How to avoid (more of the) many tripwires in trusts

There are some common issues with trusts that need to be handled in order to unlock the full value and benefit of using a trust. Here are some of the common traps to avoid.

Stamp duty issues

When trustees change, there can be issues in regard to stamp duty.

Section 54(3) of the Duties Act 1997 (NSW) needs to be borne in mind when the trustee of a trust is changed and “dutiable property” such as real estate, is to be transferred from the old trustee to the new trustee.

The effect of this subsection is that ad valorem stamp duty may well be charged by the Chief Commissioner in respect of the transfer of the dutiable property unless the Chief Commissioner is satisfied that:

(a) None of the continuing trustees remaining after the retirement of the current trustee is or can become a beneficiary under the trust;

(b) None of the trustees of the trust after the appointment of the new trustee is or can become a beneficiary under the trust; and

(c) The transfer is not part of a scheme for conferring an interest, in relation to the trust property, on a new trustee or any other person, whether as a beneficiary or otherwise, to the detriment of the beneficial interest or potential beneficial interest of any person.

What this means is that when the trustee is changed, the trustees should be excluded as beneficiaries of the trust and that exclusion must be “entrenched” so that s54 (3) cannot be breached.

By “entrenched”, I mean that the amendment clause should itself be amended so that the effect is that the amendment clause cannot be used to amend the deed later to enable a trustee of the trust to become a beneficiary.

But wait, aren’t stamp duties being removed?

Talk about stamp duties disappearing is nonsense.

NSW has announced a new overhaul of stamp duty in favour of an annual property tax on an opt-in basis for properties purchased on and after 16 January 2023 up to $1.5 million.

Victoria’s newest stamp duties tax will apply to rezonings that occur on or after 1 July 2023. Broadly, if a rezoning occurs and the consequent capital improved value is more than $100,000, then tax applies at the initial rate of 62.5 per cent of the increase in the capital improved value less allowable deductions.

Stamp duty will still apply for properties which don’t meet this criteria.

Hiding your identity

It often happens that a client wants to provide the purchase price for the purchase of real estate but does not want his or her name to appear on the title.

The necessary document to implement this process, being a declaration of trust, will recite that the beneficiary (i.e.: the client) concerned has contributed all of the purchase monies and that the purchaser trustee (the corporate trustee of the bare trust) holds the property on trust for the client (who provided the purchase price).

To ensure that this arrangement works, and that the eventual transfer of the property from the bare trust to the client is only stamped at the concessional rate (usually $50), the declaration of trust audit material usually required by the Commissioner of Stamp Duties should show the purchase moneys going into the client’s bank account and out to the vendor.

However, if a mortgage is involved (say, where the client is borrowing some of the purchase price to advance), you will need to make sure that the mortgagor (which is the trustee because the property was to be bought in the name of the trustee), ensures that the mortgage covenants do not provide that the loan is being made to the mortgagor because the Stamp Duties Office will then argue that the apparent purchaser (the client) has not provided the whole of the purchase moneys.

Foreign entities and surcharge land tax and surcharge purchaser duty

The NSW government has implemented new laws to the effect that where an interest in residential real property is acquired directly or indirectly by or held through a family discretionary trust, the trustee of the trust may be liable for surcharge land tax and surcharge purchaser duty (together, the foreign surcharge) if any one of the potential beneficiaries is a “foreign person”.

Specifically, s104JA of the Duties Act 1997 (NSW) provides that the trustee of a discretionary trust is taken to be a “foreign trustee” for the purposes of Chapter 2A (which deals with duty charged on certain residential land transactions involving foreign persons) unless the trust prevents a foreign person from being a beneficiary of the trust.

For individuals, the issue of being a foreign person can be easily triggered. Take a typical beneficiary definition that provides that the beneficiaries include the spouse of the primary beneficiary, the children of the primary beneficiary, the spouse of any such child and any company throughout the world.

Your 26-year-old son, Bob, gets the opportunity of a lifetime to work in Los Angeles for the next five years. He is an Australian citizen. No problems there. He meets Sally who was born in Los Angeles. She is a US citizen. Bob marries Sally. Even if Sally never receives any distribution from the trust, she is entitled to receive a distribution if the trustee so resolves. Sally is a foreign person, the trustee is deemed to be a foreign trustee and the whole trust is therefore deemed to be a foreign trust for surcharge stamp duty and land tax purposes.

The surcharge purchase duty is an additional 8 per cent over the duty otherwise payable and the surcharge land tax is currently 2 per cent on residential land and this will rise to 4 per cent from 1 July 2023.

In order to avoid the above foreign surcharge liability, a new clause should be inserted into the trust deed that:

i) requires that no foreign person can become a beneficiary (the “no foreign beneficiary requirement”); and

ii) ensures that the trust is not capable of amendment in a manner that would result in there being a beneficiary of the trust potentially becoming a foreign person (the “no amendment requirement”).

Capital gains

One of the big benefits of using your discretionary trust is that you are now able to stream to specified individuals some or all of the capital gains enjoyed by the trust in a particular year (see s115-C of 11) and some or all of the franked dividends enjoyed by the trust in a particular year (see s207-B of ITAA 97).

Make sure your trust deed allows this.

CGT event K3 and non-residents

Ordinarily, there are no CGT consequences when an asset passes to an executor or beneficiary on death and any capital gain or loss is deferred until such time as the executor or beneficiary disposes of the asset.

However, you need to watch out for CGT event K3, which sets out an exception to this rule where the CGT asset passes to a beneficiary who is a “foreign resident”.

CGT event K3 occurs when a foreign resident beneficiary inherits a CGT asset that is not “taxable Australian property” (TAP). Broadly, this means that CGT event K3 can occur where the foreign resident beneficiary inherits an asset other than land or an interest in land. To that extent, the transfer of the CGT asset by the deceased estate is deemed to trigger a CGT event that can create an immediate estate tax liability — a tax which the estate has to pay — or potentially cause a latent capital loss to be forever lost.

This is the second article in a two-part series. Part 1 of one of this piece ran on Thursday, 6 April.

Leigh Adams is special counsel at Owen Hodge Lawyers.