Warning: beware of the income tax implications of amending trust deeds to exclude foreign persons
It is now well known that where a discretionary trust is to acquire or own residential land in New South Wales it may be necessary to amend the trust deed for the trust to prevent foreign person duty and land tax surcharges being imposed on the trustee. This is because where a foreign person can benefit under a trust, even as a mere discretionary beneficiary, the trust can be treated as a foreign person for the purpose of duty and land tax surcharge.
The simple solution is to amend the trust deed for the trust to exclude foreign persons from benefiting under the trust. However, the effect of such an amendment will be to prevent the discretionary trust with an amended deed from distributing to another trust whose deed has not been amended (because the second trust may be a foreign person)
This can have significant income tax implications and it is necessary to consider whether similar amendments should be made to trust deeds for other trusts that, whilst they do not own residential land themselves, may receive distributions from trusts that do own or are to acquire residential land.
Foreign person surcharges and discretionary trusts
Where a trustee of a trust is deemed to be a foreign person, the trustee will be liable to pay an extra 8% duty upon acquiring residential land and a land tax surcharge of 2% for residential land held at 31 December of each year.
The trustee of a trust will be deemed to be a 'foreign person' where:
- any of the following persons:
- an individual who is not:
- a citizen of Australia,
- permanent resident Australia who has been in Australia during 200 or more days of the preceding 12-month period;
- a citizen of New Zealand who has a special category of visa under section 32 of the Migration Act 1948 (Cth) and who has been in Australia during 200 or more days of the preceding 12-month period; or
- a foreign corporation or a foreign government investor,
- an individual who is not:
holds a 'substantial interest' in the trust, being an entitlement to 20% of the income or capital of the trust, inclusive of any interest held by their associates;
- Another entity that is deemed to be a foreign person, being an entity in which a foreign person referred to in paragraph 1(a) or (b) has a substantial interest, has a 'substantial interest' in the trust; or
- for the purposes of land tax, the trustee itself is a foreign person, either because the trustee is
- an individual who is a foreign person;
- a foreign corporation; or
- a corporation in which foreign persons have a 'substantial interest.'
In this E-Alert, we only consider foreign persons under paragraph 1 and 2 above. The following discussion in this E-Alert assumes that the trustee of a trust is not a foreign person under paragraph 3 above.
It is important to note that where the trustee of a trust has discretion to appoint income of the trust, a person is deemed to have the maximum percentage interest in the income or property that a trustee can distribute to them and their associates. For example, if under the terms of a trust, the trustee could potentially distribute all of the income or capital of the trust to a foreign person (irrespective of whether they actually or intend to do so), the foreign person will be deemed to have 100% interest in the income of the trust and the trustee of the trust will be treated as a foreign person.
The solution to this problem, where it is not intended that any foreign persons are to benefit from the trust, is to amend trust deeds for trusts that own or are to acquire residential land to exclude foreign persons from benefiting under the trust. If done properly such an amendment works to ensure there is no liability for the duty and land tax surcharges.
Distributions from land holding trusts to other trusts
However, an issue that many may not have turned their mind to is that where a trust deed for a trust that holds residential land in New South Wales (the amended trust) has been amended, the trustee of the amended trust may no longer be able to distribute income and capital of the amended trust to any discretionary trust for which such an amendment has not been made (the non-amended trust). This is because the non-amended trust may still be a foreign person, being a trust under which foreign persons can potentially benefit, and under the terms of the trust deed for the amended trust it cannot distribute to foreign persons.
That is, even if the non-amended trust appears to fall within the class of beneficiaries of the amended trust, the exclusion of foreign persons benefiting under the amended trust, may mean that the non-amended trust is no longer a beneficiary of the amended trust.
The income tax implications of this are significant. It means that any distribution of income from the amended trust to the non-amended trust will be invalid and such income may be assessed to either:
- if there is a default beneficiary under the trust deed for the non-amended trust, to the default beneficiary being the person presently entitled to the income; or
- otherwise, to the trustee of the amended trust at the top marginal rate as there is no beneficiary of the amended trust presently entitled to that income.
There are often important reasons, particularly within family groups, why a trustee may wish to distribute income to another trust, such as to take advantages of tax losses in the recipient trust, where permitted under the trust loss rules.
The solution to this problem is to amend the trust deeds to exclude foreign persons as beneficiaries for any trusts that, whilst they do not own residential land in New South Wales, may receive distributions of income or capital from a trust that is to acquire or does own residential land. If such an amendment is made to the trust deed for a trust, the trustee of that trust will cease being a foreign person so that they may be able to receive distributions of income or capital from trusts, the terms for which do not permit distributions to foreign persons, assuming they otherwise fall within the class of beneficiaries of the trust.
Other Australian states have similar, but not identical, statutory regimes that impose land tax or duty surcharges on foreign persons and, as such, similar considerations may arise from trusts that own or are to acquire land in other Australian states.
If you would like us to assist you with amending the trust deed of trust or have further questions concerning the issues raised in this E-Alert, please do not hesitate to contact us.
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