Australian non-fixed trust liable for CGT on non-TAP gains given to a foreign resident: Peter Greensill Family Co Pty Ltd

BigBen

A mirror of the general principle of source and residence taxation broadly setting the parameters of international taxation, and reflected in Australia’s income tax law, is that income of a foreign resident not from sources in the state is not taxable in the state (in this post called the Mirror Principle). In Australia:

  • interests in real property in Australia and related interests; and
  • interests in assets used in business in permanent establishments in Australia:

are designated “Taxable Australian Property” (TAP) (see Division 855 of the Income Tax Assessment Act (ITAA) 1997). TAP is used in Australian income tax law to apply the Mirror Principle.

Foreign resident capital gains from non-TAP disregarded

Property which is not TAP, that is, property not taken to be connected to Australia for income tax purposes in the hands of foreign residents includes shares and securities as opposed to property interests in or related to Australian land or of permanent establishments carrying on enterprises in Australia which are TAP.

Capital gains made by foreign residents from non-TAP assets are disregarded for tax purposes: section 855-10.

Trouble pinpointing trusts as foreign or not

Trusts are elusive and create enormous difficulties in the international tax system see Trusts – Weapons of Mass Injustice. Trusts can detach beneficiaries who benefit from property who may be in one state from:

  • the trustee of the trust, in whose name the property is held, who may be in another state; and
  • the activities of trust which may be in yet another state.

Apt taxation of those activities in line with Mirror Principle thus poses a significant challenge to governments. States are justified imposing laws to counter offshoring with trusts to ensure the integrity of their tax systems.

Some states don’t recognise trusts.

In Australia trusts are mainstream. Some types of trusts are considered tax benign and conducive to legitimate business, investment and prudential activity. Fixed trusts are often treated transparently for Australian income tax purposes so that a fixed trust interest holder is:

  • taxed similarly to a regular taxpayer or investor; and
  • no worse off, tax wise, than a taxpayer or investor who owns the property outright rather than by way of a trust beneficial interest.

So, consistent with the Mirror Principle that a foreign resident owner of non-TAP who makes a gain on the non-TAP shouldn’t be taxable on the gain, a foreign resident beneficiary (FRB) of a fixed trust can disregard a capital gain made in relation to their interest in a fixed trust: section 855-40.

Peter Greensill Family Co Pty Ltd (trustee) v Commissioner of Taxation

In the Federal Court case Peter Greensill Family Co Pty Ltd (trustee) v Commissioner of Taxation [2020] FCA 559 this week the issue arose whether an Australian resident family discretionary trust – a non-fixed trust, was entitled to rely on section 855-10 and the Mirror Principle to disregard capital gains distributed to a FRB, a beneficiary based in London, of the trust from realisation by the trust of shares in a private company, GCPL, which were non-TAP of the trust.

Detachment of capital gains from the workings of trust CGT tax rules

The capital gains of a trustee are distant from the capital gains of a beneficiary under the ITAA 1936 and the ITAA 1997. Transparent treatment or look through to the capital gains of the trustee as capital gains of the beneficiary/ies became even more remote following changes to Sub-division 115-C of the ITAA 1997 including the introduction of Division 6E of Part III of the ITAA 1936.

These changes brought in distinct treatment of capital gains and franked distributions of a trust from other trust income following the High Court decision in Commissioner of Taxation v Bamford [2010] HCA 10 and the clarification of taxation of trust income in that case.

Legislation unsupportive of transparent treatment

In Greensill Thawley J. analysed the provisions in Sub-division 115-C and Division 6E to deconstruct the applicant’s case to disregard capital gains using Division 855. 

Section 855-40 specifically allows a FRB of a fixed trust to disregard non-TAP capital gains. The absence of an equivalent exemption for FRBs of non-fixed trusts is telling unless section 855-40 is otiose or represents an abundance of caution. Thawley J. did not follow that line. As the applicant in Greensill could not disregard the capital gains using section 855-40 in the case of non-fixed trust, or section 855-10, the capital gains were taxable in Australia.

Unless there is an appeal to the Full Federal Court the Commissioner can finalise his draft taxation determination TD 2019/D6 Income tax: does Subdivision 855-A (or subsection 768-915(1)) of the Income Tax Assessment Act 1997 disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3)? as the Federal Court has accepted the view in it.

Deep pockets couldn’t overturn tax resident and evasion decision

Full Wallet

Plenty was spent by Malaysian multinational timber tycoon Yii Ann Hii unsuccessfully fighting $A 64m in income tax. This tax litigation looks like it has just ended with Hii v Commissioner of Taxation (No 2) [2020] FCA 345 in March 2020.

The litigation

Although the litigation with the Commissioner of Taxation was about whether the taxpayer was a resident of Australia between 30 June 2001 to 30 June 2009 (the relevant years), this issue never came to be decided in the litigation with the Commissioner which included:

  • a tax appeal to the Federal Court from objection decisions;
  • an appeal to the Administrative Appeals Tribunal for administrative review in relation to penalty assessments for the relevant years;
  • proceedings under section 39B of Judiciary Act 1903 collaterally taken in the Federal Court: Hii v Commissioner of Taxation [2015] FCA 375 before Collier J.;
  • an original proceeding in the High Court under sub-section 75(5) of the Constitution seeking writs of certiorari and mandamus; and
  • further proceedings under section 39B of Judiciary Act taken in the Federal Court seeking to quash an audit decision and an objection decision: Hii v Commissioner of Taxation (No 2) [2020] FCA 345 before Logan J.

An insight into the Australian tax system

Although the litigation never came to decide whether the Commissioner was correct in finding that the taxpayer was a resident taxable on worldwide income during the relevant years there is something to be drawn from these cases about the operation of Australia’s tax system.

Forum to fight the Commissioner

As we have said before on this blog in Is an objection needed to amend a tax assessment?, proceedings against the Commissioner other than under Part IVC (of the Taxation Administration Act 1953) where taxpayers can object against assessments of tax and appeal against the objection decisions arising, are expensive and are prone to failure. In Hii No. 1 Collier J. applied the High Court’s decision in Federal Commissioner of Taxation v Futuris Corporation Ltd (2008) 237 CLR 146 where it was held, by virtue of section 175 and section 177 of the Income Tax Assessment Act (ITAA) 1936, that judicial review under section 39B of the Judiciary Act 1903 is limited to where:

  • an assessment is tentative or provisional; or
  • where conscious maladministration by the Commissioner has occurred.

There were no allegations of tentativeness or bad faith of the Commissioner amounting to maladministration by the taxpayer in Hii No. 1; the taxpayer’s counsel instead sought to establish that the principles from Futuris did not apply to the taxpayer.

The taxpayer did not succeed. The Federal Courts in Hii No. 1  and in Hii No. 2 applied the principles from Futuris and decided for the Commissioner.

Getting advice or legal help in tax disputes

It would appear that the taxpayer was selective about taking or, alternatively, following counsel. It appears that the taxpayer conducted the section 39B proceedings in Hii No. 2 from Malaysia seemingly without Australian legal representation. The Federal Court found his action in Hii No. 2 to be an abuse of process. Moreover a vexatious proceedings order was made against the taxpayer preventing the taxpayer taking further action in the court in relation to these disputes.

In contrast, through the earlier litigation, the taxpayer engaged experienced senior and other counsel. In the appeal against the objection decisions the Commissioner obtained an order for security for costs in the Federal Court against the taxpayer who is a citizen of Malaysia and who had, by then, left Australia. The taxpayer never complied with the order nor sought any extension of time to do so. One can only assume his counsel would have advised him of the risk that he would lose his rights to contest the tax bills by not engaging with the security for costs order.

