Is Your Client's Testamentary Trust a Foreign Trust?

This question is more important than you might think.

But first, what is a 'foreign trust' – and why is this so important?

In NSW, the Office of State Revenue levies an additional 'surcharge' stamp duty of 4% on acquisitions of residential land by 'foreign persons', plus an additional 'surcharge' land tax of 0.75 per cent in relation to residential land owned by a foreign person. (There are also similar but slightly different provisions that apply in Victoria and Queensland.)

Note that the normal principal place of residence exemption does not apply for surcharge land tax. Even if an owner is residing in the property, it will still be liable for the surcharge if an owner is a foreign person. The surcharge also applies even if the land is under the land tax free threshold (in NSW currently $549,000).

For these purposes, a 'foreign person' includes:

• an individual who is not ordinarily resident in Australia (in this regard, an Australian citizen is considered to be ordinarily resident in Australia even if they live overseas); and
• companies and trusts in which a foreign individual holds a substantial interest, or in which two or more persons, each of whom is an individual who is not ordinarily resident in Australia, hold an aggregate substantial interest.

For a trust (including a unit trust), a 'substantial interest' is a beneficial interest in 20% or more of the income or property of a trust or a person who holds a 20% interest in the trust.  For example, this could be an individual who owns 20 units out of a total of 100 units in a unit trust.

However, for discretionary trusts, each beneficiary is taken to hold a beneficial interest in the maximum percentage of income or property that the trustee may distribute to that beneficiary. Therefore, if any one or more of the potential beneficiaries are foreign persons, the trustee will be liable for the additional surcharge stamp duty on acquisitions of residential land, and also for the additional surcharge land tax on the trust’s interests in residential land.

The thing is, these rules can also apply to a testamentary discretionary trust. In fact, the issue is even more important for estate planning with testamentary discretionary trusts than for trusts set up inter vivos or during a person's lifetime.

This is because with an inter vivos trust a decision can be made by your client during their life whether or not to exclude foreign persons from the trust at the time of establishment, or even at any time after it is set up, and before residential land is purchased or acquired by the trust.

Plus, given that discretionary family trusts are often established for a specific purpose, such as to conduct a specific business or to hold certain investment assets or as part of a tailored taxation strategy, they are usually meant to benefit a particular and fairly well-defined immediate family group (such as the client, their spouse, and their children and grandchildren), so that the decision regarding whether or not to exclude foreign persons as discretionary beneficiaries of the trust is usually fairly straightforward since those persons would usually be too remote (from a relationship perspective) to be considered for a distribution of income or capital from the trust.

On the other hand, with a testamentary discretionary trust the issue is much more critical, for at least three reasons:

First, given that a testamentary discretionary trust is usually being considered in an estate planning context, it is not such an easy decision to automatically exclude foreign persons as potential beneficiaries. This is because in order to avoid an intestacy in the event that the immediate family do not survive the testator, it is important to include the testator's extended family members as potential “back up” discretionary beneficiaries. To automatically exclude them in case any of them are now or may become at the time of the testator's death (which may not be for perhaps decades into the future) is fraught with danger from an intestacy avoidance perspective – especially since the exclusion of foreign persons needs to be permanent and irrevocable to be effective under the tax rules.

Second, the likelihood that a testamentary discretionary trust will own residential land either from its initial establishment or at some time afterwards is extremely high. This is because the testamentary discretionary trust will usually be designed to hold and protect the main assets of the testator and the inheritance of their loved ones, which typically – and especially if we are also talking about Aussie baby boomers – include residential land, such as the family home and / or one or more investment properties. Particularly where one of the main purposes of the trust is to provide for the proper and secure accommodation of one or more family members.

Third, apart from the original indigenous Australians, every Aussie is either an immigrant or descended from one. Plus, Millennials are a pretty mobile bunch globally speaking. So the likelihood that a client in Australia will have one or more relatives who are now or may sometime in the future become foreign persons is again extremely high. And not all of them are going to be Australian citizens. Are you going to exclude family members from a testamentary discretionary trust just in case they may be or become foreign persons? Would you even know who to exclude or how to even choose who to exclude? Would your client?

What all this adds up to is making sure that any lawyer who your client sees – or to whom you are thinking of recommending to your client - is across all of these issues and is able to suggest and expertly implement appropriate strategies for your client. Depending on your client’s circumstances and instructions, these might include:

• defining the beneficiaries or classes of beneficiaries to be excluded (or included) as potential beneficiaries of the trust  - and under what circumstances - very precisely;
• making the testamentary discretionary trust 'optional'; and / or
• providing appropriate powers and discretions to enable the executor or trustee to deal with the issue at the relevant time.

Visit the SUPERCentral product range if you would like more information on a unit trust, discretionary trust or testamentary discretionary trust.

For further information call our office on 02 8296 6266 or email info@supercentral.com.au