The ATO’s Stance on Capital Gains, Discretionary Trusts and Foreign Residents

In the decisions of Greensill (Thawley J) and Martin (Steward J), the Federal Court found in favour of the Australian Taxation Office (ATO) that section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997) did not disregard a non-taxable Australian property capital gain distributed to a foreign beneficiary of an Australian discretionary trust.

The taxpayers in Greensill and Martin appealed to the Full Federal Court and the Court handed down its unanimous judgment on 10 June 2021 denying the appeals and finding for the ATO.

These cases concern the interaction of the trust taxation rules in Division 6 and Subdivision 6E of the Income Tax Assessment Act 1936, Subdivision 115-C of the CGT rules in the ITAA 1997, and Division 855 of the ITAA 1997 about capital gains and foreign residents.

The factual scenarios were common to both Greensill and Martin, namely:

• both the Peter Greensill Family Trust and the Martin Family Trust were Australian resident discretionary trusts;

• both trusts sold assets that were not “taxable Australian property” for the purposes of Division 855;

• in each case, the trusts distributed the capital gain from the disposal of the non-taxable Australian property to a foreign resident beneficiary of the trust;

• in each case, the ATO assessed the trustee under section 98 of the ITAA 1936, on the basis that section 855-10 did not apply to disregard the capital gain;

It was contended that the assessments were excessive. The appellants argued they were excessive because section 855-10 required that the capital gains, from the disposal of non-taxable Australian property, which the trusts distributed to the foreign beneficiaries, should be disregarded.

A key question was whether the capital gain distributed to the foreign beneficiaries was “from a CGT event” for the purposes of section 855-10? The trusts made a capital gain from a CGT event, but was the capital gain distributed to the beneficiaries “from a CGT event” after the application of the rules in Subdivision 115-C to the capital gain?

The Full Federal Court held that:

Thawley and Steward JJ were correct to hold that s 855-10(1) has no application to the facts of either case. The provision did not apply to the trustees of the respective trusts because both trusts are resident trusts. Likewise, the provision did not apply to the foreign beneficiaries to disregard any capital gain in the calculation of the amount under s 115-215(3) treated as the beneficiary’s capital gain for the purposes of the application of div 102 to the beneficiary, because “the amount mentioned in s 115-225 in relation to the beneficiary” for the purposes of s 115-215(3) and s 115-220 is not a “capital gain … from a CGT event” within the meaning of s 855-10. We would therefore dismiss both appeals with costs.

The appellants also submitted that their construction of section 855-10 promotes the objects and purposes of Division 855 and that the ATO’s contentions, accepted by the Courts at first instance, triggered the following anomalous and capricious results.

• An Australian resident beneficiary of a foreign trust would not be subject to tax on a capital gain from a CGT event in relation to a CGT asset which is not taxable Australian property, merely based on the residency of that foreign trust.

• A gain made on the happening of a CGT event in relation to an asset which is not taxable Australian property would be disregarded if made by a foreign resident directly, or if made by a foreign resident trustee and distributed to a foreign resident beneficiary, but would not be disregarded if made by the trustee of a resident trust estate yet distributed to a foreign resident beneficiary.

The Full Federal Court dismissed those arguments, saying:

Neither argument is persuasive. First, although anomalous or capricious consequences may be an indication that Parliament did not intend the provision to be read in that way … the identification of possible anomalies or capricious consequences does not mean that the provision should be construed differently. … Secondly, underpinning the appellants’ arguments about the proper construction of [Division 855] is the a priori assumption that Parliament did not intend that foreign residents be taxable on gains from non-taxable Australian property. As the High Court cautioned in Certain Lloyd's Underwriters v Cross (2012) 248 CLR 378 … in construing legislation the purpose of legislation must be derived from what the legislation says, not from any assumption about the desired or desirable reach or operation of the provisions. …

Three courts and five judges have now considered these facts and issues. The result is 3-0 and 5-0 in favour of the ATO. As of the date of writing it is not known if the taxpayers will seek special leave to appeal to the High Court.

The Full Federal Court decision affirms the ATO interpretation of section 855-10 and is important for Australian discretionary trusts that make capital gains and have foreign beneficiaries.

For more information, please contact:

Rob Warnock
Principal Lawyer
T: 03 5226 8541
M: 0419 892 115
E: rwarnock@ha.legal