An important feature of a discretionary trust is its flexibility to distribute income and capital to a range (or class) of beneficiaries for estate planning, asset protection and to optimise the tax treatment of income or capital.
In many cases however the trustee or class of beneficiaries could cause the trust to be deemed a ‘foreign person’ attracting premium rates of stamp duty and land tax.
Surcharges for foreign persons owning or acquiring residential land in New South Wales have applied since June 2016. These rates were recently increased with surcharges for stamp duty doubling from 4% to 8% and land tax increasing from 0.75% to 2%.
The surcharges apply to individual and corporate foreign investors as well as trust vehicles where the trustee is deemed a ‘foreign person’.
How can a trust be deemed a foreign person?
A ‘foreign person’ is:
· a natural person who is not an Australian citizen, or a permanent resident who has not lived in Australia for 200 or more days during the preceding year; or
· a natural person who is a New Zealand citizen on a special category visa who has not lived in Australia for 200 or more days during the preceding year; or
· a foreign corporation or foreign government investor; or
· the trustee of a trust, who is a natural person (as defined in the above categories), a foreign corporation or foreign government investor and who / which holds a ‘substantial interest’ in the trust.
A ‘substantial interest’ arises if a person (either individually or together with any one or more person or associate) holds a beneficial interest in at least 20% of the income or capital of the trust.
If a trust deed allows the trustee absolute discretion to distribute income to a class of beneficiaries that includes a foreign person, that beneficiary will be deemed to have a maximum entitlement, and the trustee will be considered a foreign person. This situation is very conceivable, given that many trusts include a wide class of beneficiaries. A foreign relative of the principal beneficiary (even though there may be no intention to benefit such a person) could quite easily be captured within the class, and the trust will consequently be subject to the applicable surcharges.
Amending a trust deed to avoid higher rates
Amending the trust deed to exclude a foreign person from benefiting under the trust has been the typical approach to avoid these higher rates of duty and tax. Indeed, when the surcharges were introduced the Chief Commissioner of State Revenue was given discretion to give retrospective effect to amendments to discretionary trusts that hold real estate to preclude foreign investors as beneficiaries or to alter their potential interests in the trust.
However great care must be exercised when amending a trust deed. There are potential adverse tax consequences which need to be considered. It is therefore important that professional advice be obtained when considering amending trust deeds to exclude foreign persons.