Charities around Australia are highly reliant on donations and bequeaths to keep their programs running – with a significant proportion of their funding coming from trusts.
However, the question of whether a trustee of a discretionary or testamentary trust can make a distribution to a particular charity can actually be quite difficult for the trustee to resolve if the trust deed includes exclusionary clauses to prevent it from becoming subject to foreign surcharges. This is becoming more and more relevant for proper establishment and administration given that foreign surcharges (if they apply), generally more than double the duty or land tax otherwise payable. For those jurisdictions which look to potential beneficiaries (New South Wales, Victoria and Tasmania), for which the trust deed has an exclusionary clause, it could be difficult, if not impossible, for a trustee to determine whether a charity is a “foreign person”, particularly if the charity is in the form a trust.
How can this be? Well, particularly for New South Wales, the legislation heavily borrows concepts from the Foreign Acquisitions and Takeovers Act 1975 (Cth) (“FATA”), including the definition of “foreign person” with some stated modifications set out in section 104J(2) of the Duties Act 1997 (NSW) (“NSW Duties Act”).
The definition of “foreign person” in the FATA does not exclude foreign charities.
Rather, the FATA excludes its operation through another mechanism, being regulation 35(1)(d) of the Foreign Acquisitions and Takeovers Regulation 2015 (Cth) (“FATA Regulations”), which applies to a charity “operating in Australia for the benefit of persons ordinarily resident in Australia”. That is, it goes to the purpose of the charity which is usually publically available information, and not the ownership structure of the charity, or the extent to which the charity (for example, through its own wide class of beneficiaries) can have a “foreign person” as a potential beneficiary, which then causes the charity to be a “foreign person” for the purposes of the NSW Duties Act and Land Tax Act 1956 (NSW). In such a case, unbeknownst to the trustee, the charity is an excluded beneficiary due to the exclusionary clause required of the New South Wales legislation.
The perverse outcome of all this is that a trustee could unwittingly cause a breach of trust because the exclusionary clause (which is required by the New South Wales legislation – and soon to be required to be irrevocable) prevents the trustee from making the distribution in the first place because the charity is nonetheless a “foreign person” under the NSW legislation.
Example 3 in Commissioner’s Practice Note CPN 004 (“Practice Note”) provides comfort that inclusion of such a beneficiary does not cause the trust to become a “foreign person” for the purposes of administering the NSW surcharges. However, the Practice Note does not cure the breach of trust. Rather, unless the exclusionary clause extends to Commissioner’s practice (and not just the law), this is a very real potential outcome. While the solution might be to do just that (ie extend the meaning of “foreign person” to include administrative practice), it is always a nervous adviser who builds in such administrative practices into a document (being practices and interpretation which can be changed without the will of Parliament) as important as a trust deed.
Indeed, if such administrative practice merely lives on the revenue office website (for example, the “practical approach” adopted by the Victorian State Revenue Office (“SRO”) until now), it can disappear or change at any time, as it did on 5 February 2020 when the SRO announced the end of the “practical approach”. Proving what was on a website historically is an added difficulty for a trustee or taxpayer.
Speaking of Victoria, the same outcome for charities may also become problematic in Victoria and Tasmania (if not already), who also extend the foreign person test to potential beneficiaries, but without equivalent published guidance similar to the Practice Note. That is, amending and establishing trusts to prevent Victorian and Tasmanian surcharges from applying could unwittingly be putting the trustee at risk.
The “fix” seems simple enough, being to amend the state tax legislation to specifically exclude an entity under regulation 35(1)(d) of the FATA Regulations from the definition of foreign person (or equivalent), which would clearly be consistent with New South Wales Government policy as set out in the Practice Note.
To put this in another context, a charity who is a “foreign person” would not itself be subject to surcharges if it is exempt. However, the ability for a trustee to make a distribution to that same charity would cause that trust to become foreign, and for the trust to be burdened by surcharges. Perhaps a fairer test would be to allow distributions to a charity (regardless of foreign person status) if it is tax exempt, which is also publically available information. It would also be much easier for a trustee to administer the trust with certainty.
Until then, unfortunately, these are things a prudent trustee should properly consider if it is administering a trust which has a relevant surcharge exclusionary clause.
Dealing with property owned in discretionary trusts and foreign surcharges?
Following from the Victorian State Revenue Office (SRO) announcement that it is removing its “practical approach” for not assessing discretionary trusts as foreign persons effective 1 March 2020, it has become clear how complicated the differing surcharge rules are making the establishment and administration of discretionary and testamentary trusts.