Additional duty for acquisitions by ‘foreign’ discretionary trusts
Since 1 July 2015, the State Revenue Office (the “SRO”) has imposed additional duty on acquisitions of property by foreign purchasers. This article will touch upon the application of additional duty in the context of purchasers using discretionary trusts.
The Duties Act 2000 (the “Act”) was amended to give effect to the additional duty by including the following definition of a ‘foreign purchaser’:
(a) a foreign natural person; or
(b) a foreign corporation; or
(c) the trustee of a foreign trust.
A ‘foreign trust’ was further defined as a trust in which one of the following persons has a substantial interest in the trust estate:
(a) a foreign corporation; or
- a corporation that is incorporated outside Australia; or
- a corporation in which one of the following persons has a controlling interest –
- a foreign natural person;
- another foreign corporation;
- the trustee of a foreign trust.
(b) a foreign natural person; or
- a natural person who is not any of the following –
- an Australian citizen within the meaning of the Australian Citizenship Act 2007;
- the holder of a permanent visa within the meaning of section 30(1) of the Migration Act 1958;
- a New Zealand citizen who is the holder of a special category visa within the meaning of section 32(1) of the Migration Act 1958.
- a natural person who is not any of the following –
(c) another person that holds the substantial interest as trustee of another foreign trust.
The threshold issue of what constitutes a ‘substantial interest in a trust estate’ is addressed by the insertion of Section 3B in the Act. A person has a substantial interest in the trust estate of a trust if:
(a) the person has a beneficial interest of more than 50% of the capital of the estate of the trust; or
(b) the Commissioner has made a determination under Section 3D (which reposes the Commissioner with the discretion to determine that a substantial interest in a trust estate exists notwithstanding Section 3B is not satisfied but forms the opinion that such substantial interest arises in light of the practical influence the person can exert upon the administration of the trust).
Subsection (b) is clear in its purpose that it is attempting to target puppet or proxy trusts, which on the face of the relevant trust deed, would not be subject to the imposition of additional duty, but in actuality, having regard to matters beyond the deed, should be treated as a foreign trust.
The above provisions, we must say, are relatively uncontroversial in achieving the purpose of identifying what is and what is not, a foreign trust. However, the catch-all nature of Section 3B(2), in light of what has been circulated by the SRO as its new treatment, is now cause for caution. This subsection provides that:
(2) if, under the terms of a trust, a trustee has a power or discretion as to the distribution of the capital of the trust estate to a person or a member of a class of person, any such person is taken to have a beneficial interest in the maximum percentage of the capital of the trust estate that the trustee is empowered to distribute to that person.
What does this mean?
Originally, the SRO interpreted this subsection in line of what it termed a ‘practical approach…so that trusts that have foreign beneficiaries who have not and who are, based on available information, unlikely in the future to receive any distributions, will not be considered a foreign trust’. For most, this was a completely reasonable and accommodating treatment. However, in a paradigm shift, the SRO ‘will no longer apply the practical approach’ and will effectively shift the onus onto the acquiring entity to positively establish that it is not a foreign trust. In order to satisfy this, the trust deed of the relevant trust must contain an express exclusion clause which excises foreign persons from taking benefit as a capital or income beneficiary under the trust – notwithstanding that the benefit that such foreign person has or potentially stands to receive is less than the threshold prescribed by Section 3B(a) of the Act. In our experience, only trust deeds that have been established in the last few years are somewhat consistent in containing such an exclusion clause and even then, given the variations in phrasing adopted by lawyers and accountants, whether the clause is robust enough to satisfy the SRO is a matter that remains to be seen.
Additionally, the new approach is a tense one for purchasers when, on the one hand, the SRO will no longer be adopting a ‘practical approach’ in interpreting Section 3B(2), but on the other, the Commissioner under Section 3D of the Act continues to be reposed with the power to take into account matters which are said to be the ‘practical influence’ that persons may have upon the administration of a trust. As can be seen, the balance is now heavily weighted against prospective purchasers who intend to use a discretionary trust as the beneficial owner of dutiable property.
