This article is relevant to you if:
- You have a Discretionary Trust which currently holds residential property in NSW, or which may own land in the future; or
- You either currently have a Testamentary Trust Will or are contemplating having a Testamentary Trust Will in the future.
Action should be taken now to ensure your Trust Deed or Testamentary Trust Will is amended to avoid significant surcharges to land tax and duty being applied to residential land held in NSW by Trustees.
What are Discretionary Trusts and Testamentary Trust Wills?
A Trust is an arrangement that lets a person or company hold property or assets for the benefit of others. The person holding the asset or property is known as the ‘Trustee’. The people, or even companies, who would benefit from the Trust are known as the ‘beneficiaries’.
A Discretionary Trust is the most common form of Trust used by families. Here, the beneficiaries have no defined entitlement to the income or the assets of the Trust. Instead, each year the Trustee decides which beneficiaries are entitled to receive income and how much this amounts to. For this reason, Discretionary Trusts have become popular in family tax planning, as they allow income to be allocated to all members of a family, including children under the age of 18 years.
In common usage today a Testamentary Trust is a Discretionary Trust which is created under your Will, but only comes into effect once you have passed away.
What are the changes to legislation?
The State Revenue Legislation Further Amendment Act 2020 (NSW) (the “Amendments”) came into effect on 24 June 2020 and contains significant tax implications for Discretionary Trusts that own or are intending to acquire residential land in NSW.
The Amendments now mean that the Trustee of a Discretionary Trust will automatically be deemed to be a ‘foreign person’, and thus liable for a foreign land tax and foreign duty surcharge unless the Trust Deed specifically states that:-
- no foreign person can be a “potential beneficiary”; and
- the terms of the Trust cannot be amended to allow a foreign person to become a potential beneficiary in the future.
Foreign persons have a specific meaning under the legislation but are generally taken to be non-Australian citizens.
Most Discretionary Trusts include a broad range of classes of discretionary or potential beneficiaries for tax planning, and that class may include a foreign person. However up until now, most Discretionary Trusts were able to avoid incurring these surcharges because it was presumed that all eligible beneficiaries of the Trust were Australian citizens unless declared to be foreign persons.
Importantly, the changes now reverse this presumption so that all trustees of Discretionary Trusts will now be deemed to be a foreign Trustee in NSW unless the Trust Deed is amended accordingly.
The Amendments also apply to Testamentary Trusts.
What are the consequences of being deemed a foreign person?
If a Discretionary Trust is deemed to be a “foreign person”, it will be subject to pay in respect of residential land held in NSW:
- a surcharge duty of 8% in addition to the usual duty payable on the purchase; and
- a surcharge land tax of 2% in addition to the usual land tax payable on the ownership of the property.
We have set out below two examples where a Discretionary Trust acquires residential land in NSW:
Example 1: Duty and Land Tax – Discretionary Trust (non- foreign)
A Discretionary Trust proposes to buy a $900,000.00 apartment in the city. The Trust Deed expressly excludes foreign persons as eligible beneficiaries of the Trust and is therefore not a foreign Trustee for the purposes of foreign duty and foreign land tax surcharges.
The duty payable on $900,000.00: $35,835.00
Foreign Duty surcharge: Nil
Total duty payable is: $35,835.00
The annual land tax payable is: $2,756.00
Foreign land tax surcharge: Nil
Total annual land tax payable is: $2,756.00
Example 2: Duty and Land Tax – Discretionary Trust (foreign)
A Discretionary Trust proposes to buy a $900,000.00 apartment in the city. The Trust Deed does not expressly exclude foreign persons as eligible beneficiaries of the Trust and the Trustee will therefore be deemed to be a foreign person for the purposes of foreign duty and foreign land tax surcharges.
The duty payable is: $35,835.00
Foreign duty surcharge is 8% of $900,000.00: $72,000.00
Total duty payable is: $107,835.00
The annual land tax payable is: $2,756.00
Foreign land tax surcharge is 4% of $900,000.00: $18,000.00
Total annual land tax payable is: $20,756.00
That’s a difference of more than $90,000 in the first year after the acquisition of the property.
Furthermore, the changes are retrospective which means that surcharge(s) apply to dutiable transactions over residential land from 21 June 2016 in the case of foreign duty surcharge, and from 2017 onwards for land tax surcharges.
What do I need to do to avoid these surcharges?
If you have Discretionary Trust which either currently owns, has previously owned (since 21 June 2016) or is intending to own residential land in NSW in the future, you can avoid the surcharges or apply for a refund of any surcharge already paid if you review and amend your Trust Deed before 31 December 2020 and, in accordance with the legislation, irrevocably and permanently exclude foreign persons as eligible beneficiaries of the Trust.
If you have a Testamentary Discretionary Trust Will, the surcharges will not apply if the Will or amendment was signed before 31 December 2020. However, for any new Testamentary Discretionary Trust Wills executed after 31 December 2020, unless the Will specifically excludes foreign persons as eligible beneficiaries, it will be subject to the surcharges.
The decision to exclude foreign persons as potential beneficiaries of a Discretionary Trust or Testamentary Discretionary Trust should not be taken lightly.
Once established, a Trust can last for up to 80 years in most Australian jurisdictions. Any variation to a Trust Deed carries with it a risk of resettlement of the Trust which can result in substantial duty and capital gains tax being imposed and other unforeseen consequences.
Because of this, it is important that any Trust Deed or variation is correctly and appropriately drafted from the outset to limit the chance of a variation being required in the future.
In addition, the exclusion of foreign persons from being eligible beneficiaries of a Discretionary Trust or Testamentary Trust should not be undertaken without proper consideration of all the consequences. Clients should ensure that they are aware of who is likely to be excluded from being a beneficiary by excluding foreign persons as this may have unintended consequences.
To get advice as to whether you need to review and amend your Discretionary Trust Deed or Testamentary Discretionary Trust Will in your circumstances, please do not hesitate to get in contact with our Estate Planning Team on (02) 6140 3263.