The subsequent litigation shows that is what happened. The Part IVC appeal was struck out because security for costs was not given to the Commissioner.  From then the taxpayer was unable to get his tax residence issue, or any review of the Commissioner’s decisions to treat him as a resident, before the courts at all despite his numerous and expensive efforts to do so.

Commissioner’s residency findings

As stated the courts were never able to get to the residence issue in the litigation. In the transcript of the High Court refusing an extension of time to apply to the High Court to the taxpayer the Commissioner’s findings of fact about the taxpayer nonetheless appear:

(i) the plaintiff was granted a permanent residency visa on 20 March 1992;

(ii) the plaintiff was granted a five year resident return visa on 27 February 1995, which allows current or former Australian permanent residents to re-enter Australia after travelling overseas and to maintain status as a permanent resident on return to Australia;

(iii) the plaintiff was issued a Queensland Drivers Licence on 6 February 1996, and his most recent Queensland Drivers Licence had effective dates of 23 December 2005 to 30 January 2011, with a Queensland address listed by the plaintiff;

(iv) the plaintiff applied on 6 September 2005 to alter his credit card limit with the National Australia Bank, listing the same Queensland address for his contact details;

(v) the plaintiff and his wife purchased the property at that Queensland address on 2 April 2001 for $6.5 million and more than six gigabytes of documents pertaining to the plaintiff’s business interests were found at that Queensland address and another property owned by companies controlled by the plaintiff;

(vi) the plaintiff’s immediate family, his wife and six children, resided in Australia as permanent residents of Australia, the plaintiff’s extended family lived in Brisbane, and his brothers lived in Victoria;

(vii) all the plaintiff’s children undertook their schooling at Queensland schools, and several children attended the University of Queensland and Queensland University of Technology; (viii) the plaintiff held in his own name 15 separate Australian bank accounts in the relevant years;

(ix) the plaintiff stayed at seven different hotels between 2002 and 2007 on his visits to Malaysia, but there was no evidence of any hotel stays when he was in Brisbane;

(x) As at 21 January 2009, the plaintiff had a number of vehicles registered to him or his wife in Australia for which insurance was obtained listing either him or his wife, or both, as the main driver, including a Lamborghini Murcielago, a Rolls Royce Phantom, a Ferrari Coupe, and a Bentley Continental;

(xi) in the relevant years, the plaintiff departed Australia 85 times, of which 84 departure cards were located on each of which the plaintiff indicated that he was an “Australian resident departing temporarily”;

(xii) the plaintiff spent between 65 and 189 days in Australia in each of the relevant years with 6 to 125 in Malaysia for the years known;

(xiii) the plaintiff was a director of seven Australian companies with registered offices in Queensland (in six of which the plaintiff held between 35% and 90% of the shares) during the relevant income years; and

(xiv) the plaintiff wrote a letter dated 12 March 2009 to the Australian Department of Immigration which he signed on behalf of one of the companies in which he was a director, which included his statement that “My family currently resides permanently in Brisbane since our first landing in 1993 … Due to the nature of my business I am forced to regularly travel overseas, because of other business interests”.

Did the taxpayer get advice about tax residency?

If these findings are plausible then, without even expressing a view on whether the Commissioner should have determined that the taxpayer was a tax resident of Australia as no Australian tribunal or court did, it can be inferred that the taxpayer was desultory in either taking or, if he took it, following advice on how to avoid being treated by the Commissioner as a tax resident of Australia.

A journalist’s report https://is.gd/KWH9jj suggests that the taxpayer may have over relied on the 183 day test (in the definition of “resident” or “resident of Australia” in sub-section 6(1) of the ITAA1936) but that report is unconfirmed. Could it be that the taxpayer did not take advice during the relevant years about the risks of his activities and circumstances possibly leading to him being treated as a tax resident of Australia either:

  • under ordinary concepts?; or
  • due to adopting Australia as a domicile of choice?

(See our blog from February 2020 When 183 days is not enough to make you an Australian tax resident )

It is through the relevant years in particular that advice or legal assistance to the taxpayer acted on by the taxpayer may have really counted.

Evasion and the resident determination

A further grievance of the taxpayer in the litigation was that in those years of the relevant years where the Commissioner raised original assessments based on the taxpayer’s non-resident returns, the Commissioner was out of time to amend the assessments raised under section 170 of the ITAA 1936.

Amended assessments were there raised by the Commissioner on a footing of evasion under Item 5 of sub-section 170(1).

Is getting tax residence wrong evasion?

One would think that an error by a taxpayer on the frequently nuanced and complex question of whether or not the taxpayer is a resident of Australia does not amount to evasion. However once the question of tax residence is investigated under audit by the Commissioner it is then more awkward to hide behind that simple proposition. In Hii No. 1 it is stated that the Commissioner justified his evasion determination on the following acts of the taxpayer:

  a.           Listing a Singapore business address on his Australian tax return as his residential address

  b.           Providing different reasons as to why various addresses are used in each country [during the course of the audit]

    c.           Not providing details of his offshore income and assets when requested [during the course of the audit]

    d.           Failing to provide full and complete details of foreign entities he controls [during the course of the audit]

    e.           Omitting foreign source income from his Australian tax returns; and

    f.            Failing to pay appropriate tax in Australia.

(see paragraphs 12 and 28)

Viewed skeptically one could suggest that facts e. and f. could happen when a taxpayer innocently believes they are a tax non-resident and may not be evasion. Facts  a. to b. more strongly can support an evasion finding.

Evasion & co-operating with an audit

From c. and d. it can be inferred that full co-operation with the Commissioner in the course of an audit is an imperative where a taxpayer is contesting an amended assessment which would be out of time in the absence of fraud or evasion.

The question again arises, did the taxpayer get or follow advice this time about what information to provide to the Commissioner’s auditors? Based on c. and d. the withholding of information from the auditors prejudiced the taxpayer’s position on the evasion issue.

When 183 days is not enough to make you an Australian tax resident

The recent AAT case of Schiele v. Commissioner of Taxation [2020] AATA 286 (24 February 2020) illustrates when 183 days presence in Australia in an income year is not enough to make someone a resident for tax purposes.

Background

Mr Schiele:

  • is a German citizen;
  • lived with his parents prior to coming to Australia;
  • obtained a working holiday visa for the year ended 30 June 2016;
  • arrived in Australia on 30 October 2015 and departed Australia on 18 July 2016;
  • left his personal belongings and furniture with his parents in Germany while in Australia;
  • did not leave Australia between 30 October 2015 and 18 July 2016;
  • stayed on a farm between 1 December 2015 and 5 June 2016 where he did farm work between 22 March 2016 and 4 June 2016, and travelled to visit friends and to see the country in his remaining time while in Australia;
  • did not become a member of any community groups, churches, clubs or organisations while in Australia; and
  • returned to live with his parents in Germany after departing Australia.

Before the AAT the taxpayer contended he was an Australian tax resident for the 2016 income year. The taxpayer was looking for the tax free threshold that applies to an Australian tax resident’s taxable income.

A visitor

From the above facts the AAT found that the taxpayer was a visitor to Australia.

What makes an individual an Australian tax resident?

The relevant passages of the taxation legislation in the case are from the definition “resident” or “resident of Australia”:

  (a)  a person, other than a company, who resides in Australia and includes a person:

    (i)  whose domicile is in Australia, unless the Commissioner is satisfied that the person’s permanent place of abode is outside Australia; or

    (ii)  who has actually been in Australia, continuously or intermittently, during more than one-half of the year of income, unless the Commissioner is satisfied that the person’s usual place of abode is outside Australia and that the person does not intend to take up residence in Australia;

from sub-section 6(1) of the Income Tax Assessment Act 1936

If the taxpayer could satisfy any of the phrase in paragraph (a), or either of sub-paragraphs (i) or (ii), then the taxpayer would be a tax resident. It is to be noted that both sub-paragraphs (i) and (ii) have prominent conditions (after the word “unless”).

paragraph (a) resides – resident according to ordinary concepts

The term resides in Australia in paragraph (a) is the legal parameter of residence (in Australia) according to ordinary concepts. Residence according to ordinary concepts has been developed in the common law in tax court cases each typically involving a controversy about where a person resides. The AAT approved of a summary of case authority on residence according to ordinary concepts submitted by the Commissioner. To keep this extract brief I extract the Australian High Court cases so summarised in paragraph 24 of the AAT decision:

…. Determination of a person’s residence is a “question of degree and …fact”; ….

