Contributed by Rajan Verma and Andrew Henshaw, Directors, Velocity Legal
Subjecting discretionary trusts that have little real connection to “foreign beneficiaries” to foreign purchaser duties appears to be the “hot new trend”.
On 23 October 2019, the NSW government introduced legislation which would deem all discretionary trusts to be “foreign trusts” (for the purposes of duty and land tax), unless the terms of the trust explicitly prevented a foreign person from being, or ever becoming, a beneficiary of the trust. The legislation is not yet law; however, the changes are widely anticipated to become law shortly.
Not to be outdone, the Victorian State Revenue Office (SRO) has recently announced that their “practical approach” to applying the foreign purchaser additional duty (FPAD) to discretionary trusts will cease from 1 March 2020. The effect of this change will be to widen the application of FPAD to discretionary trusts.
The FPAD was first legislated by the State Taxation Acts Amendment Act 2015 (Vic) with effect from 1 July 2015. The applicable rate of FPAD has rapidly increased since then, as illustrated in the table below.
|Applicable period||FPAD rate|
|1 July 2015 to 30 June 2016||3.00%|
|1 July 2016 to 30 June 2019||7.00%|
|1 July 2019 and onwards||8.00%|
When does FPAD apply?
All purchases of residential property in Victoria by “foreign purchasers” are subject to the FPAD.
Are trusts affected?
“Foreign purchaser” includes “the trustee of a foreign trust”. A “foreign trust” is defined in s 3(1) of the Duties Act 2000 (Vic) (the Act) to mean any trust in which a “foreign corporation”, “foreign natural person” or “trustee of another foreign trust” has a substantial interest.
But what if the trust is a discretionary trust?
Section 3B(1) of the Act explains that to have a “substantial interest” in a trust, a beneficiary must have a greater than 50% interest in the capital of the trust. While one would expect that a mere general beneficiary of a trust can never be said to have a “substantial interest” in that trust, s 3B(2) states that if the trustee of the trust has a discretion as to the distribution of capital of the trust to any person, that person is taken to have an interest equal to the maximum percentage which the trustee is empowered to distribute to that person.
In the authors’ experience, most (if not all) discretionary trust deeds established prior to 2015 give the trustee the complete discretion to distribute some or all of the capital of the trust to any beneficiary it chooses. Practically this means that any trust which has even one potential foreign beneficiary will meet the technical definition of a “foreign trust”. This is because the trustee can potentially distribute all the capital of the trust to that foreign beneficiary.
Does that mean that most discretionary trusts are “foreign trusts” under these rules?
Yes. According to the 2016 census results published by the Australian Bureau of Statistics:
“In 2016 nearly half (49%) of all Australians were either born overseas or had at least one parent who was born overseas.”
Given that most discretionary trust deeds define their general class of beneficiaries to include parents, grandparents, aunts, uncles, cousins, etc, it is likely that most, if not all discretionary trust deeds in Victoria will include at least one person in its beneficiary class who is not an Australian resident. That will be the case even if the primary beneficiaries are Australian residents.
But what if the trust never distributes or intends to distribute to foreign people?
The SRO’s “practical approach” in these cases was to not apply the FPAD. Provided the trustee could demonstrate that it had never distributed to foreign beneficiaries previously and had no intention to do so in the future, FPAD would not apply even though the trust is technically a “foreign trust”.
End of practical approach
Recently the SRO announced via its website that it will cease to apply the “practical approach” from 1 March 2020. Specifically, it has said:
“…the State Revenue Office will no longer apply the practical approach. Instead, the special rules for discretionary trusts will be applied to all discretionary trusts (including family discretionary trusts), so that if the discretionary trust has any potential foreign beneficiary, the trust will generally be a foreign trust for the purpose of the provisions.”
In the interim, the SRO will continue to apply the “practical approach” to transactions where the contract of sale is entered into before 1 March 2020.
What should I do?
Since many discretionary trusts will meet the technical definition of a “foreign trust” in Victoria, any trustee which intends to purchase residential property should have its trust deed checked and (if required) varied to ensure that it is not a “foreign trust”.
A failure to do this could result in the trustee becoming liable to FPAD on the purchase of property, and potential liability for advisors and conveyancers who fail to alert the purchaser to this risk.
[This article was published in CCH Tax Week on 14 February 2020. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]