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Fixed trust present entitlement – a land tax trap?

Trusts and land tax in NSW

To protect the integrity of land tax:

  • so no advantage is given to trust owned land that can’t be treated as owned by a taxable person viz. an individual or a company; and
  • by means now also similarly adopted in other jurisdictions, notably Victoria (trust surcharge rate applicable mainly to land acquired by a trust after 31 December 2005 Land tax and trusts | State Revenue Office Victoria https://t.ly/ex6Jw );

New South Wales taxes a trust that owns NSW land not entitled to concessional tax treatment at an ample land tax rate as a special trust without threshold allowed to an outright individual or a company owner of land viz. not subject to a trust: see section 25A of the Land Tax Management Act (NSW) 1956 (LTMA).

Photo by Jon Tyson on Unsplash

Fixed trusts

A key concession where the special trust rate will not apply is where a trust is a fixed trust:

the equitable estate in all of the land that is the subject of the trust is owned by a person or persons who are owners of the land for land tax purposes …

and the trust won’t then be a special trust: sub-sections 3A(1) and 3A(2) of the LTMA.

Where a trust is a fixed trust the trustee is not separately taxed for persons, who are owners of the equitable estate in the land:

  • are taken to be owners for land tax purposes;
  • are liable for land tax as if they were the legal owners of the land: section 25 of the LTMA; and
  • unlike the trustee of a special trust who can’t apply threshold, these land tax owners can apply their remaining threshold and thereby access or potentially access a lower land tax rate.

Usually, as this term of art is understood in trust law, a fixed trust will be a fixed trust under section 3A of the LTMA. It doesn’t follow that a unit trust will usually be a fixed trust.

When can a unit trust be a fixed trust?

Whether or not a unit trust is a (section 3A) fixed trust will vary case by case as some unit trusts meet the above formulation of a fixed trust in sub-section 3A(2) and some, likely most, do not.

The demarcation was authoritatively considered by the High Court in CPT Custodian Pty Ltd v Commissioner of State Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53. CPT Custodian Pty Ltd was a Victorian land tax case where unit holders of a unit trust where found not to have an equitable estate in the property of the trust. It followed that the unit holders could not be treated as having a fixed interest in the property of the trust and so they could not be treated as owners of the land of the trust for Victorian land tax purposes.

CPT Custodian Pty Ltd distinguished the earlier decision of the High Court in Charles v. Federal Commissioner of Taxation (1954) HCA 16 where, unlike in CPT Custodian, unit holders were conferred equitable proprietary interests in the property of the unit trust in the proportions in which they held units under the terms of the trust deed of the relevant trust in Charles, the Second Provident Unit Trust.

The LTMA approach

If what is a fixed trust under the LTMA ended with the sub-section 3A(2) formulation as enunciated in CPT Custodian Pty Ltd then a fixed trust under the LTMA would be conceptually clear and land tax integrity aims would be achieved. But sub-section 3A(2) and CPT Custodian Pty Ltd are either:

  • somehow not enough assurance of the integrity of the distinction to the legislator; or
  • unintelligible to or incapable of ready application by Revenue NSW officers;

and so the LTMA proffers additional relevant criteria viz. guidelines for what is a fixed trust viz. when the “relevant” criteria are met, a trust will be taken to be a fixed trust with owners taken to have the required equitable estate in the land of the trust: section 3A(3A) of the LTMA.

Safe harbour?

In other words the relevant criteria are a safe harbour viz. where the relevant criteria are satisfied by a trust then it will be notionally unnecessary to separately apply the principles enunciated in CPT Custodian to ascertain whether the equitable estate in the subject land under the trust is wholly owned by a person or persons who are owners of the land for land tax purposes.

The relevant criteria are:

(a) the trust deed specifically provides that the beneficiaries of the trust–

        (i) are presently entitled to the income of the trust, subject only to payment of proper expenses by and of the trustee relating to the administration of the trust, and

        (ii) are presently entitled to the capital of the trust, and may require the trustee to wind up the trust and distribute the trust property or the net proceeds of the trust property,

    (b) the entitlements referred to in paragraph (a) cannot be removed, restricted or otherwise affected by the exercise of any discretion, or by a failure to exercise any discretion, conferred on a person by the trust deed,

    (c) if the trust is a unit trust–

        (i) there must be only one class of units issued, and

        (ii) the proportion of trust capital to which a unit holder is entitled on a winding up or surrender of units must be fixed and must be the same as the proportion of income of the trust to which the unit holder is entitled.

section 3A(3B) of the LTMA (emphasis added)

But what safety is there in the safe harbour?