Federal Commissioner of Taxation v Miller [1946] HCA 23; (1946) 73 CLR 93, 103

… “a person does not necessarily cease to be a resident there because he or she is physically absent. The test is whether the person has retained a continuity of association with the place … together with an intention to return to that place and an attitude that the place remains “home””; ….


Koitaki Para Rubber Estates Limited v The Federal Commissioner of Taxation [1941] HCA 13; (1941) 64 C.L.R. 241 at p.249

The AAT found that the taxpayer did not reside in Australia and was not a resident according to ordinary concepts as a matter of fact and degree. The AAT found no persuasive evidence that the taxpayer intended to dwell permanently or for a considerable time in Australia. His presence in Australia for 7 months did not make him a resident on its own.

sub-paragraph (i) – the domicile test

Domicile is another technical legal test governed by the Domicile Act (C’th) 1992. Shortly stated a domicile is most often in the country where a person is born, or based on the nationality the person is born with which is taken to be where he or she intends to live indefinitely (domicile of origin) . Domicile of origin is intractable but can be changed: where the person can demonstrate his or her intention to make his or her home in another place indefinitely. Without a quest for a permanent right to live in a country no change to that country as a domicile of choice is evident. Clearly in the taxpayer’s case, the taxpayer has a domicile which remains his domicile of origin in Germany.

The condition to domicile in Australia concerning the permanent place of abode of the taxpayer is not enlivened because the taxpayer does not have a domicile in Australia.

sub-paragraph (ii) – the 183 day (half year) test

The 183 day test was the test on which the taxpayer sought to qualify as an Australian resident. The taxpayer was present in Australia for over 183 days and sought to correct immigration records that suggested to the contrary through the course of the case.

However the taxpayer’s difficulty in the case was not with his presence in Australia for more than 183 days, which the AAT accepted, but with the condition to the 183 day test of residence. The Commissioner and the AAT were satisfied that the taxpayer’s usual place of abode was in Germany so the condition to sub-paragraph (ii) was both enlivened and satisfied. The taxpayer was not an Australian tax resident because his usual place of abode was not in Australia despite his presence in Australia of more than 183 days.

Does a SMSF that holds only life insurance satisfy the sole purpose test?

LifeInsurance

I was recently asked if a SMSF whose only assets are an insurance policy and cash topped up by contributions used to meet premiums on the policy would comply with the sole purpose requirement in the Superannuation Industry (Supervision) Act 1993.

It depends. It will depend on the terms of the life policy and significantly on the age of the member:

The sole purpose test in sub-section 62(1) is structured as follows:

(1) Each trustee of a regulated superannuation fund must ensure that the fund is maintained solely:

(a) for one or more of the following purposes (the core purposes ):

… or

(b) for one or more of the core purposes and for one or more of the following purposes (the ancillary purposes ):

….

In other words a fund maintained for any of the listed core purposes complies with the sole purpose test. A fund maintained for an ancillary purpose or purposes also complies with the sole purpose test so long as it is also maintained for a core purpose or purposes.

The life insurance policy in question would need to be considered. Will the policy pay out insurance proceeds to the trustee of the fund on the death of the member to be used by the trustee to pay death benefits?

Pursuing a core purpose

If the policy would indemnify the trustee on the death of the member before the member:

  • ceases gainful employment; or
  • reaches age 65;

the trustee of the fund would appear to pursue core purposes either in sub-paragraph 62(1)(iv) or (iv) which are:

(iv)  the provision of benefits in respect of each member of the fund on or after the member’s death, if:

(A)  the death occurred before the member’s retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged; and

(B)  the benefits are provided to the member’s legal personal representative, to any or all of the member’s dependants, or to both;

(v)  the provision of benefits in respect of each member of the fund on or after the member’s death, if:

(A)  the death occurred before the member attained the age (65) prescribed for the purposes of subparagraph (ii); and

(B)  the benefits are provided to the member’s legal personal representative, to any or all of the member’s dependants, or to both;

by taking out life cover to fund these death benefits.

Pursuing an ancillary purpose

If the life cover in the policy:

  • is in respect of the life of a member who is over age 65 and who has ceased gainful employment; or
  • only extends cover following both of those events;

then the fund is only maintained for ancillary purposes in sub-paragraph 62(2)(iii) and (iv) which are:

(iii) the provision of benefits in respect of each member of the fund on or after the member’s death, if:

(A) the death occurred after the member’s retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged (whether the member’s retirement occurred before, or occurred after, the member joined the fund); and 

(B) the benefits are provided to the member’s legal personal representative, to any or all of the member’s dependants, or to both;

(iv) the provision of benefits in respect of each member of the fund on or after the member’s death, if: 

(A) the death occurred after the member attained the age prescribed for the purposes of subparagraph (a)(ii); and 

(B) the benefits are provided to the member’s legal personal representative, to any or all of the member’s dependants, or to both;

and the fund is not maintained for core purposes and so the fund does not comply with the sole purpose requirement in sub-section 62(1).

Summary

To reiterate: where the member has both:

  • reached the age of 65; and
  • ceased gainful employment;

or the policy doesn’t fund death benefits before either case then core purposes in sub-paragraph 62(1)(iv) and (iv) don’t apply to life cover taken out by the fund and the sole purpose test in section 62 could be breached for failure to pursue a core purpose in addition to an ancillary purpose or purposes.

Tax residence – is it administrable after Pike?

passportsIn the recent case of Pike v Commissioner of Taxation [2019] FCA 2185 Federal Court judge Logan J. noted:

This is the third in a succession of taxation appeals in the original jurisdiction entailing a taxation residence issue, the others being Stockton v Commissioner of Taxation [2019] FCA 1679 (Stockton) and Addy v Commissioner of Taxation [2019] FCA 1768 (Addy), which have fallen for determination by me since the Full Court’s judgment in Harding v Commissioner of Taxation (2019) 365 ALR 286 (Harding).

The Commissioner’s losses

In each of the cases, the Federal Court overturned decisions of the Commissioner of Taxation that each of the protagonists were residents of Australia for tax purposes, and found that they were non-residents. Addy and Stockton were “working holiday” cases. In Pike too Logan J. overturned an objection decision of the Commissioner that Mr. Pike was a resident for the 2009 to 2014 income years but the Pike case raises wider questions about the income tax residence rules and indeed, Pike differs from the Full Federal Court decision (special leave to appeal to the High Court refused) in Harding too as it concerned a taxpayer whose spouse and children lived in Australia during the income years in dispute and was especially borderline. How that perhaps perplexing outcome could come about is the concern of this post.

Dissatisfaction with the residency rules already

In 2016 the Board of Taxation initiated a review into income tax residence rules which considered:

  • whether the existing Australian individual income tax residency rules that are largely unchanged since enactment in 1930:
    • are sufficiently robust to meet the requirements of the modern workforce;
    • address the policy criteria of simplicity, efficiency, equity (fairness) and integrity;
  • integrity concerns;
  • the increase in litigation relating to the residency rules since 2009; and
  • any changes that could be adopted to improve the residency rules.

The Board reported a core finding that the current individual tax residency rules are no longer appropriate and require modernisation and simplification but the Board also noted that any change has inherent integrity risks such that high net worth individuals in particular could become citizens of nowhere.