The duty consequence of a trust which acquires a property which is deemed to be a foreign trust as against a ‘domestic’ trust is stark. By way of example, if a property is purchased for $1 million (and that is the dutiable value for the purposes of Part 2 of the Act), in the case of a domestic trust, it would be liable for duty of $55,000. However, if there is no satisfactory foreign beneficiary exclusion clause in the deed, the trust would be deemed a foreign trust and be exposed to an additional 8% duty, which would total $135,000 in duty payable (a liability of $80,000.00 more than a non-foreign trust).
As can be seen in the above example, a discretionary trust, regardless of whether all of its members and potential members of the various classes of beneficiaries are not considered foreign persons, will nevertheless be treated as a foreign trust, and be charged accordingly, purely on the basis of not having an effective foreign beneficiary exclusion clause.
The new approach of the SRO is to commence from 1 March 2020. If contracts of sale were entered into before that date, it appears that the SRO will continue to apply the ‘practical approach’, thereafter, it will determine duty in accordance with the presence or not of a foreign beneficiary exclusion clause.
The UberEats message
The change of tact by the SRO is definitely a matter not to be ignored by purchasers who intend to use their discretionary family trust as the acquiring entity. It never sits comfortably with practitioners when a regulatory body explicitly states, in its own words, that it is no longer going to apply a ‘practical approach’. This is further pronounced by the significant financial impost which the shift of onus on purchasers could create if not appropriately addressed.
If in doubt, purchasers should have their trust deeds reviewed to see if they would withstand the application of additional foreign purchaser duty. The amendment of a trust deed to include an exclusion clause should, for the most part, not be too cumbersome an exercise; however, each trust deed is unique in its content. There may be restrictions within the deed as to any amendments which effectively reduce the entitlements of a class of beneficiaries. Caution should always be had with amendments which affect the interests of beneficiaries so that such tinkering avoids being captured as a resettlement and as such, would be liable to duty of itself.
This also serves as an opportune time to have trust deeds reviewed generally. This is said in the context of succession planning and ensuring that control and benefit can pass to desired objects. In particular, a problem which we are more frequently encountering in the realm of older family trust deeds, is whether the relevant offices have been effectively succeeded to from the previous generation to the present. Most deeds have rigid manner and form requirements as to how offices are to be filled in light of what may be the retirement, incapacity or death of the relevant holder (mainly the offices of trustee, guardian, supervisor or appointor). Scarily, it can often be the case that the slightest defect in that appointment can taint not only the previous decisions made which are referential to that officeholder, but also the future management of the trust – which if impugned, can quickly erode the utility of the structure and expose significant financial consequences. As is the case in many deeds, the written consent of the guardian/supervisor/appointor consent is a precondition to the exercise of certain powers (often the reserved or restricted powers), and if there is a latent deficiency in that appointment, then the power may not be able to be relied upon (unless there is a protocol within the deed as to how such can be remedied). In such a scenario, it may be that due to a defective appointment of a particular office, that the ability for the deed to be amended to exclude foreign beneficiaries is out of reach.
Likewise, when passing control to the next generation, we find with older deeds that there are scant mechanisms in place which contemplate how the various offices are to be administered when multiple individuals assume the one role (e.g. multiple appointors – which often unintentionally arises if the power of appointment is not exercised by the deceased during their lifetime and as a result, the default provisions of the deed provides that the office is to be assumed by the deceased’s LPR). Most critically, these deeds are completely silent on providing a process for dispute resolution when internal disagreements arise. In the absence of an effective dispute resolution clause which may overcome the deadlock, and as may also be the case in the event of a defective appointment of an office discussed above, then the only option may be an application to the Court for directions, the outcome of which is always bedevilled with uncertainty – a course which ideally can be avoided through appropriate planning.