Imagine this scenario: George, who lives in Melbourne and is aged 23, gets a call from his grandmother in Athens. Grandma says she is going to give him $100,000 for Christmas. George is ecstatic. With profuse thankfulness, George gives Grandma the bank details.
A couple of weeks later, the money appears in his bank account. George is into cars, and he purchases a new BMW. Could life be better?
A few months later, an official-looking envelope arrives at George’s home. Inside is a politely worded, but official letter from the Australian Taxation Office. The letter states that the ATO has noticed a receipt of $100,000 into George’s bank account. George is requested to explain where the money came from and whether it should be included in his tax return as assessable income.
George consults the source of all wisdom in his life – his mates. “Nah”, they say. “It’s a gift. You don’t pay tax on gifts.” Accordingly, George writes back to the ATO and says the $100,000 is a gift (without mentioning his authoritative sources) and there is no tax.
The ATO is persistent. It writes back and says (to the effect) “George, that’s not good enough. We want to really know where the money came from.”
Soon after receiving the money, George had received a letter from Grandma. There was lots of love and kisses. But also enclosed was a letter from a firm of Greek solicitors explaining that a trust which had been set up some years ago had vested and he was entitled to $100,000. George thinks, “If I give the ATO a copy of the letter, that will satisfy them”. So, he writes back to the ATO and encloses a copy of the letter from the solicitors and thinks no more of it.
Later, he lodges his income tax return for the year in which he received the $100,000. He doesn’t include it in the return as assessable income as, per his authoritative sources, there is no tax to pay. George is expecting a refund with which he is going to purchase gleaming new wheels for the Beamer.
A few weeks pass. George receives another official-looking envelope. Enclosed is his tax assessment for the year and he has around $30,000 of tax to pay and there is a penalty of 25 per cent! Shock! “Oh dear”, says George (with some editing). There are no new wheels for George and a lot of the “shine” comes off the Beamer because he now has to find the money to pay his tax bill. Will he have to sell his beloved car?
Beware section 99B!
What happened? George has been assessed under section 99B Income Tax Assessment Act 1936. This story, although fictitious, is a real approximation of the potentially dramatic, and unexpected effect of section 99B.
Section 99B has existed in the income tax law of Australia for many years. However, it is an obscure provision and many tax agents and accountants in public practice are not aware of its existence nor aware of the shock to clients that can arise when the provision is applied.
What section 99B does
At first instance, s.99B taxes anything that is paid out of a trust to a beneficiary of the trust who is a tax resident. However, there are some very important exclusions to the section’s operation. This is where the difficulty in applying this provision lies.
Excluded from being taxed (among other things) are:
- Amounts paid from the corpus (capital) of the trust;
- Amounts already assessed to a beneficiary or trustee; and
- Amounts that, if they had been derived by a tax resident taxpayer, would not have been assessable income.
Proving the components
You can see that to avoid an assessment under s.99B, you need to be able to prove to the ATO what makes up the payment you received from a trust. How will you do this, particularly if the trust existed overseas? In the case of Campbell v Commissioner this was a key problem the taxpayer faced. This taxpayer lost the case because she could not prove to the Administrative Appeals Tribunal that what she had received was corpus of the trust.
Added to the “proof” point just mentioned, there are issues with how s.99B is to be interpreted. For example, one of the exclusions mentioned above requires you to determine whether a hypothetical resident taxpayer would, or would not, have been assessable on some part of the amount received by the trust.
The ATO states in Taxation Determination TD 2017/24 that s.99B posits a “hypothetical taxpayer” who is a resident. There are no other characteristics of that taxpayer specified. So, in the ATO view, it cannot be assumed that this hypothetical taxpayer has other characteristics; for example, that it is an entity eligible for the CGT discount.
Here is an example from TD 2017/24:
The trustee of a foreign trust for CGT purposes sells shares in an Australian public company that it had owned for five years. The shares are not taxable Australian property. The trustee makes $50,000 capital gains from the share sale, but these are not relevant in calculating the trust's net income, because they are not from taxable Australian property.
The trustee distributes an amount attributable to the capital gains to Erin, a resident of Australia. Erin has a $40,000 net capital loss that she has carried forward. According to the ATO, Erin must include the entire $50,000 in her assessable income under section 99B. She cannot reduce the amount by her net capital loss or by the CGT discount.
Australia’s migrant population
Although s.99B can apply to any trust, its operation will most often be experienced when money is paid from an offshore trust to an Australian tax resident.
Australia has a significant migrant population. This means that extended families, with accumulated wealth, could be overseas. Trusts located in offshore jurisdictions are outside the Australian tax net, provided the trust does not have Australian sourced income. When those trusts pay money to an Australian tax resident, the obscurity and complexity of s.99B must be faced.
The example of George, set out above, is not a rare occurrence. Accountants, tax agents and lawyers need to be aware of what can be the dramatic and unexpected operation of s.99B.
John Jeffreys CA CTA is an experienced tax professional that specialises in providing tax consulting advice and tax training to accountants and tax agents in public practice.
John Jefferies / Emma Ryan
20 December 2021