- Discretionary trusts and foreign surcharges
Following on from the alert last week, it has become increasingly clear how complicated the differing surcharge rules are making the establishment and administration of discretionary and testamentary trusts.
This is in the face of one of the key advantages of a discretionary trust - flexibility. On the other hand, the primary focus of foreign surcharges is to impose an additional tax on non-Australian citizens which effectively limits the extent that discretionary trusts can have link to foreign persons (or otherwise face a surcharge).
This is becoming more and more relevant for proper establishment and administration given that surcharges (if they apply), generally more than double the duty or land tax otherwise payable.
The complexity of it all
The concept of a “foreign person” or “absentee” differs in each Australian state and territory. It also doesn’t help that some have different concepts depending on whether the surcharge is in relation to duty or land tax. Those differences then flow through to different treatment of certain entities such as discretionary and some testamentary trusts.
In the last few months we have seen New South Wales, and now Victoria, and soon to be Tasmania, insist that discretionary trust deeds include exclusionary language such that a trustee is not permitted to make certain distributions to a foreign person. As a consequence, we have seen many instances where trust deeds are being amended or established with surcharges in mind.
However, there is a concern that such changes are being made without appreciating the full impact of what they mean for the administration of the trust, and the interpretive burden it places on trustees.
We have also seen trust deeds attempting to “cover the field” to include exclusionary language with the intention to cover off any potential surcharge implications in each relevant jurisdiction. While that seems logical at first blush, it can create undue complexity for a trustee.
Before looking at what might be the most appropriate approach from an establishment or administrative perspective, the following table highlights some of the major (but not all) differences in determining whether a discretionary or testamentary trust could be subject to surcharge. Note that the table only deals with individual beneficiaries.
It is even more complex when determining the outcome for beneficiaries who are companies or trustees, as tracing through ownership layers is then required.
How surcharges can apply to discretionary trusts (current as at 13 Feb 2020)
|Criteria||QLD | Absentee (land tax)||QLD | Foreign person (land tax and duty)||NSW | (land tax and duty)||VIC | Foreign purchaser (duty)||VIC | Absentee (land tax)||ACT | (land tax)||SA | (duty)||WA | Duty||TAS | (duty)||TAS | (land tax)|
|Type of land||All||All for land tax, residential for duty||Residential||Residential||All||Residential||Residential||Residential||Residential & primary production||Residential & primary production|
|Clawback of duty if intend to change to residential||N/A||No||No||Yes||N/A||N/A||No||No||Yes||N/A|
|Clawback of duty if trust becomes foreign||N/A||Yes||No||No||N/A||N/A||Yes||No||Yes||N/A|
|Person who can make the trust foreign/absentee||Individual||Taker(s) in default with 50% or more interest||Any named or potential beneficiary||Trustee or any named or potential capital benficiary||Any named beneficiary||Any named capital beneficiary||Trustee, appointor, named beneficiary or taker in default||Trustee or taker(s) in default with 50% or more interest||Named or potential capital||TBD|
|Excluded beneficiary clause required to be irrevocable||N/A||N/A||Not until Bill commences  in current form||Not currently required on website||N/A||N/A||N/A||N/A||N/A||TBD|
|Residency requirement not to be foreign||Ordinarily resides in Australia /or||No||200 days||No||Ordinarily resides in Australia /or||No||No||No||No||TBD|
|Need to be in Australia on taxing date||Yes /and||Yes||No||N/A||Yes /and||N/A||N/A||N/A||N/A||TBD|
|Residency requirement||More than 6 months||N/A||N/A||N/A||More than 6 months||N/A||N/A||N/A||N/A||TBD|
The first illuminating aspect from the table is just how different it all is. No one jurisdiction is the same as the other. Further, some jurisdictions have different rules for duty and land tax surcharges. Thereby, attempting to create a trust deed as a “one size fits all” is a feat in itself.
The risks of taking a ‘one size fits all’ approach
While an exclusionary clause is likely to be required in New South Wales, Victoria and Tasmania, it may cast the net too wide for other jurisdictions and unnecessarily fetter the trustee’s discretion. For those jurisdictions, it is likely to be more appropriate to simply monitor the relevant person’s immigration status – see below.
Regarding distributions to an entity which is not a natural person, the trustee is required to determine the foreign person status of the entity by tracing up the ownership chain, which again, differs among the jurisdictions. This is a significant issue and means that it may be necessary to review not just the trust that owns property but also related trusts. If their deeds do not have exclusion clauses, then the property owning trust may still have to deal with surcharges.
Regardless of the path chosen, the trustee actually has to turn their mind to these issues, being either:
- if there is an exclusionary clause – ensure that a distribution is not made to a beneficiary who is, or has become, an excluded beneficiary; or
- if there is no exclusionary clause – monitor the immigration status of the named persons who could change the foreign person status of the trust.
Dealing with foreign beneficiaries
For those beneficiaries who rely on permanent residency or a New Zealand citizen with the appropriate visa or actual residency (only relevant in New South Wales), close monitoring of their status is warranted.
On the other hand, if a wide exclusionary clause is included in a trust deed, and the beneficiary loses their appropriate immigration status (or doesn’t have it in the first place), the person will not be a beneficiary and the trustee will not have a discretion to make a distribution to that person.
For those trusts which do not have exclusionary clauses, the added need to monitor the immigration status of the relevant person would be to manage any “clawback risk”. Each of Queensland, South Australia and Tasmania have provisions which require a surcharge to be later assessed if the person becomes foreign.
For example, if a trust purchased residential land in Queensland while the taker in default is a permanent resident, the trust would not be subject to surcharge on acquisition. It would however be subject to clawback if the taker in default ceases to be a permanent resident within 3 years. A surcharge can also arise even if the trust does not hold the land in question at the time of change in foreign person status or the land has ceased to be residential.
To give another example in the context of a trust having acquired residential land in Queensland, a taker in default who is a New Zealand citizen may not be able to leave Australia for 3 years. Otherwise, they would lose their special category Visa, thereby causing the trust to become foreign and trigger the clawback.
Navigating the myriad complexities of setting up or managing a trust can be difficult. We are well placed to guide taxpayers through the best ways to achieve their (your) goals through the use of trusts and ensure the balance is as desirable as possible.
 Does not apply to trustees, but is included to demonstrate the different residency rules in Qld.
 Yet to commence.
 The Commissioner can also determine a person has a significant interest if they have sufficient capacity to determine or influence the outcome of decisions about the administration and conduct of the trust even if the practice or behaviour involves a breach of trust.
 An “absentee corporation” is separately included in the definition of absentee. Despite that, we understand that the State Revenue Office does not separately test whether a trustee corporation as an absentee.
 Includes a person in a position to influence, either directly or indirectly, the vesting of capital or income of the trust.
 Note that all trusts are taken to be foreign unless the Commissioner is satisfied otherwise, unless and until the Duties Amendment Bill 2019 (Tas) is passed in its current form, in which case taxpayers will have 6 months to change the trust deed (if it is a foreign trust at the time) to limit capital distributions to foreign person(s) to less than 50% of the trust capital.
 State Revenue Legislation Further Amendment Bill 2019 (NSW).
 Residency test does not apply to Australian citizens (all jurisdictions), permanent residents (other than NSW) or NZ citizens with a special category Visa (other than Qld absentee and NSW). Residency also does not prevent a non-permanent resident from being foreign (other than Qld absentee, Vic absentee and NSW).
 Practical requirement for all NZ citizens with a special category Visa (other than NSW).