Family trust subject to surcharge land tax in NSW as deed did not exclude foreign persons

Overview

Unless a discretionary trust deed excludes foreign persons, foreign trustees and foreign corporations, significant additional duty and land tax is typically imposed if the trust acquires residential property. The best way to minimise such tax is to make sure you obtain assistance from a quality supplier and obtain advice well in advance.

Why did the family trust incur additional NSW land tax?

The recent decision of the New South Wales Civil and Administrative Tribunal (NCAT) shows that a ‘deed of rectification’ to vary a trust deed after a land tax assessment had already issued is not sufficient to avoid foreign land tax surcharge. The deed of rectification was not effective as there was no evidence to support the intention to exclude foreign beneficiaries from the establishment date.

What were the facts of this NSW case?

The facts of the case Chloe Adolphi Pty Ltd as trustee for The Chloe Adolphi Family Trust v Chief Commissioner of State Revenue [2024] NSWCATAD 48 (22 February 2024) were as follows:

• The Chloe Adolphi Family Trust (Trust) was established on 16 April 2021.
• The trustee was Chloe Adolphi Pty Ltd (Trustee), Mr Guidera was the appointor and Mr Palyga was the settlor. Mr Palyga broadly drafted the trust deed.
• In May 2021, the Trust acquired residential property in NSW.
• The main beneficiary was Chloe Adolphi, with a wide definition of other beneficiaries who could benefit under the Trust. A broad discretion was conferred on the Trustee.
• The trust deed did not seek to exclude foreign persons from benefitting under the Trust. This point was not in contention.
• In October 2022 the Trust was assessed for land tax and surcharge land tax for the 2021 land tax year. The Trustee objected to the assessment.
• In December 2022 the Trustee, settlor and appointor executed a “deed of rectification”. The reason recited in the deed of rectification was that the terms of the deed needed amendment to give effect to the intention of the settlor, appointor and Trustee that no foreign person could benefit from the Trust. They argued that the effect of the deed of rectification was to cause the basis for liability to surcharge land tax to be absent from the establishment of the Trust. That is, that the Trust was not a foreign trust from establishment.

What is a foreign trust?

The Land Tax Act 1956 (NSW) provides that a discretionary trust is deemed to be a foreign person if the terms of the trust deed does not exclude a foreign person from benefiting from the trust. This requires that the terms of the trust specifically exclude foreign persons and that the trust cannot be amended to include foreign persons as potential beneficiaries.

In NSW a ‘foreign trust’ will pay a surcharge land tax rate on the taxable value of all residential land it owns. While initially lower, the surcharge rate is 4% from the 2023 land tax year.

What is rectification?

Explaining what ‘rectification’ is through the relevant authorities, the NCAT said:

… rectification is a remedy to correct the record of an agreement where that has failed, whether through mutual or unilateral mistake, has omitted a term or failed to express a term of an agreement

…

Having regard to its purpose, rectification of a document is considered to have retrospective effect; accordingly, the document to which the rectification applies is read as if it had been executed in the rectified form

…

A document is not capable of being rectified … in circumstances where the parties never considered a matter that has then been brought to their attention subsequently. If there is no actual intention at the time of creation of the document, then there has been no mistake.

…

Nor is rectification effective to correct an error about the legal or factual consequences of a document

…

the retrospective alteration of the parties’ rights or obligations under a rectified instrument may be resisted by third parties to whom rights have accrued

Outcome

NCAT found it was not necessary to decide whether there was a potential beneficiary of the trust that was a foreign person. Further, the Trustee could not establish that the requisite intention to exclude foreign persons from benefiting under the Trust existed on establishment of the Trust.

Accordingly, the ‘deed of rectification’ did not change the (taxable) facts that existed at the time the land tax liability arose. Thus, the Trustee was liable to the surcharge.

Can an SMSF be a foreign trust?

It appears likely that the state revenue authorities will treat an SMSF in the nature of a fixed trust and look to the member balances to determine whether the relevant interest threshold has been met. Although it is likely that an SMSF does not face the same risks as a discretionary trust, the application of the additional surcharge is still a further consideration for SMSFs purchasing property.

Conclusion

This case shows the importance of including foreign trust exclusions in a trust from the establishment date. The ability to make retrospective amendments to a trust deed after a tax liability arises is limited and such changes will typically not be effective against third parties such as state or federal tax commissioners.

Where there is an existing discretionary trust that acquires residential real estate, advice should be obtained on varying the trust deed to exclude foreign persons. Unless a variation is completed before a liability arises, it is difficult to avoid the additional tax.

Advisers should ensure that they query what a client plans for any new trust, and recommend they consider excluding foreign persons from the commencement date. Advisers should also be notifying clients with existing trusts to make sure they are aware of the strategies to minimise the foreign person surcharge tax rates.

Naturally, if requested, DBA Lawyers would be please to provide assistance. We offer a wide variety of trust related services including discretionary trust packages that exclude foreign beneficiaries.

Related articles:

Some articles relating to trusts are:

• Discretionary trusts — NSW duty & land tax surcharges — act before 31 December 2020 or incur extra NSW tax
• Update on foreign purchaser surcharges
• Is your discretionary trust still discretionary? Case law developments on trustee duties
• Discretionary trusts – variations and issues

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

Note: DBA Lawyers hold SMSF CPD training throughout the year. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your practice, visit www.dbalawyers.com.au.

By Shaun Backhaus ([email protected]), Senior Associate, Fraser Stead ([email protected]), Lawyer and Daniel Butler ([email protected]), Director, DBA Lawyers

DBA LAWYERS

15 March 2024