A discretionary or ‘family’ trust is commonly used as an entity to acquire residential property due to the advantages that they afford, such as flexible income splitting arrangements. People who use a discretionary trust will now need to be aware of a significant change if they wish to avoid paying additional land transfer duty (i.e. stamp duty) when acquiring a property from March 2020.
Provisions have applied in Victoria since 1 July 2015 that result in foreign purchasers paying additional stamp duty when acquiring residential property. A foreign purchaser can be a natural person, a corporation or a trust.
A trust will be a foreign trust when a foreign person, foreign corporation or other foreign trust has a ‘substantial interest’ in the trust. The legislation in relation to this enabled the State Revenue Office (SRO) in Victoria to deem a substantial interest to exist when a foreign beneficiary had a beneficial interest in more than 50% of the capital of the trust. Alternatively, the SRO could deem a trust to be a foreign trust based on how it was administered.
Notwithstanding the above, the SRO applied a practical approach to consider whether or not a discretionary trust was foreign. This meant that the SRO would consider the likelihood of a foreign beneficiary receiving a distribution, and not just what the trust deed permitted. If the clauses of a trust deed were broad enough to permit distributions to foreign beneficiaries but there was never any intention to make distributions to these beneficiaries then the trust would not be considered to be a foreign trust.
The SRO has announced that it will no longer be applying the practical approach from 1 March 2020. As a result of this, a trust will be deemed to be a foreign trust when a potential foreign beneficiary is entitled to more than 50% of the capital of the trust. Importantly, this does not mean that a foreign beneficiary needs to actually receive a distribution of capital, and they merely need to be eligible to receive such a distribution (even if they never will). The following example considers how this will apply to a future property purchase:
A husband and wife are the trustees of a family trust, and use this entity to make distributions of income to themselves and their children. To increase the income available for distribution, the trustees use the family trust to buy a residential property.
The deed of the family trust has a general clause that allows distributions of income and capital to other relatives, including cousins of the husband and wife. The husband’s cousin has lived and worked in the United Kingdom for a long time. They are not a resident of Australia for income tax purposes.
The trustees of the family trust had a significant disagreement with the husband’s cousin. They never intend to speak to the cousin again. The previously never made a distribution from the family trust to the cousin and, as a result of the disagreement, are absolutely confident that they never will make a distribution to them in the future. The cousin, however, is an eligible beneficiary of the trust as a result of the general clause regarding distributions to relatives. The family trust will therefore be a foreign trust, and additional stamp duty will apply to the residential property purchase if this occurs after 1 March 2020.
The above change will apply to contracts entered into from 1 March 2020. To avoid a liability for additional stamp duty on residential purchases from this date it will necessary to either amend an existing trust deed so that foreign beneficiaries cannot receive a distribution of more than 50% of capital, or use a new trust with a deed that has this restriction.
To ensure that you are not adversely affected by the above, please contact your advisor at Saward Dawson well before you enter into a contract for the purchase of a residential property.