So if you are establishing a unit trust to hold NSW land that is to be treated as a fixed trust, or you are the lawyer acting for prospective NSW land owners setting up a unit trust what do you do? Should you simply include the relevant criteria so a Revenue NSW officer can give the trust a sign off on the safe harbour for a fixed trust under section 3A(3A) so the trustee won’t be taxed on the land on a special trust basis?

Discretions and classes of units

Section 3A(3A)’s relevant criteria concerning discretions shouldn’t present a difficulty. A unit trust that meets the  principles in CPT Custodian and is comparable to the Second Provident Unit Trust in Charles doesn’t give discretions to any person to distribute, redirect or accumulate income or to distribute or redirect capital to beneficiaries other to the unit holder who holds the so fixed proportion of the equitable estate of the trust. Similarly there would be no point to more than one class of units, as prescribed by the relevant criteria, when designing a trust with fixed proportions of the equitable estate in property of the trust referable to each unit as in Charles.

However present entitlements proposed by Section 3A(3A)’s relevant criteria for a fixed trust are a different matter:

Present entitlements are inapt

Present entitlement as a measure in the relevant criteria is drawn from sub-section 97(1) of the Income Tax Assessment Act (C’th) 1936 (C’th ITAA 36) which speaks of “a beneficiary of a trust estate” who is “presently entitled to a share of the income of the trust estate” and is understood to have a corresponding meaning in the relevant criteria.

Under Division 6 of Part III of the C’th ITAA 36 (Division 6) a beneficiary is presently entitled if, and only if:

  • the beneficiary has an interest in the income which is both vested in interest and vested in possession; and
  • the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

[Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199, at pp 215-216, 219-220; Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444, at pp 450-452; Harmer v. Federal Commissioner of Taxation [1991] HCA 51 at para. 8 and Commissioner of Taxation v. Bamford & Ors, Bamford & Ors v. Commissioner of Taxation [2010] HCA 10 at para. 37.]

Present entitlement is an evaluative state at a particular point of time which is applied under Division 6 to retrospectively determine income tax liability at the end of either an income year or some other period of a trust in practice. In that context present entitlement is not used as a means to define estates or interests in trusts in succession prospectively by a preparer of a trust deed. It is instead used as a determinant of tax liability turning on whether a person is presently entitled to income of a trust. Despite that the relevant criteria in sub-section 3A(3B) agitate specific trust deed provisions that beneficiaries of a trust “are presently entitled” to income and capital of a fixed trust to attract the safe harbour.

Temporal fail

This doesn’t work as even a fixed trust with fixed correlation between the income and capital of the unit holders as holders of the equitable estate in the property of the trust can’t always achieve present entitlement in a time continuum, and certainly not at the outset of the trust when a trust deed of a trust may likely be drafted to potentially include the relevant criteria and executed, and the trust is yet to acquire property to which the beneficiaries may become presently entitled to income and capital but not “are” yet.

The relevant criteria oblige that beneficiaries are presently entitled seemingly to all income and capital of the trust through its existence. Beneficiaries can’t be presently entitled to income and capital in property of a trust that the trust is yet to acquire or to income of future periods or to capital on dates in the future of the trust. Beneficiaries are not presently entitled to income and capital from property that is yet to be property of the trust and a provision to the contrary in a trust deed to the effect that they are makes no sense.

Senseless provisions in a trust deeds unhinge the effectiveness of their other provisions and the trust itself.

Present entitlement when a unit holder dies?

