On 27 November 2024, the ATO finalised the following guidance in relation to section 99B of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936):

• Taxation Determination - TD 2024/9 Income tax: factors taken into account in applying paragraphs 99B(2)(a) and 99B(2)(b) of the Income Tax Assessment Act 1936 (TD); and
• Practical Compliance Guideline - PCG 2024/3 Section 99B of the Income Tax Assessment Act 1936 - ATO compliance approach (PCG).

Drafts of the TD and PCG were released on 31 July 2024. We commented on the draft TD and PCG, in our earlier article.

The finalised guidance applies with retrospective effect.

Section 99B - Background

Aside from subsection 99B(1), the provisions of Division 6 of Part III of the ITAA 1936 only assess a beneficiary on the net income of a trust, based on their entitlement to trust income.

Subject to limited exceptions, subsection 99B(1) provides for the inclusion in the assessable income of a beneficiary of a trust, of amounts (being trust property) paid to, or applied for the benefit of, that beneficiary, where the beneficiary was an Australian tax resident at any time during the income year in which the amount was paid or applied,

The explanatory memorandum (EM) to the act which introduced section 99B explained that section 99B 'will normally apply where accumulated foreign-source income of a non-resident trust estate … is distributed to a resident beneficiary.' However, there is ongoing uncertainty regarding its application to resident trusts (which is discussed below).

The assessable income of a beneficiary under subsection 99B(1) is reduced by certain amounts, under two key exceptions, which proceed on the basis of a 'hypothetical resident taxpayer':

1. the 'corpus reduction' - under paragraph 99B(2)(a), an amount that represents corpus of the trust estate, except to the extent to which it is attributable to amounts derived by the trust that, if they had been derived by an Australian resident taxpayer, would have been included in the assessable income of that Australian resident taxpayer in an income year ; and
2. the 'non-taxable reduction' - under paragraph 99B(2)(b), an amount that, if it had been derived by an Australian resident taxpayer, would not have been included in the assessable income of that Australian resident taxpayer in an income year.

The harsh consequences of section 99B are compounded by the fact that the Australian beneficiary may also be assessable on an interest charge on the distribution (as a consequence of the deferral of Australian tax), calculated broadly from the income year following the income year in which the income or profits distributed were derived (or 1 July 1990, whichever is later).

TD

The TD provides guidance on the ATO's approach regarding the 'hypothetical resident taxpayer' for the purposes of paragraphs 99B(2)(a) and (b).

In particular, it sets out the ATO's views on:

• the characteristics of the hypothetical taxpayer being limited to residency;
• the need to have regard to the circumstances that gave rise to the relevant amount in the hands of the trustee; and
• the relevance of the source of the amount paid or applied to the beneficiary.

The ATO illustrates its views on these issues through the use of a number of examples in the TD.

The ATO has previously expressed its views regarding the hypothetical taxpayer test posited by paragraphs 99B(2)(a) and (b) in Taxation Determination TD 2017/24 – Income tax: where an amount included in a beneficiary's assessable income under subsection 99B(1) of the Income Tax Assessment Act 1936 (ITAA 1936) had its origins in a capital gain from non-taxable Australian property of a foreign trust, can the beneficiary offset capital losses or a carry-forward net capital loss ('capital loss offset') or access the CGT discount in relation to the amount?.

In TD 2017/24 the ATO indicates that the hypothetical taxpayer posited by paragraphs 99B(2)(a) and (b) is:

1. a resident, but it cannot be assumed that this hypothetical taxpayer has other characteristics - for example, that it is an entity eligible for the capital gains tax (CGT) discount; and
2. not the trustee of the trust, but an entirely separate, fictional entity.

The TD is broadly consistent with the ATO's previous guidance and the jurisprudence. It does not represent a major shift in the ATO's approach to section 99B.

Characteristics of the hypothetical taxpayer

The ATO confirms that the characteristics of the hypothetical taxpayer are limited to those expressed in the hypothesis under paragraphs 99B(2)(a) and 99B(2)(b) – namely, residence in Australia. It cannot be assumed that the hypothetical taxpayer has any other characteristics, such as being an individual, trust, or company.

Therefore no CGT discount would be available to the hypothetical taxpayer (given the CGT discount is only available to individuals, complying superannuation entities and trusts).

In this regard, the comments made in the TD are substantially the same as those which the ATO has previously made in TD 2017/24 regarding the characteristics of the hypothetical taxpayer.