Pike – applying the existing tests

The curious and complex aspects of the existing Australian individual income tax residency rules where comprehensively considered and applied by Logan J. in Pike. Mr. Pike, even in the submission of the Commissioner, was a dual resident of Australia and Thailand during the relevant years. This meant that Logan. J needed to look to the “tie-breaker” provisions in the Australia Thailand Double Tax Agreement (the DTA) to determine which of Australia or Thailand could treat Mr. Pike as a tax resident of their jurisdiction during those years.

The domicile test

In the residency tests in the definition of “resident” or “resident of Australia” in sub-section 6(1) of the Income Tax Assessment Act (ITAA) 1936 there is an interplay between ordinary residence with the test in paragraph (a)(i) where the “domicile” of the taxpayer is relevant. Under that definition in the ITAA a “resident” or “resident of Australia”means:

(a)  a person, other than a company, who resides in Australia and includes a person:

(i)  whose domicile is in Australia, unless the Commissioner is satisfied that the person’s permanent place of abode is outside Australia; …

And so Logan J. needed to consider the evidence in Pike to understand whether Mr. Pike had a domicile in Australia during the relevant years.

Principal facts relating to the domicile test in Pike

In the context of Mr. Pike’s domicile the principal facts in Pike were:

  1. Mr. Pike was a native of Zimbabwe.
  2. Mr. Pike and his de facto, Ms. Thornicroft, with whom Mr. Pike had children, left Zimbabwe. Ms. Thornicroft obtained a position with Ernst & Young in Brisbane however Mr. Pike’s skills and career were in the tobacco industry and he had to relocate elsewhere. In the event he relocated alone to Thailand, and after 2014, to Tanzania and to the United Arab Emirates to use his skills and pursue his career in the tobacco industry.
  3. Ms. Thornicroft and their children became Australian citizens in 2010. Mr Pike applied to become an Australian citizen in 2013 and, initially, he was rejected presumably with the Department of Immigration taking into account the paucity of time Mr Pike was physically in Australia and his Thailand connections:
Income year Days spent in Australia Percentage of time spent in Australia
2008 76 20%
2009 155 42%
2010 97 27%
2011 109 30%
2012 102 28%
2013 86 23%
2014 123 33%
(2015) 32 8%
(2016) 44 12%
(2017) 77 21%
  1. Despite those Mr. Pike did eventually become an Australian citizen in 2014.

These principal facts are but a snapshot and simplification of the factual matrix in Pike all of which beared on, in varying degrees, the questions of residence and domicile at issue in the case. Resolution of these questions based on these facts plainly justified the full remittance of penalties by the Commissioner which the Commissioner conceded to Mr. Pike at the objection stage.

Domicile of origin of Mr. Pike

Logan J. observed that Mr. Pike had sought to become and became an Australian citizen though somewhat as a matter of convenience to overcome the complications for an international businessman travelling on a Zimbabwean passport. Logan J. found that Mr. Pike clearly had a domicile of origin in Zimbabwe and applied legal reasoning and learning to understand when Mr. Pike may have acquired Australian domicile as a domicile of choice. Even though the evidence was far from conclusive Logan J. stated that there were sufficient signals from Mr. Pike’s activity to conclude that Mr. Pike did not have a domicile of choice in Australia before 2014.

Thus Logan J. found that Mr. Pike was not a “resident of Australia” due to the operation of the domicile test in paragraph (a)(i) of the definition in sub-section 6(1) even should the Commissioner have reason not be satisfied that Mr. Pike had a permanent place of abode in Thailand.

Dual resident

Logan J. explained with reference to applicable authority including Dixon J. in Gregory v D.F.C.T. (W.A.) [1937] HCA 57; 57 CLR 774 at p.777-778 that an individual can be ordinarily resident in two places. In Pike further principal facts relating to Mr. Pike’s ordinary residence included:

  1. Ms. Thornicroft and their children opted not to move to Thailand so that the children’s schooling could be in Australia and could continue undisrupted.
  2. Despite their living apart the Federal Court was impressed by Mr. Pike’s commitment to his de facto, children and his wider family including his full economic support of Ms. Thornicroft and the children after Ms. Thornicroft ceased earning an income from her employment in 2011 after sustaining an injury.
  3. Although Mr. Pike and Ms. Thornicroft had purchased a vacant block in Brisbane in the hope of building a home, the block was sold undeveloped for a loss in 2014. Ms. Thornicroft, the children, and Mr. Pike when in Australia, thus always occupied rental accommodation in Australia.
  4. Mr. Pike too rented a succession of apartments and cottages in Chaing Mai, Thailand which accommodated the family when Ms. Thornicroft and their children visited Mr. Pike in Thailand; and
  5. Mr. Pike was keen on sports, both as a participant as a spectator and was a member of a number of sports clubs in Thailand. Logan. J. accepted evidence of Mr. Pike and Ms. Thornicroft that Mr. Pike had his own “life abroad” for the long periods he was present in Thailand for his work commitments.

As stated, the Commissioner too had accepted that Mr. Pike was an ordinary resident of both Australia and Thailand. Thus the Federal Court needed to apply the “tie-breaker” tests in the DTA.

The paramount DTA

Logan J. explained how the DTA is paramount over the ITAA  in cases where the DTA applies. Thus an individual who is, or could be a resident of, Australia under the ITAA definition in sub-section 6(1) could nevertheless come to be treated as a resident of Thailand and not a resident of Australia under the DTA. That is the outcome under sections 5 and 4 of the International Tax Agreements Act 1953 if, under the DTA, the “tie-breaker” provisions of the DTA apply to treat a dual resident as a resident of Thailand.

The DTA tie-breakers

However like with the domicile test considered above, the tie breaker tests in the DTA were not so readily capable of application to resolve Mr. Pike’s circumstances.

The first tie-breaker under Article 4.3(a) of the DTA is:

the person shall be deemed to be a resident solely of the Contracting State in which a permanent home is available to the person;

Based on relevant authorities and OECD commentary Logan J. found that a rented home, albeit a family home occupied as such for the foreseeable future, is not a permanent home in this context. Similarly Mr. Pike’s various accommodations in Thailand also did not amount to any permanent home. So this tie-break was of no assistance to the Federal Court to resolve the question of Mr. Pike’s tax residence.

The second tie-breaker is in Article 4.3(b) of the DTA:

if a permanent home is available to the person in both Contracting States, or in neither of them, the person shall be deemed to be a resident solely of the Contracting State in which the person has a habitual abode;

which also turns on the availability of a permanent home to Mr. Pike was similarly to no avail.

The third tie-breaker in Article 4.3(c) of the DTA is:

if the person has a habitual abode in both Contracting States, or in neither of them, the person shall be deemed to be a resident solely of the Contracting State with which the person’s personal and economic relations are closer.

was applied by Logan J. Logan J. analysed Mr. Pike personal relations to Australia which included the presence of his de facto wife and children in Australia and the availability of a not so permanent home which he occupied in Australia when he was living with his family. Those were clearly of greater significance, as personal relations, than his sporting and social activity in Thailand to him in his personal space. Against that Logan J. considered Mr. Pike’s economic relations to Thailand which gave rise to all of his income which, from 2011, was the income which sustained both Mr. Pike and his family in Australia.

Although Mr. Pike spent considerably more days each year between 2009 and 2014 in Thailand due to work than in Australia Logan J. stated:

I do not accept Mr Pike’s submission that habitual abode ought to be determined just by length of residence such that Mr Pike’s greater length of residence in Thailand in each year meant that, between the 2009 and 2014 income years, only in Thailand could be said to have a habitual abode.

Although it was something of an oranges versus apples comparison Logan J. broadly found that Mr. Pike’s relations (in the main, economic) to Thailand were closer than Mr. Pikes relations (in the main, personal) to Australia.

