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Your discretionary trust may unwittingly be subject to extra duty or land tax

By Shaun Backhaus ([email protected]), Lawyer and Daniel Butler ([email protected]), Director DBA Lawyers

Background

Foreign purchaser additional duty (‘FPAD’) was introduced in Victoria from 1 July 2015 which adds an extra 7% land transfer duty on residential property purchases in Victoria if there is a foreign beneficiary of your discretionary or family trust (s 28A Duties Act 2000 (Vic) (‘Act’)).

This article examines how the Victorian FPAD regime applies with respect to discretionary trusts, as many trusts may unexpectedly be regarded as foreign trusts and be liable to pay FPAD when acquiring residential property.

While this article focuses on Victorian legislation a number of other Australian jurisdictions have or are contemplating introducing similar taxes discussed in this article. At the time of writing, both NSW and Queensland had introduced equivalent regimes and WA and SA were in the process of introducing similar regimes.

When are discretionary trusts treated as foreign trusts?

The starting position is that a foreign purchaser will be liable to pay FPAD. A ‘foreign purchaser’ is defined in s 3(1) of the Act to mean a transferee that is:

  • (a) a foreign natural person; or
  • (b) a foreign corporation; or
  • (c) the trustee of a foreign trust.

A ‘foreign trust’ is defined in s 3(1) of the Act to mean a trust in which one of the following persons has a substantial interest in the trust estate:

  • (a) a foreign corporation;
  • (b) a foreign natural person; or
  • (c) trustee of another foreign trust.

A ‘foreign natural person’ is a natural person who is not any of the following:

  • (a) an Australian citizen;
  • (b) permanent visa holder; or
  • (c) a New Zealand citizen holding a special category visa.

Importantly, an Australian citizen living overseas will not be liable for FPAD nor will a trust in respect of a beneficiary who is an Australian citizen living overseas necessarily be subject to FPAD but not all beneficiaries of a trust may be Australian citizens or otherwise excluded.

We will now explore what is meant by ‘substantial interest in the trust estate’.

Substantial interest in the trust

Under most discretionary trust deeds, the trustee has a discretion to distribute income and capital between a range of beneficiaries. Discretionary trust deeds will typically distinguish between different types of beneficiaries such as:

  • beneficiaries that are specifically named in the deed (these beneficiaries are often called primary beneficiaries and may have additional rights or entitlements under the deed); and
  • general beneficiaries.

General beneficiaries are often defined as a class of persons, companies or trustees of trusts by reference to the primary beneficiaries. Specification of beneficiaries by class rather than by their specific identity provides a great deal of flexibility as different persons may fall within the class definition over time if they have the relevant attribute (eg, a relationship to a primary beneficiary) and will therefore be eligible to benefit under the trust. For example, rather than specifically naming their current children as beneficiaries under a trust, parents may simply create a class of beneficiaries being ‘their children’ which will typically encompass both their living and any future children.

Classes of general beneficiaries typically include the primary beneficiary’s direct family (being their spouse and children, grand-children and lineal descendants), various classes of extended relatives and the direct family of the people in these classes as well as eligible corporations and eligible trusts in respect of the other beneficiaries of the trust. While it is generally seen as beneficial to include as many potential beneficiaries as possible this can lead to unintended duty consequences under the FPAD regime.

Broadly, any person or member of a class of persons who a trustee has the power or discretion to distribute the trust’s income or capital to is taken to have a substantial interest in the trust estate. This interest is to the maximum percentage of the capital that the trustee is empowered to distribute to that beneficiary. This means that where a trustee has the discretion to distribute all of the trust’s income or capital to any beneficiary and a beneficiary of the trust is a ‘foreign person’, the trust will be deemed to be a foreign trust for FPAD purposes.

Example — where a discretionary trust is regarded as a foreign trust

Mr Robert Smith and Mrs Mary Smith are the trustees and primary beneficiaries of the Smith Family Trust; a discretionary family trust.

The trust deed grants the trustees a wide discretion to distribute the trust’s income or capital to any of the beneficiaries.

The beneficiaries under the trust deed include:

  • (a) the Primary Beneficiaries (ie, Mr and Mrs Smith);
  • (b) the children, brothers, sisters, parents, uncles, aunts, nieces and nephews of the Primary Beneficiaries;
  • (c) the spouse and children of all of the persons described in subclause (b) above;
  • (d) certain other beneficiaries.

Mr and Mrs Smith have a nephew that recently moved to Spain and entered into a defacto relationship with a Spanish woman named Francesca (who is not an Australian citizen or permanent visa holder and therefore a foreign person as defined in the Act).

In accordance with the trust deed provisions, Francesca is the spouse of the nephew and is therefore a beneficiary whom the trustees can distribute to. Although Mr and Mrs Smith as trustees have never distributed any income or capital of the trust to their nephew or Francesca, the Smith Family Trust is deemed to be foreign trust for the purposes of the Act.

Thus, an extra 7% land transfer duty (on top of the usual 5.5%) is payable on the Victorian residential property recently purchased for $970,000 by the Smith Family Trust. This has amounted to additional duty of $67,900.

Many Australian trusts will inadvertently meet this definition of foreign trust, despite never having distributed to a foreign person and never intending to do so. If the trustee of a foreign trust purchases residential property in Victoria, it will be liable to pay FPAD.

Additional land tax on absentee owners

Trustees considering purchasing property in Victoria should also be aware of the land tax surcharge provisions found in the Land Tax Act 2005 (Vic) (‘LTA’). As a general overview, the trustee of an ‘absentee trust’ will be liable to pay the ‘absentee owner surcharge’ of 1.5% on the total taxable value of Victorian land owned which will be included in their land tax assessment. For a discretionary trust to be an absentee trust, at least one specified beneficiary must be an ‘absentee person’ (see s 3 of the LTA for definitions of these terms). An absentee person must typically be specifically named as a beneficiary of a discretionary trust for it to be deemed an absentee trust.

Discretionary trusts moving forward

Anyone establishing a discretionary trust should carefully consider their clients’ circumstances and whether the trust could, initially or at some point in the future, be deemed a foreign trust. If the trust is not intended to be a foreign trust for the purposes of the Act, consideration should be given as to whether the trust deed should be drafted to restrict the trustee from distributing to a foreign person. A deed drafted in this way may prevent a trustee from inadvertently incurring FPAD should they acquire residential real property in Victoria.

Discretionary trusts may also face land tax surcharges if there are any absentee persons who are covered by the deed.

As discussed above, similar regimes to the above additional duty and land tax imposts apply in a number of other Australian jurisdictions.

For an explanation on our approach to the issue of excluding foreign persons from being beneficiaries please read our article: ‘Managing the extra duty and land tax surcharges on foreigners’ here. As this area is subject to changes, contact us to discuss.

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2000 (Cth).

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

DBA LAWYERS

2 October 2017

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