Further Division 6 contains failsafes that apply where no beneficiary is presently entitled viz. sections 99 and 99A. Section 99 dealing with deceased estate cases is of particular significance as it could be that a unit holder in a unit trust with provisions in its trust deed to comply with the relevant criteria and to gain the safe harbour dies. From the moments after death until full administration of the deceased estate of the deceased unit holder, if that occurs, there is no owner of an equitable estate in the property of the trust reflecting the interest of the deceased who is presently entitled to the income of the property such as the fixed trust interest in the deceased estate: see Taxation Ruling IT 2622 Income tax: present entitlement during the stages of administration of deceased estates.

Until a legal personal representative obtains probate or letters of administration no equitable owner has standing to require the trustee of the fixed trust to require the trustee to transfer the property reflecting the interest of the deceased over to them.

But that is contrary to and in breach of a trust deed that obliges continual present entitlement, viz. that beneficiaries remain “are” presently entitled to the income and capital in land in succession.

Present entitlement when a unit holder is an infant or lacks legal capacity?

It could be that units in a unitised fixed trust that has adopted the relevant criteria come be to owned by an infant or a beneficiary subject to a disability who cannot be presently entitled to income or capital of the trust. In Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444, at pp 450-452 Kitto. J was able to deal with how section 98 can apply to these beneficiaries at para. 11 as follows:

Notwithstanding a passage in the joint judgment of Latham C.J. and Williams J. (Federal Commissioner of Taxation v. Whiting (1943) 68 CLR, at pp 214-215 ) which I must own I do not altogether understand in view of the recognition by s. 98 that a beneficiary may be “presently entitled” to income notwithstanding that by reason of a legal disability he has no right to obtain immediate payment, the tenor of the judgments is, I think, that “presently entitled” refers to an interest in possession in an amount of income that is legally ready for distribution so that the beneficiary would have a right to obtain payment of it if he were not under a disability.

(at p452)

but sub-section 3A(3B)(a) of the LTMA, unlike section 98 in Division 6, is neither qualified nor focused on application to a beneficiary under a legal disability who has no right to immediate payment of the amount such that the beneficiary can be considered presently entitled to income and capital of the trust so there is no reason why present entitlement of an infant unit holder, who can’t demand payment of trust income to him or her, for instance, should be inferred under sub-section 3A(3B)(a) of the LTMA based on Taylor.

Companies that “are” presently entitled – more likely to work

Unlike individuals, companies have perpetual succession and so, when they are beneficiaries of a fixed trust they can likely sustain continual present entitlement to the income and capital of a trust.

Is the inference thus to be drawn that a trust deed of a trust that includes the “are” presently entitled conditions to meet the relevant criteria and attract the safe harbour precludes individuals from becoming beneficiaries because an individual cannot necessarily sustain continual present entitlement such that they always are presently entitled because they may die, lose or never have legal capacity?

Lawyer’s quandary

How is a drafter of a deed for a fixed trust to deal with sub-section 3A(3A)’s relevant criteria in sub-section 3A(3B) then? I can’t follow what legitimate concern it is of the NSW legislature in a taxation statute or Revenue NSW to dictate trust terms to lawyers tasked with defining fixed interests in estates in succession but clearly blind adoption of the relevant criteria gives a tempting assurance to a drafter of a trust deed that a trust will be a fixed trust not land taxed as a special trust.

But inclusion of the relevant criteria which shouldn’t be strictly necessary has unintended consequences. A lawyer drafting a trust deed for a client is obliged to ensure that the drafting of a trust:

  • does not have adverse implications for the client such as precluding individuals who can be taxable owners for land tax from being unit holders; and
  • needs be wary of including trust deed terms that make no sense for which the lawyer, and not the legislator, is professionally responsible to the client.

Of further concern is that, despite the primary notion of the definition of fixed trust in section 3A(2), my recent experience is that Revenue NSW is obliging trustees to meet section 3A(3A)’s relevant criteria as if it is on those criteria, rather than the actual definition of fixed trust in section 3A(2), on which a fixed trust characterisation under the LTMA will turn. Without express inclusion of the are presently entitled stipulations of beneficiary interests in the trust deed of the trust Revenue NSW is treating a fixed trust that meets the CPT Custodian principles and so makes out as a fixed trust under section 3A(2) as a special trust. Officers at Revenue NSW don’t appear to follow or recognise that sub-sections 3A(3A) and (3B) are a safe harbor for the fixed trust notion specifically defined in sub-section 3A(2) of the LTMA.