Hence Logan J. found that, under the DTA tie breaker in Article 4.3(c), Mr. Pike was a resident of Thailand and a non-resident of Australia between the 2009 and 2014 income years.

How then to change the residency rules?

At the outset of this post I raised the Board of Taxation’s recommendation that the residency rules should be modernised and simplified. In the context of Pike and how that case ultimately turned it is not so easy to formulate how the residency rules could be changed to avoid the perhaps arbitrary application of overly simple and ineffective DTA tie-breakers based on OECD settled model provisions which change may put Australia out of alignment with international norms.

Or is Pike too unusual to worry about?

That said the facts in Pike seem exceptional to the wisdom that tax residence will generally be at the habitual place of abode a taxpayer has with his or her spouse and children. In Pike the following factors, which were somewhat unusual, appear to have given rise to a different outcome:

  • Mr. Pike had a foreign history and never seemed to really settle with his family in Australia before 2014;
  • Mr. Pike and Ms. Thornicroft never purchased a home in Australia and the family lived in a succession of rented homes; and
  • Mr. Pike and Ms. Thornicroft were unusually credible and convincing witnesses who were able to establish to the Federal Court that they really had reasons for and had a believable distance though stable family relationship.

Commissioner hamstrung by equivocal residency rules

Still unusual residential arrangements abound and, for many taxpayers, this means wide surveys of their facts and background of their residency will need to be undertaken and presented to the Commissioner. The Commissioner does not have the benefit of laws fit for purpose to assist the Commissioner to administer the law and clearly resolve the question of tax residence even when fully appraised of assiduously supplied facts. This ultimately can lead to administration challenges for the Commissioner and to expensive disputes with taxpayers over tax residency which will be as impenetrable as Pike was to resolve.

Closely held trusts, “family trusts” and circular trust distributions – a tax net nuanced again for the compliance burden

trusts guardrail

In Australia the income taxation of trusts is based on the trust being a conduit with look-through to beneficiaries of the trust who are presently entitled to the income of the trust. In the standard case of an adult resident beneficiary of a trust, the beneficiary is taxed on trust income and the trust is broadly treated as a transparent entity and isn’t taxed.

Even where a beneficiary is:

  • not an adult; or
  • not a tax resident;

the trustee of the trust pays tax though ostensibly on behalf of the beneficiary entitled to trust income at the rate applicable to the beneficiary and the beneficiary is entitled to a credit for tax paid on that income should the beneficiary file his, her or its own tax return.

Tax capture when no beneficiary entitled to the income

Look-through taxation of income doesn’t work when there is no beneficiary presently entitled to income of the trust to look through to. Under the Australian system, in these cases, the trustee of a trust pays tax at the highest marginal rate on income plus applicable levies including medicare levy. That is where no beneficiary is presently entitled to the income of a trust under section 99A of the Income Tax Assessment Act 1936.

The trustee beneficiary complication

Trusts can be beneficiaries of other trusts. These beneficiaries are “trustee beneficiaries” of a trust.

Example

  • The trustee of trust B is a beneficiary and so is a trustee beneficiary of trust A.
  • C, a beneficiary of trust B, takes (is presently entitled to) a share of the income of trust A.
  • C may be an individual or a company, viz. an ultimate beneficiary, or may be a further trust – a further trustee beneficiary.

It is then necessary to trace trust income of trust A through trustee beneficiaries to find if there is an ultimate individual or company beneficiary entitled to that income. There may be no ultimate beneficiary entitled to income and the case of a “circular” trust distribution is a case in point.

The circular trust distribution by trusts

A definitive example of a circular trust distribution of income is where:

  • trust X distributes income of trust X to trust Y; and
  • trust Y distributes its income (back) to trust X.

There is thus no ultimate individual or company beneficiary. The income is in a state of flux.  Nonetheless it is clear no beneficiary is presently entitled to the income and the highest marginal rate and applicable levies imposed under section 99A should be applicable to a circular trust distribution of income under the regime so far described.

That is a fair point in principle but a circular trust distribution, or any distribution to a trustee beneficiary that isn’t on-distributed to an ultimate beneficiary, is not necessarily readily traceable and identifiable as income to which no beneficiary is entitled. That is especially so where a labyrinthine structure of numerous trusts is used to conceal who is entitled to trust income and that there is no ultimate beneficiary who is not a trustee beneficiary entitled to trust income.

The legislative countermeasures

Countermeasures in the below legislation apply to support the integrity of flow through taxation of trusts. These countermeasures were introduced in Division 6D of Part III of the Income Tax Assessment Act 1936 which has lead to these new taxes:

  • firstly, the ultimate beneficiary non-disclosure tax when introduced with the A New Tax System (Closely Held Trusts) Act 1999 (see below); and
  • currently the trustee beneficiary non-disclosure tax as introduced to reform the ultimate beneficiary non-disclosure tax under the Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 1) 2007 and the Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 2) 2007.

These taxes were or are in substance proxies for tax on the trustee under section 99A for presumed lack of present entitlement of an ultimate beneficiary to ensure that income of a trust does not escape income tax either:

  • for want of an ultimate beneficiary entitled to the income; or
  • because of the opaque lack of an ultimate beneficiary where a trustee beneficiary may seem to be an ultimate beneficiary in the tax return of the trust.

Like the rate that applies under section 99A the rate of trustee beneficiary non-disclosure tax is the highest marginal rate plus applicable levies including the medicare levy.

The countermeasures also include a concept of “trustee” group which expands liability for trustee beneficiary non-disclosure tax to corporate directors of trustees of closely held trusts personally: an impost beyond the section 99A impost for falling under the purview of these anti-avoidance provisions.

A New Tax System (Closely Held Trusts) Act 1999

The first legislation to grapple with the tracing problem was in the A New Tax System (Closely Held Trusts) Act 1999 which introduced a wide and indiscriminate ultimate beneficiary statement reporting obligation on all closely held trusts.

Closely held trusts

A trust is a closely held trust if it:

  • is a discretionary trust, or
  • has up to 20 individuals who, between them, directly or indirectly, and for their own benefit, have fixed entitlements to a 75% or more share of the income or a 75% or more share of the capital of the trust;

where the trust is not an excluded trust. Examples of excluded trusts are complying superannuation funds and, for their first five years, deceased estates.

Reset of the closely held trust compliance burden

In response to sustained complaints from many trustees of trusts which did not distribute to trustee beneficiaries and their advisers, the federal government came to amend the regime in 2007 so that only trustees of closely held trusts which distribute income to:

  • trustee beneficiaries;
  • where the distribution includes an “untaxed part”;

have reporting obligations to file a trustee beneficiary (TB) statement. TB statements need to be filed with a tax return and, in the case of resident trustee beneficiaries, need to disclose the following about the trustee beneficiary:

  • name,
  • tax file number,
  • the untaxed part of their share of trust income; and
  • their share of tax preferred amounts;

and to withhold trustee beneficiary non-disclosure tax and to pay it to the Commissioner of Taxation where the relevant trustee beneficiary fails to provide the information for the TB statement when it is sought by the (distributor) closely held trust.

This more nuanced or targeted solution imposes a less onerous compliance burden on closely held trusts than the 1999 measures did.

Further, in accord with policy to treat “family trusts” viz. trusts that have

  • a valid family trust election; or
  • a valid interposed entity election;

in force or that otherwise forms part of a “family group” less onerously, family trusts were excluded trusts to which the closely held trusts regime did not apply following the 2007 reform.

2018-19 Budget changes to closely held trusts

Following an announcement in the 2018-19 Federal Budget, the closely held trust arrangements have been further tweaked by the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Act 2019. Under these changes it is still the case that family trusts still do not have to comply with the TB statement reporting requirements however family trusts are no longer excluded trusts.