Circumstances giving rise to the amount

The ATO's view is that in order to determine whether an amount would be included in the assessable income of a hypothetical resident, it is relevant to consider the circumstances giving rise to that amount. If the relevant amount being tested under the 'hypothetical resident taxpayer' tests is the proceeds of realisation of a capital asset of the trustee of the trust, the acquisition of the asset by the trustee and its sale are relevant circumstances in determining whether the proceeds would be assessable to a hypothetical resident taxpayer.

Example 1 in the TD illustrates that when determining whether or not a capital gain arising from a CGT event A1 would be assessed in the hands of the hypothetical taxpayer, consideration is given to whether or not the asset was acquired before 20 September 1985. If it was, then the CGT provisions would usually operate to disregard the capital gain such that the amount attributable to the capital gain would not be included in the assessable income of the hypothetical resident taxpayer.

Example 5 in the TD illustrates that where the asset disposed of is not a pre-CGT asset, then the amount (if any) by which the proceeds exceed the cost base represents a gain which would be assessable to a hypothetical resident taxpayer. The distribution would be assessed under subsection 99B(1), reduced only under paragraphs 99B(2)(a) or (b) by an amount equal to the cost base of the asset. The distribution is not reduced by an amount equal to the gain.

From these examples it is clear that a capital gain arising from the disposal of pre-CGT assets by a trustee should not be brought to tax by virtue of section 99B (although the outcome may be different if the asset is pre-CGT shares in a company and CGT event K6 applies). This is useful guidance for trusts that hold pre-CGT assets.

In finalising the TD, the ATO included an additional example (example 7) which illustrates what happens when a non-resident trust later becomes a resident trust for CGT purposes (such that the special rules in section 855-50 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) are turned on to replace the trustee's historic cost base in certain assets with the assets' market value at the time the trust becomes a resident trust for CGT purposes). In that scenario, a distribution by the trustee (after the trust becomes a resident trust for CGT purposes) which represents, and is attributable to, proceeds of the sale of trust assets which became assets of the trust when it was a non-resident, is assessed under section 99B(1), and would be reduced under paragraphs 99B(2)(a) or (b) by an amount equal to the cost base of the asset (at the time of its acquisition and not at the time of the change in residence). That is, the market value cost base rules in section 855-50 which are triggered on the change in residence of the trust are not relevant for 99B(2)(a) or (b) purposes, This is a particularly important interpretation for foreign trusts which become Australian resident trusts for CGT purposes.

The TD also includes other examples in relation to the relevant circumstances of derivation, such as a distribution from a non-resident deceased estate (and the operation of Division 128 of the ITAA 1997to modify the cost base and reduced cost base of the CGT asset in the hands of the legal personal representative, executor or beneficiary). The approach in respect of using the modified cost base being under Division 128 and not using the market value cost base in 855-50 is reconcilable as the Commissioner states that "things that happen to the trustee after acquiring an asset are not relevant".

Source of the amount

In addition, the ATO expresses the view that paragraphs 99B(2)(a) and (b) require a determination of what the relevant amount received by the beneficiary represents and is attributable to. That is, the hypothetical resident taxpayer test involves looking beyond the distribution by the trustee to consider how the trust property became a trust asset.

Example 8 of the TD illustrates that where a non-resident trust:

• derives substantial income from a lending arrangement in an income year;
• uses a portion of that income in a subsequent income year to acquire a CGT asset that is later disposed of at a loss; and
• distributes the proceeds of sale to a resident beneficiary,

it is necessary to look behind the capital gains transaction and identify how the asset which gave rise to the relevant amount become a trust asset (i.e. the distribution represents, and is attributable to interest income from the lending arrangement) for the purposes of determining whether the amount would be assessable to the hypothetical resident taxpayer, given the hypothetical taxpayer would not have been assessable on the proceeds from the sale of the CGT asset (as the asset was realised at a loss).

It is worth noting that the ATO does not cite any authorities for taking the position that there is an obligation to look behind the distribution, or intervening transactions, to the source of the distribution. The Commissioner's position may require a complex and difficult tracing exercise, and records may not be readily available to ascertain the source of the distribution.

PCG

The PCG provides guidance on the ATO's approach to section 99B for arrangements where property of a non-resident trust (or trust property accumulated while a trust was a non-resident) is paid or applied for the benefit of a resident beneficiary. In particular, the PCG provides clarity on:

• common scenarios where section 99B may need to be considered;
• record keeping where reliance is sought to be placed on an reduction; and
• the ATO's compliance approach for scenarios considered to be low risk (including the availability of a safe harbour for certain agreements between the trustee of a non-resident trust and a resident beneficiary).