Land tax assessments arising due to this approach by Revenue NSW should be challenged and disputed.

The capital gains tax main residence exemption, affordable housing and caps

CGT beginnings

With wage and salary earners taxable on virtually every dollar they earn from their work, sources from the Asprey Report (1975) through to the tax summit of 1985 identified the lack of a capital gains tax as a tax regressive unfairness in the Australian income tax system which then relied on a narrower tax base. Before the CGT, gains on investments made by their owners escaped income tax and allowed already wealthier people to step up their wealth untaxed where less wealthy typically working people who paid their taxes could not.

Still it would have been near unthinkable for the Hawke Keating government of 1985 to have introduced the capital gains tax, which then was a partisan political and controversial proposal, into the Australian income tax system without CGT relief on the family home following the tax summit.

In those days a greater proportion of working people and middle Australia owned their own homes. So the exemption now legislated as the CGT main residence (MR) exemption in Division 118 of the Income Tax Assessment Act (ITAA) 1997, then not thought especially regressive, was a political price the government then had to pay to have a constituency-supported capital gains tax in the Australian income tax mix at all.

The uncontained housing tax exemption

But the breadth of the CGT MR exemption has made the CGT MR exemption itself regressive.

The CGT MR exemption is unlimited and especially generous when compared to CGT relief given in other countries.

The CGT MR exemption has these characteristics:

  • generally, where there is no income-earning use of a home and a taxpayer is or is taken to have occupied the home as their main residence while he or she has owned it, any capital gain on the home is fully exempted from the Australian CGT;
  • there is no qualifying length of ownership period to wait before the CGT MR exemption can be applied to exempt CGT on sale of an Australian home – the owner can live there for a month, rent the property out for five years, go overseas, come back and sell the (former) home and claim the full exemption – see section 118-145 of the ITAA 1997; and
  • a taxpayer can turnover any number of homes and keep claiming the exemption from CGT on every successive capital gain. In other words there are no limits on the amount of, or numbers of tax free step ups in, wealth a taxpayer can achieve with no taxation by selling each of their successive and possibly more expensive homes.

This has made Australian home ownership an incomparably attractive investment for tax reasons. This frustrates wider social housing objectives such as opportunity and ability for the populace to securely house themselves when they cannot afford to compete in the housing market especially as long term renting in Australia is not so secure either.

Sources of unaffordable housing

The CGT MR exemption has indisputably contributed to unaffordible housing both as a tax shelter, as a driver of demand for real estate and as an improver of the financial case to own an expensive home. To what extent is not for a tax lawyer, who is no econometrician, to judge. The CGT MR exemption may not even be the greatest contributor to unaffordable housing in Australia. Housing markets around the world are elevated due to the abundance of money injected into major economies by quantitative easing. But in Australia add:

  • dark money laundered through Australian real estate attributable to persisting slack regulation of money flows into Australia, including continuing failure by government to commence the 2007 AML/CTF measures to expand the range of oversight of AUSTRAC to non-financial businesses and professions including the legal, accounting and real estate professions: see my 2017 blog – Sluggish anti-money laundering reform in Australia https://wp.me/p6T4vg-6J and The Lucky Laundry by Nathan Lynch https://cutt.ly/JCwVAyK;
  • housing financialisation; and
  • light and regressive taxation of housing in Australia;

to the reasons why Australian residential property prices have reached the unaffordable levels they have.

The wrong culprit

Light taxation has been widely canvassed in the media as a contributor to unaffordable housing but journalists and commentators frequently focus on the 50% CGT discount for investors and negative gearing as the tax system causes of unaffordable housing unfortunately ignoring the CGT MR exemption or even the various land tax exemptions that Australian state and territory governments extend which shelter owner-occupied homes from state taxation too.

