The Australian Taxation Office (ATO) has recently issued Taxation Determinations TD 2017/21 and TD 2017/22 (the ATO Determinations) which are relevant to Australian companies that receive foreign equity distributions (eg dividends) via an Australian partnership or trust.
Broadly, an Australian company is not subject to tax in Australia on foreign equity distributions where certain conditions are satisfied relating to the interest it holds in the foreign company. However, the view expressed by the ATO in TD 2017/22 can result in foreign equity distributions that are made to an Australian company throughout an income year via an Australian discretionary trust being subject tax.
This Tax Insight provides an overview of the ATO Determinations and in particular, focusses on the above issue relating to foreign equity distributions made indirectly to an Australian company via an Australian discretionary trust.
How are foreign equity distributions typically taxed in Australia?
Where an Australian resident ‘corporate tax entity’ (ie a company or trust that is taxed like a company) satisfies certain conditions, foreign equity distributions paid by a foreign resident company are ‘not assessable and not exempt’ income of the Australian corporate tax entity (ie not subject to tax). Very broadly, these conditions require the Australian corporate tax entity to be a resident for Australian tax purposes and hold an interest (directly or indirectly) of at least 10% in the foreign company.
The ATO Determinations confirm that the 10% interest requirement can also be satisfied where the Australian corporate tax entity has an indirect interest in the foreign company through a partnership (TD 2017/21) or a trust (TD 2017/22).
What is the relevant test time?
In determining whether the Australian corporate tax entity satisfies the 10% interest requirement, the relevant test time is when the foreign company makes the equity distribution. This then becomes particularly relevant to Australian corporate tax entities that are beneficiaries of an Australian discretionary trust.
How does this apply to discretionary trusts?
In relation to a discretionary trust, it is necessary to determine whether the corporate tax entity has an interest in the trust at the test time.
The ordinary rules in the tax legislation provide that this is done by ascertaining the share of income or capital to which the beneficiary is entitled at the end of the income year and assuming that this is the share to which the beneficiary is entitled at all other times during that income year. This share (or percentage) is the interest the corporate tax entity holds in the trust. Relevantly, the draft version of TD 2017/22 (TD 2016/D7) reiterated this approach, meaning that where the entitlement of a corporate tax entity beneficiary’s share of the income or capital of a discretionary trust is not determined until the end of an income year and a foreign equity distribution is made before the end of the income year, that corporate tax entity would still hold an interest in the relevant trust.
However, in TD 2017/22 the ATO asserts the view that (assuming the foreign equity distribution is made before the end of the income year), at the test time the corporate tax entity beneficiary is merely a potential object of the trust. The reason for this position is that the trustee of the trust would usually only exercise its discretion concerning the income and capital of the trust at the end of the income year, being the relevant point in time it would have an entitlement and in turn, hold an interest in the trust. In this scenario, the foreign equity distribution would not be exempt from tax and taxable to the Australian corporate tax beneficiary.
When does the view in TD 2017/22 apply?
Both of the ATO Determinations apply from 17 October 2014.
However, Australian companies that have relied on draft Taxation Determination TD 2016/D7 with respect to discretionary trusts, are entitled to have done so until 18 October 2017.
Impact on business
Australian companies that have either received a foreign equity distribution via an Australian discretionary trust since 30 June 2017 or propose to receive foreign equity distributions should carefully consider the application of TD 2017/22 to their facts and circumstances. Tax planning may be required to ensure the foreign equity distribution is not inadvertently taxable to the Australian company.
Please contact a member of our National Taxation Group to discuss how these changes could impact you.
This article was written by Nima Sedaghat, Partner and Alina Sedmak, Associate.