Non-Residents, CGT and Australian Family Trusts – where does the dust lie pending the outcome of the Full Federal Court appeal in Greensill?

Andrew Henshaw, Director, Velocity Legal

The Full Federal Court’s judgment for the appeal of Peter Greensill Family Co Pty Ltd (trustee) v Commissioner of Taxation (No 2) [2020] FCA (Greensill) is eagerly anticipated within the international tax community.

The purpose of this article is to recap on where the dust lies, and assuming the Greensill decision is upheld, what non-resident controllers of Australian family trusts could do to improve their tax position.

The Decision in Greensill

In Greensill, an Australian family trust (Family Trust) made a capital gain in each of the years of income ended 30 June 2015, 30 June 2016 and 30 June 2017, arising because the Family Trust disposed of certain shares it held.

The shares were not ‘taxable Australian property’ and the trustee of the Family Trust resolved to make Mr.Greensill, a foreign beneficiary, ‘presently entitled’ to the income of the trust.

Consistent with ATO ID 2007/60, Draft Taxation Determination TD 2019/D6 and Draft Taxation Determination TD 2019/D7, the ATO’s position was that:

1. the Family Trust made a capital gain;
2. through the trust capital gain provisions (Subdivision 115-C of the ITAA97), the capital gain was attributed to Mr. Greensill;
3. Mr. Greensill cannot apply Division 855 of the ITAA97 (which permits non-residents to disregard capital gains arising from non-taxable Australian property) to this attributed capital gain. This is because Mr. Greensill’s attributed capital gain was not ‘from a CGT event’ (rather – it was ‘from’ the construct of Subdivision 115-C).

In contrast, the taxpayer argued that Division 855 should apply to disregard the attributed capital gain. That is despite that the legislation provides for a specific exemption for capital gains arising from ‘fixed trusts’ (section 855-40), and does not provide for any specific exemption for capital gains arising from non-fixed trusts.

Appeal to the Full Federal Court

The decision in Greensill and a similar case, N & M Martin Holdings Pty Ltd v Commissioner of Taxation [2020] FCA 1186, have been appealed and are concurrently being heard in the Full Federal Court. This appeal was listed for hearing on 22 to 24 February 2021 (inclusive) via Microsoft Teams, and the Full Federal Court’s decision is eagerly anticipated within the international tax community.

Much has already been written regarding the correctness of the decision in Greensill and ‘so-called’ policy objective of not taxing foreign beneficiaries of resident trusts in respect of CGT events in relation to non-taxable Australian property. It is suffice to say that I consider that decision in Greensill correct – however the Full Federal Court (and potentially the High Court) will have the final say on the matter.

Assuming the Federal Court decision in Greensill is correct, the result is that Australian family trusts are a poor structuring vehicle for non-resident controllers/beneficiaries to hold non-real property assets (e.g. shares). In particular, the outcome essentially means that the trustee of an Australian discretionary trust will pay tax at 45% (owing from the fact that the trustee is subject to withholding obligations under section 98, and that the general 50% CGT discount cannot apply to a beneficiary who is a non-resident).

What, if anything, can be done to improve this situation from an Australian tax perspective for existing structures and investments, particularly those already sitting on large unrealised capital gains? The article considers some of the possible options.

#1 – Become an Australian Resident

While difficult given travel restrictions in a COVID-19 environment, the ‘intended beneficiary’ could become an Australian resident for tax purposes some time prior to a CGT event. This would at least entitle a claim to a portion of the general 50% CGT discount (for any periods that the ultimate beneficiary has been an Australian resident and for periods prior to 8 May 2012).

#2 – Distribute to an Australian Individual

Most discretionary trust deeds permit the trustee to distribute the income or capital of the trust to a wide range of persons related to any ‘specified beneficiary’. Further, many trust deeds allow new beneficiaries to be added.

Subject to any family trust elections, the family trust could make an individual who is currently an Australian resident presently entitled to the income of the trust (for example, the parents or children of the non-resident). This income amount may or may not include any capital gain – depending on how the trustee determines income. This would potentially allow the entire benefit of the general 50% CGT discount to be claimed.

This type of arrangement would need to be carefully considered. There is a risk of anti-avoidance rules applying (e.g. section 100A or Part IVA) if the relevant parties do not intend for the Australian resident to actually benefit from the arrangement.

#3 – Distribute to an Australian Company

Another alternative would be to make an Australian company presently entitled to the income of the trust (again, which may or may not include the capital gain). While Australian companies cannot claim the general 50% CGT discount, the corporate tax rate will apply.

The Australian company would pay tax at either 26% (if it is a base rate entity, noting that capital gains are considered passive income) or 30% on the taxable income. To the extent that dividends are declared to a non-resident, no further tax would apply in Australia (on the basis that those dividends are fully franked). In other words, tax could be capped at the corporate tax rate.

#4 – Become a Fixed Trust?

Division 855 provides a specific exemption for non-residents who derive a capital gain from an Australian ‘fixed trust’ (section 855-40). A ‘fixed trust’ is a trust where entities have fixed entitlements to all of the income and capital of the trust. Clearly, this is inconsistent with the very notion of a ‘family trust’ (i.e. where beneficiaries usually do not have fixed entitlements, and the trustee may determine who the income and capital of the trust is paid to).

However, the Trust Deeds to most ‘family trusts’ contain variation powers. Some variation powers are narrowly constructed, and some are extremely wide (for example, the ability to vary all of the provisions of the Trust Deed). Further, the cases of Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [2001] HCA 33 and Commissioner of Taxation v. David Clark [2011] FCAFC 5 support the view that even widespread changes to a trust deed will not result in CGT event E1 or CGT event E2 occurring (colloquially called a ‘resettlement’). This is also (perhaps begrudgingly) supported by the ATO in Taxation Determination 2012/21.

Keeping in mind that terms ‘discretionary trust’, ‘family trust’, ‘unit trust’ and ‘fixed trust’ are merely labels to describe the attributes of a particular trustee-beneficiary relationship, one alternative strategy may be to vary the provisions of a ‘family trust’ to qualify the trust as a ‘fixed trust’.

Some tentative support for this alternative can be found in Private Binding Rulings (e.g. Private Binding Ruling 1051328095804, where a discretionary trust was varied to satisfy the criteria of a fixed trust, under section 3A(3B) of the Land Tax Management Act (NSW) 1956). If possible, this could remedy the decision in Greensill entirely, allowing for a CGT-free capital gain for non-resident beneficiaries. Of course, there are many tax and trust law issues hurdles to overcome, including the whether the variation is permitted, the resettlement issue, whether any other CGT ‘E’ events could occur (e.g. CGT event E5) and whether the general anti-avoidance provision (Part IVA) could apply.

Summary

The international tax community eagerly awaits the Full Federal Court decision. If Greensill is correct, the result is that Australian family trusts will often be a poor structuring vehicle for non-resident controllers/beneficiaries to hold non-real property assets. But, there are still some strategies to consider which may improve on a 45% tax rate for the trustee.

In contrast, if Greensill is overturned, the ‘floodgates’ may open, whereby any capital gain on non-taxable property that is streamed from an Australian family trust to a non-resident beneficiary would be disregarded. This interpretation creates further difficulties, particularly regarding deemed capital gains arising under the market value substitution rule (based on the ATO’s views in Draft Taxation Ruling TR 2012/D1, these cannot be included in the ‘income of the trust estate’).