We outline how to potentially reduce your tax burden by being aware of the foreign person surcharge.
Trusts may be surprised by a ‘foreign persons’ surcharge
In 2016, the NSW government introduced surcharges targeted at foreign ownership of residential property. However, due to the broad definition of ‘foreign persons’, even discretionary trusts set up for Australian residents may have to pay.
For example, the Golden family set up a discretionary trust to manage a private college in Sydney. The trust also purchases and holds a block of units in Eastwood. Mr and Mrs Golden include their grandparents as beneficiaries under the trust. Since their grandparents live in Indonesia, the Golden family will need to pay the new surcharge.
What are the surcharges?
These surcharges broadly include:
- an additional duty of 4% of the purchase price of the property levied on foreign persons who purchase residential property on or after 21 June 2016.
- a land tax surcharge equal to 0.75% of the unimproved value of all of the residential land owned by a foreign person at midnight on 31 December in any year (commencing on 31 December 2016). This tax is additional to the usual land tax liability.
Who will they impact?
This surcharge has the potential to surprise many trusts. A trust may not consider itself to have any foreign trustees, but the definition of a foreign beneficiary is broad. It basically excludes Australian citizens, regardless of where they may reside, and permanent residents who have been in Australia for 200 or more days of the preceding 12-month period.
But the definition does include any foreign person or company which holds a beneficial interest in at least 20% of the income or property of the trust.
In the case of the Golden family, for example, their grandparents have visited Australia on many occasions. However, they have not resided here in the last 12 months and are neither citizens or permanent residents, so the Golden family will need to pay the surcharge under the current terms of their trust. This is despite the fact that their grandparents do not have any involvement in the Golden family’s business.
Even more significantly, foreign persons or companies do not have to actually benefit from the trust for the surcharge to apply – potential or possible foreign beneficiaries are liable to incur these costs. If the foreign person or entity could potentially receive all of the income or capital of the trust, then regardless of whether or not they actually do so they are considered as having a 100% interest in the trust.
For example, the Golden family has included their grandparents as possible beneficiaries under the trust, but has not delivered any income or capital to them. No money from the trust has yet gone overseas; the Golden family does not even intend for their grandparents to benefit. Despite this, since the grandparents are foreigners who potentially stand to benefit, they are treated as if they have a 100% interest in the Golden family trust, and the trust is liable for the surcharge.
How can the surcharge be avoided?
Since foreigners must pay 4% on residential property purchases, first consider whether it is possible to make a purchase with an alternate trust or entity that does not have any hint of foreign ownership.
For example, the Golden family wants to buy new block of flats in Eastwood. Since they wish to avoid the surcharge, which impacts them as their current trust includes their grandparents in Indonesia, the Golden family creates new trust that does not include their grandparents or any other foreign beneficiaries, and buys the apartment block through this new trust.
Second, the trust agreement could be changed to limit or avoid the impact of this surcharge. This can be a complex process, whereby the integrity of the trust needs to be maintained while the deed is changed for the purposes of mitigating the impact of the surcharge. These kinds of trusts define a wide range of beneficiaries who are referenced in various ways to the principal trustee. This is why it is imperative that your deed is examined carefully by a small business advisor who has the experience to amend the trust accordingly.
Is there a deadline for changing a deed?
Initially, discretionary and certain hybrid trust deeds needed to be amended by no later than 31 December 2016. The Office of State Revenue, however, announced on 1 March 2017 that trustees can seek an exemption from the surcharges on a case-by- case basis.
There is a condition – trusts must amend their deeds to exclude foreign persons as beneficiaries within 6 months of the exemption being granted. Exemptions granted by the Commissioner will have retrospective effect from 21 June 2016.
Important Disclaimer: Readers should not act solely on the basis of the material on this page. Items herein are general comments only and do not constitute or convey advice. Legislation and proposals of legislation are also subject to constant change. We therefore recommend that formal advice be sought before acting in any of the areas. This news article is issued as a guide to the readers. Calibre Business Advisory Pty Ltd and its associated entities disclaims any losses that may be incurred as a result of the reader undertaking any action based on this article.