The 50% CGT discount was an inexplicable 1999 adjustment to sound original design of the CGT in 1986. It replaced the indexation of cost (base) which was to ensure an investor paid tax only on a real capital gain after adjusting for inflation but at ordinary income tax rates so the CGT could work fairly and progressively as designed. The 50% CGT discount instead effectively and regressively reduced the income tax rate on investment capital gains made by property investors, as it turned out, during a period of negligible inflation which the 50% discount was meant to overtly but more crudely counter. Now inflation is back so a nuanced policy response may be to scrap the 50% CGT discount and to revert back to the 1986 indexation of cost which should never have been altered in the first place.

In contrast to the CGT MR exemption, the 50% CGT discount has a waiting period, 12 months – see section 115-25 of the ITAA 1997, which is not much, and is limited to 50% as a highest discount to individuals. Like the CGT MR exemption, availability is not limited or capped to those who qualify and this is a boon to investors in the property market although major investors and developers need to be tax wary that their property investment activity is not treated by the Commissioner of Taxation as a business of profit-making by sale with the consequences that:

  • proceeds of sale of investment in housing become taxable as ordinary income;
  • thus CGT relief, such as the 50% CGT discount, is unavailable – see section 118-20 of the Income Tax Assessment Act (ITAA) 1997; and
  • their activities become an enterprise where they must charge the goods and services tax (GST) to buyers for reasons set out in Miscellaneous Taxation Ruling MT 2006/1.

Tax relief saving for a home?

The CGT MR exemption is of no benefit to someone who is saving for a home, but does not have a home yet, whom one would think would be the focus of a real and progressive tax exemption to house. Capital gains made on investments by someone saving for a home are not exempt from tax, and get no better than the 50% CGT discount I have maligned in this post, which is odd when it is understood the tax system gives already housed wealthier citizens, who may turnover a series of homes of increasing value and for increasing gains, full tax relief on each gain made on their homes through the CGT MR exemption.

For the CGT MR exemption to be fairer, and to discourage home buyers from taking on higher mortgages to get into the housing market where ruin may be more likely than gain, could the CGT MR exemption extend to capital gains made by persons who are saving for a home or who are yet to own home on portfolio assets set aside to buy a home they hold in the interim? Clearly the former First Home Saver’s Account scheme, which was an utter failure and repealed in 2014, was not ambitious enough and was a false move to help those accumulating what they need to buy a home.

A cap on the CGT main residence exemption?

A limit or cap could be put on the CGT MR exemption that a taxpayer can use to exempt capital gains on his or her home during their lifetime. This would take heat out of the housing market.

An arguably generous lifetime cap of $A 1 million would still bring in substantial additional CGT revenue that could fund social and universal housing and reduce the CGT MR exemption rort by those who take large or multiple full exemptions on their turnover of increasingly expensive homes. The CGT system already uses a lifetime limit in the small business CGT retirement exemption rules in Subdivision 152-D of the ITAA 1997 and caps now limit contributions that can be put into tax concessional superannuation on tax fairness and equity grounds.

A home turnover limitation?

In many countries in Europe a holding period of less than five years can cause capital gains on assets including the family home to be taxable. Tax relief cuts in where an asset is held for longer. Are their approaches something Australia should also consider when looking at tax exemptions and concessions for housing?

Challenge

There is no doubt changes that really improve Australian housing affordability and address inequitable and fiscally disastrous untethered tax exemptions will be politically fraught especially when there are so many interests vested in the present tax system who may lose with change. In the bigger picture lightly taxed property gains and unquarantined negative gearing deductions can be seen as scourges when proper taxation, orthodox monetary policy and extended oversight of criminal money flows could be used to re-balance the housing investment market with the social housing needs of Australia’s citizens.

Foreign purchaser stamp duty and land tax surcharges – design faults & unit trusts

DesignFault

Advent of the state foreign person property surcharges

Foreign person surcharges have applied on New South Wales, Victoria, Queensland, Tasmania, Western Australia and Australian Capital Territory property taxes following Commonwealth action to have the Foreign Investment Review Board more closely monitor the acquisition and holding of Australian real estate by foreign interests: see our July 2016 blog post:

Australia is now tracking & surcharging foreign buyers of land

https://wp.me/p6T4vg-56

NSW surcharges and current rates

In NSW, surcharges imposed since 2016 are:

(a)          a surcharge purchaser duty (currently 8% of the market value of the property) on the acquisition of residential property in NSW (Chapter 2A of the Duties Act (NSW) 1997 [DA]); and

(b)          a surcharge land tax (currently 2% of the unimproved value of the land) for  residential property in NSW owned as at 31 December each year (section 5A of the Land Tax Act (NSW) 1956).

