Improperly Drafted Exclusionary Clause Triggers Foreign Land Tax Surcharge For Discretionary Trust
1. Overview
This ruling from the New South Wales Civil and Administrative Tribunal (the Tribunal) serves as an important reminder for ensuring that discretionary trust deeds are appropriately amended to prevent the activation of "foreign" land transfer (stamp) duty and land tax surcharges.
In the recent case of Khalil & Associates Pty Ltd ATF The George Khalil Family Trust v Chief Commissioner of State Revenue [2024] NSWCATAD 23 (Khalil), the Tribunal found that a particular amendment to a discretionary trust failed to prevent the imposition of a land tax surcharge.
2. Understanding the Issue
Within Australia, most states and territories have introduced surcharges for foreign persons concerning land transfer duty and/or land tax. Despite these being primarily targeted at foreign natural persons, companies, and fixed trusts, discretionary trusts face broader implications due to their flexible nature.
The deeming rules for discretionary trusts to be classified as foreign trusts vary between state jurisdictions but will typically require amendments to the trust deed to either remove foreign beneficiaries or restrict their entitlements. As illustrated in the case of Khalil, New South Wales has the most stringent requirements of which trustees should be aware.
Regardless of whether there is any intention by a trustee to make distributions to a foreign person, ordinary Australian discretionary trusts may trigger such surcharges unless appropriate limitations are made to the trust deed.
3. The case of Khalil
The case of Khalil involves a New South Wales-based trustee of a discretionary trust.
On 24 June 2020, New South Wales introduced requirements for most taxpayers with standard family trusts to amend their trust deeds by excluding potential foreign beneficiaries by 31 December 2020 to avoid foreign owner land tax.
The Land Tax Act 1956 NSW (Land Tax Act) introduced a new section 5D. This section provides that a trustee of a discretionary trust is taken to be a foreign trustee if the terms of the trust do not prevent a foreign person from ever being or becoming a beneficiary (regardless of whether or not there actually are any foreign beneficiaries).
The Tribunal scrutinised an amending deed executed on June 3, 2021, which included a clause excluding ‘foreign beneficiaries’ without providing a definition for the term. The amending clause states:
Any foreign beneficiary that may exist in this trust is irrevocably excluded from receiving any current, or future trust distributions. For the avoidance of doubt this clause will supersede any other clause under this deed.
A subsequent deed of variation further excluded foreign persons. Despite the initial exemption from foreign owner land tax, the Chief Commissioner issued assessments on July 19, 2022.
Subsequently, on June 22, 2023, the taxpayer raised objections to the surcharge land tax assessments covering the tax years from 2017 to 2023 (inclusive). The Commissioner rejected the objection which led the taxpayer seeking review from the tribunal.
4. Arguments
The critical issue concerned whether the amended deed met the criteria outlined in section 5D of the Land Tax Act for the 2022 land tax year, specifically in its ability to irrevocably prohibit foreign persons from becoming beneficiaries of the trust.
The taxpayer argued that the Commissioner's guidance on foreign surcharges and discretionary trusts did not necessitate the inclusion of a definition for a 'foreign beneficiary' in the deed. Additionally, they asserted that there was no substantive difference between the term 'foreign beneficiary' as employed in the Amending Deed and the term 'foreign person' as defined in section 5D of the Land Tax Act.
In response, the Commissioner contended that the amending clause failed to meet the requisites outlined in paragraph 5D(3)(a) or paragraph 5D(3)(b) of the Land Tax Act . According to the Commissioner, the term 'foreign beneficiary' differed from 'foreign person' due to distinct wording. Moreover, the clause excluding foreign beneficiaries did not serve as a deterrent against the potential inclusion of future foreign beneficiaries.
5. The Decision
The Tribunal did not accept the amendment effectively prevented the applicant from modifying the trust's deed in the future to designate a foreign person as a potential beneficiary. Additionally, the taxpayer failed to furnish any evidence regarding their intentions, or any errors made. Consequently, the trust was treated as a foreign trust, and subsequently foreign owner land tax was payable.
6. Key Takeaways
Although the definition of "foreign person" varies across Australian States and Territories, this decision reaffirms the importance of being aware of non-foreign trust deed requirements and ensuring that trust deed variations are drafted to achieve their intended purpose.
In New South Wales, Victoria, and Tasmania, discretionary trust deeds must incorporate exclusionary language to prohibit trustees from making specific distributions to a foreign person. The regulations in New South Wales impose additional challenges and stringent requirements, as exclusionary clauses must be irrevocable.
7. Recommendations
While discretionary trusts provide flexibility for income and capital distribution, as well as asset protection, the trust deed should be carefully drafted and regularly reviewed to accord with legislative updates.
It is important to confirm the intent of the trust, especially in circumstances where the trust is used to acquire land in different States and Territories.
If you require any assistance or wish to obtain further information in relation to discretionary trust amendments and requirements, please contact:
Alasdair Woodford
Principal Lawyer
T: 03 5225 5217| M: 0436 456 144
E: awoodford@ha.legal
Joseph Flanagan
Associate
T: 03 5226 8504
E: jflanagan@ha.legal
Ben Smith
Lawyer
T: 03 5225 5262
E: bsmith@ha.legal
Maddi Batchelor
Graduate Lawyer
T: 03 5225 5214
E: mbatchelor@ha.legal
