time that the amount was initially derived by the trust).

Thus, the starting point is that all trust distributions could be subject to section 99B, unless one of the following exemptions apply:

1. an amount represents corpus of the trust, except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer (paragraph 99B(2)(a));
2. an amount that, if it had been derived by a taxpayer being a resident, would not have been included in the assessable income of that taxpayer (paragraph 99B(2)(b));
3. an amount included in the beneficiary’s assessable income under section 97 (or assessed to the trustee under section 98, 99 or 99A);
4. an amount that is non-assessable, non-exempt income of the beneficiary under section 802-17 (the conduit foreign income rules); or
5. an amount included in the assessable income of a taxpayer under section 102AAZD (the transferor trust rules).

In some situations, resident beneficiaries may have difficulty satisfying the evidentiary burden to apply one of the above exemptions, particularly when they are reliant on information coming from a foreign trustee.

The ‘Hypothetical Resident Taxpayer’

The Draft TD is focused on the ‘hypothetical resident taxpayer tests’ contained in paragraphs 99B(2)(a) and 99B(2)(b).

Unlike some recent ATO guidance on dealing with taxation of trusts (i.e. section 100A), the Draft TD is broadly in accordance with industry expectations.

The Draft TD sets out six examples of the ATO’s view on the ‘hypothetical resident taxpayer tests’:

• Example 1 – CGT asset acquired before 20 September 1985
  • A capital gain from the disposal of a pre-CGT asset would not be included in the assessable income of the hypothetical taxpayer. This confirms that a trust distribution sourced from a ‘pre-CGT capital gain’ made by a foreign trust should not be subject to section 99B.
• Example 2 – distribution from a non-resident deceased estate‍
  • The death provisions contained in Division 128 of the ITAA 1997 will determine the cost base and reduced cost base of the assets in the hands of the deceased estate, and cost base for the purposes of calculating the potential tax payable by a hypothetical resident taxpayer.
• Example 3 – CGT discount not available to hypothetical taxpayer
  • The CGT discount cannot be considered to reduce the amount which may be included in the assessable income of the hypothetical taxpayer. The reason for this is that the CGT discount is only available to some taxpayers (individuals, not companies). While it can be debated whether or not this is correct, this position is consistent with the views expressed in TD 2017/24.
• Example 4 – circumstances of derivation
  • The trustee’s acquisition date, cost base, and capital proceeds are considered in determining the amount included in assessable income under section 99B.
• Example 5 – settled sums and gifted assets
  • The cost base under Divisions 110 and 112 of settled sums and gifted assets will be the market value of those assets on the date of acquisition by the trust.
• Example 6 – capital asset acquired using interest income
  • When capital assets are acquired with accumulated income, in determining whether an amount received by a beneficiary represents, or is attributable to, an amount which would be assessed to a hypothetical taxpayer, the source of the distribution needs to be identified via tracing.

Draft PCG – ATO Compliance Approach

Taxpayers will no doubt be familiar with the concept of ‘Practical Compliance Guidelines’, which set out the ATO’s administrative approach on (generally) complex areas of tax law.

The Draft PCG sets out some low-risk arrangements where the ATO will not apply its audit resources, as well as arrangements that will attract audit attention, by reference to common scenarios.

The Draft PCG covers the following:

1. common scenarios where section 99B may need to be considered;
2. the practical aspects of record keeping evidencing that an exception to section 99B applies (or that would reduce the amount assessable under section 99B); and
3. the ATO’s compliance approach to distributions and benefits which it considers to be low risk, and the record keeping expected to substantiate this.

Common scenarios

The Draft PCG sets out seven examples of common scenarios where section 99B needs to be considered:

• Example 1 – non-resident migrates to Australia
• Example 2 – resident beneficiary receives a distribution
• Example 3 – resident beneficiary receives a gift
• Example 4 – resident beneficiary receives a loan
• Example 5 – trustee allows resident beneficiary to use non-resident trust property
• Example 6 – beneficiary receives an amount from a deceased estate
• Example 7 – resident beneficiary receives a loan which is later forgiven

The examples are somewhat repetitive, however serve to demonstrate the breadth of section 99B and what arrangements may come within its scope (such as migrations to Australia, ‘gifts’, loans, use of trust property, foreign deceased estates and loan forgiveness).