(Surcharges)

The foreign trusts that aren’t foreign problem

Discretionary trusts with all or predominantly Australian participants and entitled beneficiaries can nevertheless be caught as foreign trusts that must pay the Surcharges. Liability for the Surcharges is based or grounded on sub-section 18(3) of the Foreign Acquisitions and Takeovers Act (C’th) 1975 (FATA): Sub-section 18(3) provides:

For the purposes of this Act, if, under the terms of a trust, a trustee has a power or discretion to distribute the income or property of the trust to one or more beneficiaries, each beneficiary is taken to hold a beneficial interest in the maximum percentage of income or property of the trust that the trustee may distribute to that beneficiary.

sub-section 18(3) of the Foreign Acquisitions and Takeovers Act (C’th) 1975

If the income or property (capital) that could be distributed to a foreign beneficiary of a trust is 20% or more of income in a year or property of the trust, the trust is foreign for FATA and Surcharge purposes. An ameliorating aspect of the Surcharges legislation is that:

  • Australian citizens who are non-residents of Australia; and
  • some New Zealand citizens with certain Australian visas;

who are foreign persons under the wide sweep of sub-section 18(3) of the FATA are excluded from being foreign persons for NSW Surcharges purposes: see sub-section 104J(2) of the DA.

The lengthy transition

Even for those not averse to the idea that foreign individual and foreign trust investors should pay higher property dues the implementation of the Surcharges in NSW has been agonising. Even now, in 2020, four years after liabilities for Surcharges were first imposed under the DA and the LTA the State Revenue Legislation Further Amendment Act (NSW) 2020 (“SRLFAA”) is still needed to phase in the Surcharges, and transitional relief from them, as they apply to trusts.

As well as imposing the wide sweep of what the FATA treats as foreign, the SRLFAA:

  • imposes impugnable trust deed requirements on discretionary trusts (see below); and
  • extends transitional arrangements that were set to end on earlier dates in versions of Revenue Ruling G010 from Revenue NSW and the State Revenue Legislation Further Amendment Bill (NSW) 2019.

Trust deed requirements on discretionary trusts

Where a trust is a discretionary trust for Surcharge purposes then the SRLFAA requires that the terms of the trust must be amended by 31 December 2020 so:

(a) no potential beneficiary of the trust is or can be a foreign person [the no foreign beneficiary requirement]; and
(b) the terms of the trust cannot be amended in a manner so a foreign person could become a beneficiary [the no amendment requirement];

and then only does the discretionary trust, even a discretionary trust that:

  • has no foreign participants or beneficiaries; and
  • thus is not foreign after the FATA wide sweep and sub-section 104J(2) of the DA are considered;

(a Local DT) escape treatment as a foreign trust for Surcharge purposes.

Why the no amendment requirement?

The object of the no amendment requirement is to impose the Surcharges based on the contingency or possibility only that a Local DT may come to have a foreign beneficiary in the future. The position of Revenue NSW is understood to be that Revenue NSW does not have the compliance resources to monitor Local DTs for foreign beneficiaries into the future on an ongoing basis.

Although nearly all discretionary trust deeds contain some kind of variation power, a design fault of such resource-saving requirements viz.:

  • the “irrevocable” requirement of Revenue NSW in paragraph 6 of Revenue Ruling DUT 037 concerning sub-section 54(3) of the DA concerning concessional duty on changes of trustee; and
  • the no amendment requirement now in the SRLFAA;

is that the variation power in many or most trust deeds of trusts in NSW may not permit modification of the variation power to satisfy either of these requirements.