Common section 99B scenarios

The ATO confirms that section 99B is in play where a resident beneficiary receives trust property from a non-resident trust estate in circumstances involving distributions of funds, asset transfers, use of trust property, loans or amounts received from deceased estates.

The ATO puts taxpayers on notice that common scenarios where section 99B will need to be considered include:

• a non-resident migrating to Australia, winding up their overseas interests after becoming a resident and receiving a distribution from the non-resident trust;
• a distribution out of accumulated profits by a non-resident trust to a beneficiary who is an Australian resident taxpayer;
• a gift of funds by a non-resident trust to a resident beneficiary;
• a loan of funds by a non-resident trust to a resident beneficiary;
• the trustee of a non-resident trust allowing a resident beneficiary to use trust property;
• a resident beneficiary receiving an amount from a non-resident deceased estate; and
• a beneficiary who changes their tax residency and receives an amount from a non-resident trust in the same income year.

The compendium to the PCG notes that the final scenario was included as, in the feedback provided during consultation, it was considered to be the most common scenario.

These examples evidence the potential breadth of section 99B, which may not have been appreciated by some taxpayers and their advisors.

Record keeping

While recognising that it can be challenging to obtain the relevant documents/information from a non-resident trustee, the ATO highlights that the onus is on the resident beneficiary to provide sufficient evidence to substantiate the application of the 'corpus' reduction or 'non-taxable' reduction. If the onus cannot be met, the reduction will not be available.

For the 'corpus reduction', the core documents that taxpayers will be expected to provide to evidence that an amount was paid or applied from the trust's corpus include the executed trust deed (or will), minutes/resolutions and distribution statements and the trust's financial accounts (prepared in accordance with relevant accounting principles).

Further documentation required to support the 'corpus reduction' or the 'non-taxable reduction' will be determined by the ATO on a case by case basis. The PCG provides a non-exhaustive list of potentially relevant documents/information and provides a number of examples where the sufficiency of evidence is tested. From these examples, it is evident that:

• it will not be sufficient for a resident taxpayer to provide a trustee resolution confirming payment of an amount from trust corpus in circumstances where no further documentation or information can be obtained from the trustee; and
• the financial statements for the non-resident trust must be prepared in a manner which clearly identifies the source of the payment to the resident beneficiary. This will often have its challenges.

This is consistent with the approach in Campbell v Commissioner of Taxation [2019] AATA 2043 (Campbell), that in order to establish that the 'corpus reduction', the taxpayer is required to produce evidence that is consistent and reliable, and which establishes the distributions were from corpus.
In Campbell, the taxpayer's evidence was found to be inconsistent and unreliable as the evidence included two sets of contradictory financial statements (without a sufficient explanation of the relevant amounts) and only trustee resolutions/minutes for the first set of financial statements, and not the revised financial statements.

It is therefore important for taxpayers and their advisors to maintain accurate and consistent records for the purposes of relying on the 'corpus reduction'. Although Campbell is an example of when records would be regarded as insufficient, the additional guidance in the form of the PCG should assist taxpayers and advisors with meeting the substantiation requirements when seeking to rely on the 'corpus reduction'.

Compliance approach for low risk arrangements

The ATO confirms that two key scenarios will be considered low risk and for those arrangements which meet the low risk criteria, the ATO will not dedicate compliance resources to consider the application of section 99B other than to confirm that the required low-risk features are present. The identified low risk arrangements are:

1. Deceased estates involving a distribution by the executor of trust property from a non-resident deceased estate. The trust property must be distributed to the resident beneficiary within 24 months of the date of death and the total value of trust property received by the resident beneficiary, whether in multiple payments or one lump sum payment, must not exceed AUD2 million at the time of payment/application.
2. The provision of trust property by the non-resident trust to a resident beneficiary on commercial terms. There must be a written or verbal agreement (which can be substantiated with appropriate evidence) for the beneficiary to borrow, hire or use property on commercial terms. Importantly, the resident beneficiary must make a physical payment to the trustee equal to the interest, hire or use per the commercial terms. The rate applied for the interest, use or hire (and the broader terms of the agreement) must be consistent with market rates for the same or similar circumstances. A safe harbour is available for loans which apply the Division 7A benchmark rate and terms.

Prevailing issues relevant to section 99B

Residence of the trust

Despite the comments in the EM, the relevant case law and a literal reading of section 99B do not clearly support the position that section 99B is limited to applying to:

1. non-resident trusts that distribute foreign source income to Australian resident beneficiaries; and
2. Australian resident trusts that distribute accumulated foreign source income to Australian or non-Australian resident beneficiaries.