Compliance approach to low-risk arrangements

The Draft PCG addresses two common scenarios (deceased estates and provision of trust property on commercial terms) where section 99B may apply. If the arrangements meet criteria contained in the Draft PCG, the arrangements will be considered low-risk and the ATO will not apply its audit resources.

Care should be taken by resident beneficiaries and their advisors as both low-risk arrangements have criteria and minimum record keeping requirements. Failure to meet those requirements may invite ATO audit resources.

Compliance approach – deceased estates

The ATO will consider it a low-risk arrangement where the trustee (executor) distributes an amount or benefit of trust property from a non-resident deceased estate of a deceased individual who was a non-resident at their date of death to a resident beneficiary, and each of the following criteria are satisfied:

• the trust property, including cash or proceeds from the sale of trust assets is distributed to the resident beneficiary within 24 months of the date of death; and
• the total value of trust property received, whether in multiple payments or in one lump sum payment, by the resident beneficiary does not exceed A$2 million at the time the amount is paid or applied to the resident beneficiary.

The Draft PCG sets out seven examples related to deceased estates and low risk arrangement.

Compliance approach – provision of trust property on commercial terms

The second low-risk arrangement deals with a scenario where a trustee of a non-resident trust allows a resident beneficiary to use or borrow trust property, including loans of monetary amounts.

The ATO will consider it a low-risk arrangement where the non-resident trust provides trust property to a resident beneficiary as part of an agreement for the beneficiary to borrow, hire or use that property on commercial terms and each of the following are satisfied:

• the borrowing, hire or use of the trust property is subject to an agreement, whether written or verbal; and
• the agreement is made on commercial terms; and
• the resident beneficiary makes a physical payment to the trustee equal to the interest, hire or use per the commercial terms.

An agreement is on commercial terms where the resident beneficiary is able to provide documentation objectively evidencing that at the time of entering the agreement:

• the rate applied for the interest, use or hire is consistent with market rates in the same or similar circumstances; and
• the terms of the agreement are consistent with terms available in the market in the same or similar circumstances.

The Draft PCG sets out eight examples related to provision of trust property on commercial terms. Unfortunately, the reality of many trust arrangements is that the terms surrounding the use of trust property are not commercial.

Practical aspects of record keeping

The Draft PCG states that while the ATO recognises the difficulties resident beneficiaries may face, the onus is ultimately on the resident beneficiary to provide the relevant documents and information to substantiate that an exemption to section 99B applies.

The Draft PCG sets out a long list of possible sources of information that resident beneficiaries will need to obtain if seeking to apply the corpus exception or non-taxable exceptions of paragraphs 99B(2)(a) and 99B(2)(b). The Draft PCG states the following (non-exhaustive) core documents should be provided as a minimum:

• the signed and executed trust deed or Will of the deceased;
• the signed trustee minutes, resolutions or distribution statements confirming an amount was paid or applied for the benefit of a beneficiary from the trust's corpus; and
• copies of the trust's financial accounts for the relevant years, prepared in accordance with the accounting principles of the relevant country.

The Draft PCG also contains a further non-exhaustive list of documents and information that resident beneficiaries may need to obtain and sets out five examples of the evidence required to substantiate that paragraph 99B(2)(a) and 99B(2)(b) exceptions apply. This should assist resident beneficiaries and their advisors to determine what information they need to request from foreign trustees.

Next Steps

When finalised, the ATO propose that Draft TD and Draft PCG apply both before and after its date of issue. Submissions on the Draft TD are due by 28 August 2024.

While the Draft TD and Draft PCG do not break significant new ground on interpretations of section 99B, they do serve as a reminder of the breadth of section 99B, and important evidentiary matters. Unfortunately, there are also a number of important scenarios which are not considered by either the Draft TD or the Draft PCG.

The Draft PCG emphasises the importance of resident beneficiaries obtaining relevant documents and information from foreign trustees. For an example of a situation wherein the taxpayer could not prove an exemption to section 99B, see Campbell and Commissioner of Taxation [2019] AATA 2043.

In any trust dealing with a ‘foreign’ element, taxpayers and their advisors should be vigilant to the risk of section 99B applying, and seek professional advice where appropriate.

This article in no way constitutes legal advice. It is general in nature and is the opinion of the authors only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.