Changing the scope or amending the terms of a trust amendment power

In Jenkins v. Ellett, Douglas J. of the Queensland Supreme Court stated the relevant law and learning about changing the variation power in a trust deed:

[15] The scope of powers of amendment of a trust deed is discussed in an illuminating fashion in Thomas on Powers (1st ed., 1998) at pp. 585-586, paras 14-31 to 14-32 in these terms:

“In all cases, the scope of the relevant power is determined by the construction of the words in which it is couched, in accordance with the surrounding context and also of such extrinsic evidence (if any) as may be properly admissible. A power of amendment or variation in a trust instrument ought not to be construed in a narrow or unreal way. It will have been created in order to provide flexibility, whether in relation to specific matters or more generally. Such a power ought, therefore, to be construed liberally so as to permit any amendment which is not prohibited by an express direction to the contrary or by some necessary implication, provided always that any such amendment does not derogate from the fundamental purposes for which the power was created ….It does not follow, of course, that the power of amendment itself can be amended in this way. Indeed, it is probably the case that there is an implied (albeit rebuttable) presumption, in the absence of an express direction to that effect, that a power of amendment (like any other kind of power) cannot be used to extend its own scope or amend its own terms. Moreover, a power of amendment is not likely to be held to extend to varying the trust in a way which would destroy its ‘substratum’. The underlying purpose for the furtherance of which the power was initially created or conferred will obviously be paramount.”

Jenkins v. Ellett [2007] QSC 154

In our experience a small minority of trusts in NSW have a variation power which expressly permits extension of its own scope or amendment of its own terms. That kind of extended power can raise its own set of difficulties which explains why these extended variation powers are not especially popular. It follows, as stated, that a substantial number of variations of the terms of discretionary trust deeds which the no amendment requirement imposes are prone, or likely, to be beyond the power conferred by the variation power of the trust and thus ineffective on a trust by trust reckoning.

discretionary trust for Surcharges purposes

In section 1 in the dictionary of the DA a discretionary trust is defined for DA and Surcharges purposes:

“discretionary trust” means a trust under which the vesting of the whole or any part of the capital of the trust estate, or the whole or any part of the income from that capital, or both–
(a) is required to be determined by a person either in respect of the identity of the beneficiaries, or the quantum of interest to be taken, or both, or
(b) will occur if a discretion conferred under the trust is not exercised, or
(c) has occurred but under which the whole or any part of that capital or the whole or any part of that income, or both, will be divested from the person or persons in whom it is vested if a discretion conferred under the trust is exercised.

section 1 of the dictionary of the Duties Act (NSW) 1997

More time to check for unexpected foreign trust treatment

With time extended to 31 December 2020 by the SRLFAA to amend trust deeds so a discretionary trust won’t be treated as a foreign person it is timely during the remainder of 2020 to also check the terms of residential land holding trusts that may not ordinarily be thought of as a discretionary trust.

A trust, including a unit trust, that contains powers in its terms which:

  • allow for a beneficiary to be selected by someone to take income or capital;
  • allow for the amount of income or capital a beneficiary is to take to be set by someone;
  • which can change the income or capital a beneficiary will take if the discretion is not exercised; or
  • which can divest a beneficiary of an interest in income or capital which they otherwise would take;

that brings the trust within a discretionary trust in section 1 of the dictionary of the DA needs to meet the no foreign beneficiary requirement and the no amendment requirement in the SRLFAA.

Hybrid trusts and other unit trusts

This definition brings in trusts known as hybrid trusts within this construct of discretionary trust. Shortly stated a hybrid trust is a tax aggressive structure where unit or interest holders have standing vested interests in income or capital of the trust but where, usually, the trustee has a supervening power or powers to divest those interests in income, capital or both in favour of other beneficiaries such as family or related companies or trusts controlled by the unit or interest holder with the standing interest.

Other unit trust arrangements can be treated as a DA discretionary trust even where the discretion is historical, redundant and income tax benign. For instance an older style standard unit trust may be set up by way of initial units and the trustee may be given a discretion in the trust deed not to distribute income or capital to initial unitholders once ordinary units in the trust are issued.

This discretion in the terms of a trust is enough for the unit trust to be treated as a discretionary trust so it would be prudent for the terms of the unit trust to be amended to remove the discretion if that can be done:

  • without resettling the trust; and
  • less onerously than amending the trust deed to comply with the no foreign beneficiary requirement and the no amendment requirement.