That means that a family trust that is a closely held trust (which will often be the case) must now comply with the closely held trust obligations but a family trust remains relieved from the obligation to file TB statements and pay trustee beneficiary non-disclosure tax on omission to file a TB statement. Despite that a family trust is now liable for trustee beneficiary non-disclosure tax on circular trust distributions under section 102UM of the Income Tax Assessment Act 1936 but not on distributions received from other trusts (which are not circular and to which section 102UM does not apply).

How will compliance with the changes work?

It is perhaps unusual that the changed closely held trusts regime relieves a family trust, no longer an excluded trust and that distributes income to a trustee beneficiary, from filing a TB statement. The Commissioner of Taxation will have no TB statement to aid detection of a taxable circular distribution back to the family trust. Further, in the case of family trusts, the Commissioner won’t obtain TB statement level information about distributions by family trusts to trustee beneficiaries that are not circular or the opportunity to impose the trustee beneficiary non-disclosure tax on those distributions as a matter of course on the omission to file a TB statement.

Nevertheless the Commissioner of Taxation will have trustee beneficiary contact details and perhaps a tax file number, or will be alerted by the absence of a tax file number; from the tax return of a closely held trust family trust. The Commissioner can trace a distribution and ascertain when a circular trust distribution by a family trust occurs by investigative activity. Further, risk of family trust distributions tax liability under Schedule 2F of the Income Tax Assessment Act 1936 makes it less likely that a family trust will make a distribution liable to that tax, particularly a distribution of a tax preferred amount, to a trustee beneficiary that is:

  • outside of the family group; and
  • where that trustee beneficiary’s tax file number is not known by the trustee of the trust and reported in the trust tax return.

Income from private company investments – the tax scourge of SMSFs

increase

A self managed superannuation fund (SMSF) is generally a low tax entity, particularly when in pension phase where a nil rate can apply and a low 15% rate can apply when not. Still the taxable income of a complying superannuation fund (SF) can be split into a non-arm’s length component and a low tax component under section 295-545 of the Income Tax Assessment Act (ITAA) 1997. The non-arm’s length component is taxed at the highest individual marginal rate which is 45% in the 2019-20 income year.

Non-arm’s length income

The non-arm’s length component for an income year is the complying SF’s “non-arm’s length income” (NALI) for that year less any deductions to the extent that they are attributable to that income.

NALI picked up on audit – even higher tax

The recent case in GYBW v. Commissioner of Taxation [2019] AATA 4262 (GYBW) is a cogent reminder of how NALI taxed at the highest marginal rate can arise in a SMSF. In GYBW a tax shortfall arose as the NALI not returned by the SMSF was detected in an audit by the Commissioner of Taxation. Hence even higher taxes applied including shortfall interest and penalties. There was a reduction in penalties on appeal to the AAT from “reckless” to “failure to take reasonable care” level.

NALI

Section 295-550 is one of a number of superannuation rules designed to protect the integrity of the low tax complying SF regime by combatting income shifting arrangements where income, that might be taxed elsewhere to another type of taxpayer at higher rates, is non-commercially shifted to a complying SF that attracts a low rate of tax.

Section 295-550 is directed at non-arm’s length dealings where complying SFs (and other superannuation entities) earn income from an arrangement which exceeds the income that the complying SF might have been expected to derive from the arrangement if the parties to the arrangement had been dealing with each other at arm’s length.

Where section 295-550 is enlivened all of the income from the arrangement is NALI taxed at the highest rate.

Private companies dividends prone to be NALI

At the forefront of NALI is dividend income from investment by complying SFs in private companies.

In GYBW Senior Member McCabe identified an objective test in sub-section 295-550(2) which looks at a question of fact: is a dividend paid by a private company to a complying SF consistent with an arm’s length dealing? A private company dividend paid to a SMSF is NALI to the SMSF if it is not. This objective test replaced the former provisions in Part IX of the ITAA 1936 under which private company dividends were treated as special income (the forerunner to NALI) as a matter of course. That is, unless the Commissioner exercised a discretion that it was unreasonable to treat the private company dividend as special income where the Commissioner became satisfied that the income was earned at arm’s length.

Sub-section 295-550(3) sets out factors to be considered in applying the objective test.

The facts and findings in GYBW

In GYBW, the SMSF was the SMSF of a partner in an accounting practice with the pseudonym D. His client and connection pseudonym K had volatile and valuable business interests which could earn significant income from Department of Defence contracts.

D retired from his accounting practice to become the chief financial officer of the B Group.

The various partnership and corporate dealings of K are complex and supporting evidence of them before the AAT was “difficult” and incomplete. The AAT did not accept:

  • that the evidence, though involving non-related parties D, K, K’s trust and the other partners and former partners of K; and
  • that legal advice received before the SMSF invested in B Holdings;

supported a finding that the shares in pseudonym B Holdings acquired by D’s SMSF were acquired on terms where dividends would be earned from the shares consistently with an arm’s length dealing.

Senior Member McCabe observed how parties at arm’s length from each other can engage in an non-arm’s length dealing just as non-arm’s length parties can engage in an arm’s length dealing. For instance, in the latter case, a family member of the seller acquiring stock exchange listed shares of the seller on a stock exchange. Section 295-550 is directed to the dealing viz. how the SMSF came to earn the private company dividends it earned, not to the relationship of the parties to the arrangement. The AAT was therefore sceptical about the acquisition by D’s SMSF of ordinary shares in B Holdings on its formation for a nominal sum where B Holdings was also able to obtain and exploit K’s business interests a day later which D contended had negligible value then.

That AAT observed that “Fortune shined on the business” of B Holdings and B Holdings earned more than $10 million over four years which likely explains why it was picked up for an audit by the Commissioner.

Darrelen applicable

After looking at the Explanatory Memorandum with which section 295-550 was introduced Senior Member McCabe concluded that the purpose of the section did not change nor was there any change to the factors to which regard was to be had. Therefore the Full Federal Court decision in Darrelen Pty Ltd v Federal Commissioner of Taxation (2010) 183 FCR 237, which concerned the former provisions in Part IX of the ITAA 1936, remained authoritative in Senior Member McCabe’s view. In Darrelen the court had held that dividends paid by a private company were special income. In the case the SMSF had acquired its four shares in that company for a cost far less than their market value in an earlier year of income notwithstanding that the same dividend amount was paid on all 100 shares in the income year it was paid.

The cost to the SMSF of the shares on which the dividend was paid

The cost to the SMSF of the shares on which dividends were paid is a specific factor that can be taken into account under paragraph 295-550(3)(b) in determining whether their payment is consistent with an arm’s length dealing. In applying the objective test Senior Member McCabe referred to Commissioner of Succession Duties (SA) v Executor Trustee and Agency Co of South Australia Ltd (Clifford’s Case) where the High Court set out its views on how to value shares in a company:

The main items to be taken into account in estimating the value of shares are the earning power of the company and the value of the capital assets in which the shareholder’s money is invested. But a prudent purchaser does not buy shares in a company which is a going concern with a view to winding it up, so that the more important item is the determination of the probable profit which the company may be reasonably expected to make in the future, because dividends can only be paid out of profits and a prudent purchaser would be interested mainly in the future dividends which he could reasonably expect to receive on his investment. Further, a prudent purchaser would reasonably expect to receive dividends which would be commensurate with the risk, so that the more speculative the class of business in which the company is engaged the greater the rate of dividend he would reasonably require. In order to estimate the probable future profits of a company it is necessary to examine its past history, particularly the accounts of those years which are most likely to afford a guide for this purpose. In order to estimate the rate of dividend that a prudent purchaser could reasonably require on his investment it is necessary to examine the nature of the business and the risks involved and to seek the evidence of business men, particularly members of the stock exchange and experienced accountants, who can testify to the appropriate rate from the prices paid for shares in companies carrying on a similar business listed on the stock exchange or from private sales of shares in such companies or from their general business experience.