In Traknew Holdings Pty Ltd v FCT (1991) 21 ATR 1478, 1492, Hill J said that the application of section 99B to an Australian resident trust 'presents difficulty' but did not need to decide 'whether the extreme width of section 99B and associated sections require it to be read down having regard to the obvious legislative purpose in enacting it'. The reference to 'extreme width of section 99B' could be interpreted as suggesting that section 99B is capable of having wide application, including Australian resident trusts that distribute accumulated Australian source income to Australian resident beneficiaries.
As a result, this is an ongoing issue for the application of section 99B in relation to which guidance is required.

Unfortunately, the guidance does not confirm whether or not the ATO would seek to apply subsection 99B(1) in the case of Australian-resident trusts. In the compendiums to the TD and PCG, the ATO notes that consideration of this issue is outside of the scope of the TD and PCG.

However, it is noteworthy that the examples provided in both the TD and PCG relate solely to non-resident trusts, or amounts which became assets of a trust when it was a non-resident trust (see Example 7 of the TD). Further the PCG is intended to provide guidance on the ATO's approach to section 99B in respect of arrangements where property of a non-resident trust (or trust property accumulated while the trust was a non-resident, being the ATO's current focus) is paid to or applied for the benefit of a resident beneficiary, which may be interpretated as meaning the PCG does not apply to resident trusts.

The hypothetical taxpayer test and the 'look through' approach

While the TD does not expressly address tracing through multiple layers of trusts, the case of Howard v Federal Commissioner of Taxation [2012] FCAFC 149 (Howard) confirms that paragraph 99B(2)(a) operates on a 'look-through' basis where there are interposed trusts (whether Australian or foreign resident trusts) between the ultimate recipient individual and the source of the payment.

It is curious that the TD does not include any examples regarding this issue, given the other issues which the ATO has commented on, and the fact that the ATO does rely on comments made in Howard in relation to the circumstances giving rise to the amount.

Broadly, in Howard, Mr Howard (an Australian resident) was the beneficiary of an offshore discretionary trust (the Esparto Trust). Mr Howard had certain amounts paid to him, or applied for his benefit, by the Esparto Trust. The amounts consisted of distributions of corpus of the Esparto Trust (a Jersey resident) that were sourced from corpus distributions from the Juris Trust (a Jersey resident) and were received by the Esparto Trust in its capacity as beneficiary of the Juris Trust. The distributions of corpus from the Juris Trust were in turn sourced from the proceeds of a share buyback received by the Juris Trust in connection with a purchase back by Esparto Ltd (a Jersey resident) of the shares held in the company by Juris Trust.

In applying paragraph 99B(2)(a), the Full Federal Court found that Mr Howard's role as a resident taxpayer is 'subsumed by the hypothesis that the Esparto Trust estate is a resident taxpayer', which in turn is 'supplanted by the Juris Trust estate’s role as a hypothetical resident taxpayer'. Accordingly, although there were two layers of trusts between Mr Howard and Esparto Ltd, the question is simply whether the amounts received by Juris Trust from Esparto Ltd would have been assessable income had it been derived by an Australian resident taxpayer. The Full Federal Court said that section 99B(a)(a) then 'conveys that result through the overlying layers of trusts back to Mr Howard'.

Given the application of the 'look-through' approach was considered in respect of the 'corpus exception' only, guidance from the ATO in relation to whether the same approach applies in respect of the 'non-taxable exception' would be welcome. In this regard, it is noteworthy that in the compendium to the PCG, the ATO states that it considers that Howard makes it sufficiently clear that section 99B can apply in a situation where there is a chain of trusts.

Section 99C – where property is applied for the benefit of a beneficiary

Finally, the TD does not provide guidance on when section 99C applies (section 99C provides guidance on when property has been applied for the benefit of a beneficiary). When read literally, sections 99B and 99C could empower the Commissioner to assess different beneficiaries with respect to the same net income of a trust. For example, a trust might make a loan available to one beneficiary. When the loan is repaid, the proceeds could be distributed to a different beneficiary, thus resulting in the same income being taxable in the hands of multiple beneficiaries. Technically, this could be applied infinitely, and is not addressed in the ruling.

While the guidance, in particular the PCG, is valuable, it is clear that taxpayers and advisors should be alive to the risk posed by subsection 99B(1) and distributions need to be managed very carefully.

Please contact us if you would like to know more about how the ATO's guidance.