[1947] HCA 10; (1947) 74 CLR 358 at p.362

and with the benefit of hindsight, and omissions in the evidence supporting D’s SMSF’s case about how the SMSF and B Holdings came to benefit in K’s business interests, the AAT found that dividends were not consistent with arm’s length dealing as they arose from shares acquired for less than their value so evaluated. The AAT found that the dividends received by D’s SMSF from B Holdings were NALI.

NALI rules extended to expenses

The NALI rules have extended to losses, outgoing or expenditures that are less than expected to the complying SF by the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019 in Schedule 2.

Conclusion

Unless GYBW is overturned on appeal SMSF investment in a private company of a related party or in a private company of the connections of the SMSF seem destined for NALI high tax treatment. So SMSFs should be wary of investment in private companies generally: SMSF investment in a private company carries the suspicion that the investment is an opportunity to shift income from a higher taxed entity to a concessionally taxed SMSF.

It follows that the trustee of a SMSF looking to sustain concessional tax treatment needs to adequately document its dealings with and investment in private companies so the arm’s length character of the investment can be verified and, where need be, independent valuation supporting consistency with arm’s length dealing should be sought.

Changing the trustee of a trust – some elements for success

It is sometimes wrongly assumed that a minute of the current trustee is sufficient to change the trustee of:

  • a family discretionary trust (FDT); or
  • a self managed superannuation fund (SMSF) (which must be a trust with a trustee too – see sub-section 19(2) of the Superannuation Industry (Superannuation) Act (C’th) 1993 (SIS Act));

and that a change of trustee will have no serious tax consequences. The second proposition is more likely to be true, but not always.

FDTs and SMSFs invariably commence with a deed which contains the terms (the trust terms or governing rules – TTOGRs) on which the trust commences. That, in itself, is a reason why I contended in 2009 in Redoing the deed that an instrument or resolution less than a deed to change the trustee is prone to be ineffective even where change by less than or other than a deed is stated to be permitted by the TTOGRs in the trust deed.

Changing trustee relying on ability to change in the trust deed

It is thus to the trust deed that one needs to look to find:

  1. whether there is a power in the TTOGRs to appoint a new trustee or to otherwise change the trustee; and
  2. if, so, what the procedure or formalities are for doing so.

Changing trustee relying on the Trustee Acts

If ability to change trustee is not present, or is derelict, in the TTOGRs then the Trustee Acts in states (and territories) provide options for appointing a new or additional trustee which vary state to state.

Trustee Act – New South Wales

In New South Wales: section 6 of the Trustee Act (NSW) 1925 allows a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state.

However an appointment of a new trustee in these situations must be effected by registered deed: sub-section 6(1) That is the deed of appointment must be registered with the general registry kept by the NSW Registrar-General, which is publicly searchable, and the applicable fee to so register the deed must be paid to NSW Land Registry Services for the appointment to take effect.

It is apparent from sub-section 6(13) that registration of a deed of appointment is not required where ability to appoint a new trustee is in the TTOGRs where the TTOGRs express a contrary intention; that is: where the TTOGRs expressly and effectively allow an appointment to be effected without a registered deed.

Trustee Act – Victoria

In Victoria there is a comparable capability for a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in writing in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state;

under section 41 of the Trustee Act (Vic.) 1958. However this Victorian law does not impose any requirement that the required instrument of appointment in writing must be registered.

Changing trustee by obtaining a court order

The supreme courts of the states and territories are also given a residual statutory capability to appoint trustees under the respective Trustee Acts. However applying to a supreme court for an order to change a trustee of a FDT or a SMSF with sufficient supporting grounds is an option of last resort given likely significant costs and uncertainties of obtaining the order.

Changing trustee by deed

The TTOGRs in a trust deed of a FDT or a SMSF will frequently require that an appointment of a new trustee may or must be effected by a deed. It is desirable that it should do so to ensure the appointment of a new trustee does not become of a matter of uncertainty and difficulty for the reasons I have described in Redoing the deed.

Tax consequences of a change of trustee

As a change of trustee without more generally does not change beneficial entitlements under a trust, the tax consequences are usually benign:

For capital gains tax (CGT), assurance that changing trustee does not give rise to a CGT event for all of the CGT assets held in a trust is diffuse under the Income Tax Assessment Act (C’th) (ITAA) 1997:

Sub-section 104-10(2) concerning CGT event A1 states:

(2) You dispose of a * CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

Sub-section 960-100(2) with the Notes below it in fact say:

(2) The trustee of a trust, of a superannuation fund or of an approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustees, at any given time.

Note 1: This is because a right or obligation cannot be conferred or imposed on an entity that is not a legal person.

Note 2: The entity that is the trustee of a trust or fund does not change merely because of a change in the person who is the trustee of the trust or fund, or persons who are the trustees of the trust or fund.

Similarly sections 104-55 and 104-60 of the ITAA 1997 which concern:

• Creating a trust over a CGT asset: CGT event E1

• Transferring a CGT asset to a trust: CGT event E2

each restate the above Note: viz.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event E… will not happen merely because of a change in the trustee.

Stamp duty

A change of trustee can have stamp duty consequences where the trust holds dutiable property such as real estate.

Duty – NSW

Concessional stamp duty on the transfer of the dutiable property of the trust to the new trustee can be denied in NSW to a FDT unless the trust deed of the trust limits who can be a beneficiary, for anti-avoidance reasons: see sub-section 54(3) of the Duties Act (NSW) 1997.

Indeed Revenue NSW withholds the requisite satisfaction in sub-section 54(3) unless the TTOGRs provide or have been varied in such a way so that an appointed new trustee or a continuing trustee irrevocably cannot participate as a beneficiary of the trust. Contentiously satisfaction is withheld by Revenue NSW unless a variation to a FDT to so limit the beneficiaries is “irrevocable“ : see paragraph 6 of Revenue Ruling DUT 037, even though that variation may not be plausible or permissible under the TTOGRs of the FDT.

This hard line is taken by Revenue NSW to defeat schemes where someone, who might otherwise be a purchaser of dutiable property who would pay full duty on purchase of the property from the trust, becomes both a trustee and beneficiary able to control and beneficially own the property who is thus able to contrive liability only for concessional duty and avoid full duty,

Duty – Victoria

Although the Duties Act (Vic.) 2000 contains anti-avoidance provisions addressed at this kind of anti-avoidance arrangement, there is no comparable hard line to that in NSW in sub-section 33(3) of the Duties Act (Vic.) 2000 so that the transfer of dutiable property, including real estate, on changing trustee is more readily exempt from stamp duty.

Other requirements

A prominent requirement on changing trustee of a SMSF is notification to the Australian Taxation Office, as the regulator of SMSFs, within twenty-eight days of the change: see Changes to your SMSF at the ATO website.

Where changing trustee involves a corporate trustee then there may also be an obligation to inform the Australian Securities and Investments Commission of changes to details of directors of the corporate trustee, if any. There may be further matters to be addressed if any new or continuing directors are or will become non-residents of Australia and, with SMSFs, the general requirement in section 17A of the SIS Act that the parity between members of the fund on the one hand and trustees, or directors of the corporate trustee on the other, needs to borne in mind and, if need be, addressed.

Taking out tax when superannuation death benefits are paid to deceased estates and testamentary trusts

Confusion-Blue

Who pays tax and how much when a superannuation fund pays out death benefits to a deceased estate or to a testamentary trust is not intuitive. The two technical concepts of “dependant” and “taxable component” in particular are a source of confusion.

Dependant

There are two relevant kinds of dependant. The SIS Act kind of dependant (a spouse of the person, any child of the person and any person with whom the person has an interdependency relationship – section 10 of the Superannuation Industry (Supervision) Act 1993) notably differs from a death benefits dependant under section 302-195 of the Income Tax Assessment 1997 , a subset of (SIS Act) dependant, as a death benefits dependant excludes adult children who are not disabled or in an interdependency relationship. Such an independent adult child can be a (SIS Act) dependant in receipt of a death benefit from a superannuation fund but is not a (section 302-195 of the ITAA 1997) death benefits dependant.

Taxable component

For tax purposes a death benefit is split into a taxable component and a tax fee component. The tax free component is tax free to any dependant but the taxable component is a misnomer when paid to a death benefits dependant (DBD): it’s tax free too! So of the four permutations (tax free to DBD, tax free to Non-DBD, taxable to DBD, taxable to Non-DBD) it is when a death benefits dependant receives a death benefit comprising taxable component that the benefit becomes taxable.

Re-contribution

Superannuation benefits can be paid prior to death if a member has satisfied a condition of release such as reaching the age of 65 years. This can be a way of reducing the taxable component of a death benefit that might be taxable to a dependant when paid after the member’s death. Member benefits, viz. benefits withdrawn by a member during his or her lifetime, are generally not taxable to the member where the member has reached aged 60.  It is permissible to re-contribute withdrawn benefits as non-concessional contributions back into superannuation, which become tax free component, when later paid out by the superannuation fund as death benefits.

Non-concessional limits and caps on re-contribution

However the member must be within non-concessional contribution limits to re-contribute back into superannuation in this way. At over age 65 that involves meeting the work test and being within the non-concessional caps. That is being under:

  • annual non-concessional contributions of $100,000 p.a. (no bring forward allowed for over age 65s); and
  • a total superannuation balance of $1.6m.
A look at how a taxable death benefit is taxed

A payment of death benefit that flows to a beneficiary of a deceased estate is something of a three stage event. The tax system looks through to the ultimate dependant in receipt of the death benefit (the third stage) even though the trustee of the superannuation fund may simply be paying death benefits to the legal personal representative of the deceased member who is an allowable (SIS Act) dependant (the first stage).

Non-death benefits dependants only get lump sum death benefits

Only lump sum death benefits can be paid to a dependant who is not a death benefits dependant, such as an independent adult child, so ordinarily we are looking at tax at 15% on a “taxed element” (the usual source [element] of benefits from a SMSF) but other rates can apply: see this table of rates at the ATO website https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=12

A curiosity is that taxable lump sum death benefits received by the trustee of a deceased estate are not subject to the medicare levy. Taxable lump sum death benefits viz. taxable component received directly by a non-death benefits dependant from the trustee of a superannuation fund, that is, not indirectly from the fund via a legal personal representative deceased estate dependant, is subject to medicare levy and PAYG withholding.

No PAYG withholding on lump sum death benefit paid by the trustee of the superannuation fund

The ATO also confirms that a lump sum death benefit is not subject to PAYG withholding where it is paid to:

  • a death benefit dependant (tax free); or
  • the trustee of a deceased estate – this amount is taxed within the deceased estate broadly in the same way it would be taxed if it was paid directly to the beneficiary.

https://www.ato.gov.au/super/apra-regulated-funds/paying-benefits/taxation-of-super-benefits/?default

The trustee of the superannuation fund is obliged to provide a PAYG payment summary – superannuation lump sum form (NAT 70947) to the trustee of the deceased estate within fourteen days of the payment though.

Obligations of the trustee of the deceased estate

According to the 2018 trust tax return instructions at the ATO website https://www.ato.gov.au/forms/trust-tax-return-instructions-2018/?page=43

A superannuation death benefit paid to a trustee is taxed in the hands of the trustee in the same way that it would be taxed if paid directly to a beneficiary, that is, the portions of the payment are subject to tax to the extent the beneficiary is a dependant or a non-dependant of the deceased. There is no tax payable to the extent that the payment is made to dependants or eligible non-dependants of the deceased.

At stage two, the trustee returns the taxable portions applicable to the non death benefits dependants in the trust return so that the ATO can assess the tax payable by the trustee as if the estate beneficiary/non-death benefits dependant was being directly taxed (with the taxed element generally capped to 15%).

This tax is a final tax paid at the trustee of the deceased estate level so no tax at stage three! A trustee of deceased estate should not include taxable elements of a superannuation death benefit lump sum, otherwise returned and directly and finally taxed, in income in its tax return. Then these amounts will not be further taxed at stage three as income say of a resident adult beneficiary.

Declarations of trust and stamp duty on disguised conveyances

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Each of the state and territory duty jurisdictions include declarations of trust over dutiable property (typically real estate) as dutiable transactions in one form or another. Without a declaration of trust head of duty, or an apt anti-avoidance provision, conveyancing duties that would by paid on a transfer of the dutiable property to B can be avoided by A declaring that property is held on trust for B though still held legally (on title) by A. Duty on a declaration of trust generally applies at full rates chargeable against the value of the dutiable property and differs from the head of duty which applies to declarations of trust which are not made over dutiable property to which a concessional duty or, in some states and territories, no duty will apply.

Duty eagerly assessed on the mention of a trust

So the Commissioners of State Revenues Australia wide are eager to assess any document to duty which purports to contain a declaration of trust over dutiable property which could be viewed as either:

  • a transfer of beneficial interest in the property in substance; or
  • a disguised transfer.

Integrity of the state revenues

That zeal can be understood in the context of the integrity of state revenues. In New South Wales, where a “declaration of trust” is a dutiable transaction under section 8 of the Duties Act 1997, Revenue NSW will treat documents which foreshadow or even just mention a trust over dutiable property as dutiable. Hence those who have an eye to the duty implications of deeds and documents that impact dutiable property are justifiably cautious about using the expression “on trust” in a deed or document where dutiable conveyance of the beneficial ownership of dutiable property by that document is not intended.

Ambit declaration duty rejected in W.A.

A recent case in Western Australia shows that duty on documents that state that dutiable property is held on trust can be too readily assessed as a declaration of trust by state revenue. The W.A. Court of Appeal in In Rojoda Pty Ltd v. Commissioner of State Revenue (WA) [2018] WASCA 224 decided against the Commissioner where two deeds of dissolution of partnership in that case explicitly stated that a partner, the surviving registered owner of land, held dutiable property on trust for other surviving partners of the partnerships. The Court of Appeal found that the dissolution of two partnerships involving family members, whose business included property ownership and investment, were not declarations of trust and were not dutiable as declarations of trust over dutiable property.

It was determinative in Rojoda that the trusts recited in the deeds were confirmatory of trusts that already existed. It was significant that the Court of Appeal, in overturning a decision by the State Administrative Tribunal, was prepared to examine the equitable implications and the relevant legal and beneficial interests of the partners just before and on the execution of the deeds of dissolution of the partnerships. The Court of Appeal found that the legal and beneficial interests of the partners, just before the deeds were executed, were sufficiently comparable to the interests set out to be on trust in the deeds and thus held the deeds established no new trusts and thus did not declarations of trust in the context of the W.A. head of duty.

Identifiable new trust needed for a dutiable declaration of trust

The land had been used as partnership property of the partnerships. The Court of Appeal found that the wife, who was the surviving registered proprietor of the land, already held the land for the partners, which included the children of the wife and the husband, or their representatives. They thus had specific and fixed beneficial or equitable interests in the partnership properties before the deeds prepared for the dissolution of the partnerships were executed. These interests, reflecting their respective proportionate share of partnership property, were comparable interests to those said to be held on trust in the deeds. Thus the Court of Appeal found the trusts set out in the deeds were not new trusts declared over property dutiable in W.A.

The High Court has granted the Commissioner of State Revenue special leave to appeal in Rojoda. This case will likely inform what amounts to a declaration of trust dutiable in state and territory stamp jury jurisdictions.