Could trust splitting soon result in increased tax obligations?
A draft taxation determination released recently has triggered some alarm among trustees that certain previously benign trust re-arrangements may soon lead to new tax obligations being attached.
TD 2018/D3 posits that certain trust split arrangements should be viewed as the creation of a new trust over some, but not all, of the assets held by the original trust. The result, as set out in the TD, would be to trigger CGT event E1.
While the draft determination allows that there are many forms of arrangement that can be described as a “trust split”, it says that for the purposes of the change to the rules, this refers to an arrangement “where the parties to an existing trust functionally split the operation of the trust so that some trust assets are controlled by and held for the benefit of one class of beneficiaries, and other trust assets are controlled and held for the benefit of others”.
As outlined in this draft determination, the splitting of trusts generally involves a discretionary trust that is part of a family group. “These trust split arrangements often happen where there is going to be tax issues with a planned succession,” says tax policy specialist Ken Mansell. “An example of a trust split arrangement is where Mum and Dad run two shops through a discretionary trust and their two daughters want to take over a shop each as Mum and Dad retire.”
The draft determination states that the common reason given for splitting a trust is to allow different parts of a family group to have autonomous control of their own part of the trust fund.
“Rather than forming a second discretionary trust, transferring one of the shops and the associated business to this second trust and crystallising lots of capital gains tax, the sisters undertake a trust split arrangement,” Mansell says. “This involves requiring the trustee of the current trust to agree to pay all the profits from one shop to one daughter (and her family) and the profit from the second shop to the other daughter (and her family).”
The type of split as described in the determination will, in the eyes of the Commissioner, result in the creation of a new trust by declaration or settlement (as the case may be), and therefore see the trustee take on new obligations, with new rights assigned to assets. This would therefore cause the occurrence of CGT event E1 (creating a trust over a CGT asset).
“This type of arrangement was widely used to avoid the CGT that would occur transferring assets to a new trust,” Ken Mansell says. “However, this draft determination states that CGT is still payable if you use this trust split arrangement, as there are functionally two trusts now.”
The determination also contains the view that such splits will ordinarily exhibit all or most of the following features:
- the trustee of an existing trust is removed as trustee of part/some of the trust assets and a new trustee is appointed to hold those assets
- control of the original trustee is changed such that control passes to a subset of the beneficiaries of the original trust. The new trustee is controlled by a different subset of beneficiaries
- different appointors are appointed for each trustee
- the rights of indemnity of the trustees are segregated such that each trustee can only be indemnified out of the assets held by that trustee
- the expectation is that the new trustee will exercise its powers in respect of the assets it holds independently of the original trustee to benefit the subset to the exclusion of others. The original trustee will also exercise its powers in respect of the assets held by it independently of the new trustee to benefit a different subset again to the exclusion of others. This is so whether the range of beneficiaries that can benefit from particular assets is expressly limited
- the rights, obligations and powers of the trustees and beneficiaries remain governed by one deed
- the original trustee and new trustee keep separate books of account.
The draft determination, as it is proposed, will give it retrospective application.
The determination only gives one case study example to illustrate the workings of the proposal, but also states that it is assumed the split arrangement is able to be achieved, for trust law purposes, by amending the deed as necessary without bringing the whole original trust to an end. It also makes the point that there is no existing case law dealing directly with the tax implications of an arrangement as described in the determination.
Deductions for vacant land to be wound back
The government announced in May this year, as part of the 2018-19 federal budget, that it will decrease the scope of allowable deductions for expenses stemming from holding vacant land that is intended to be used for residential or commercial purposes. The measure will apply from 1 July 2019. (See page 42 of the federal budget paper.)
The announcement was couched as an integrity measure to address concerns that deductions are being improperly claimed for expenses, such as interest costs, related to holding vacant land, especially where this land is not being genuinely held for the purpose of earning assessable income. It is also intended to reduce the tax incentives for “land banking”, which can limit the availability of land for housing or other developments.
While deductions will be disallowed for holding costs associated with vacant land, such as interest, land tax and council rates, there will be two exclusions. These will be for:
- after a property has been constructed on the land, has received approval to be occupied and is available for rent, or
- the land is being used to carry on a business, including a business of primary production.
The “carrying on a business” exception, as noted above, will generally exclude land held for commercial development by those in the business of property development.
Deductions that are denied under this measure will not be able to be carried forward for use in later income years. Under the change, expenses for which deductions will be denied that would ordinarily be a cost base element (such as borrowing expenses and council rates) may be included in the cost base of the asset for CGT purposes when the property is sold. Therefore it follows that expenses that would not ordinarily be a cost base element would not be able to be included in the cost base.
Concerns have been raised that the new measure could have a significant impact on taxpayers undertaking development as property investors. It is perceived that investors who hold land for longer-term development are likely to be denied deductions for expenses incurred while such development is in the planning and building phases. Given that this can stretch out for months or even years between obtaining approval and completing the development, this could result in quite significant strains on cash flow for these investors.
Taxpayers that are in the business of property development may seem to have dodged a bullet due to the “carrying on a business” exception. It can be a fact however that property developers can be in the habit of using separate entities to hold the land, with the development itself perhaps being undertaken by another entity. In these situations, the separate entity may not be carrying on a business in its own right. It is therefore unclear at this stage how the new measures may or may not apply in these situations.
Annual vacancy fee for foreign residential property owners
At the end of 2017, an annual fee was introduced for dwellings owned by non-residents of Australia. The measure is part of the government’s housing affordability plan, and is also a financial incentive for foreign owners to make their dwelling available for rent and increase available housing in Australia.
Under the legislation, foreign owners of residential dwellings in Australia are required to pay an annual vacancy fee if their dwelling is not residentially occupied or rented out for more than 183 days (six months) in a year.
The “vacancy year” is not a calendar or financial year, but starts from when the owner first held their interest in the dwelling. The fee is paid by lodging a “vacancy fee return”, which is required within 30 days after the end of the vacancy year.
Foreign owners of vacant land do not have to lodge a vacancy fee return until a dwelling has been constructed on the land. If the dwelling is owned by two or more people as joint tenants, only one return is required, but if ownership is shared as tenants in common, each should lodge a vacancy fee return.
If during the year the dwelling is sold or otherwise legally transferred (including in the event of the death of the owner), or the owner ceases to be a foreign person, a vacancy fee return will not be required to be lodged.
If an owner can show that for at least 183 days in a vacancy year, the dwelling was incapable of being occupied as a residence, they will not be liable to pay the vacancy fee. However to claim this exemption, a vacancy fee return will need to be lodged with the ATO.
There are other exemptions, which are listed in the following table from the Foreign Investment Review Board (FIRB).
|Exemption||Examples of acceptable evidence|
|Legal ownership of the property changed during the year.||
|Your property is undergoing substantial repair due to fire, malicious damage or natural disaster.||
|Your property is undergoing substantial renovations or is deemed to be too unsafe to occupy.||
|You or your tenant is receiving long-term, in-patient, medical or residential care.||
|Legal restrictions by an order of a court or tribunal, or a law of the Commonwealth, a State or a Territory.||
|The registered owner is deceased and administration of the estate is pending.||
The amount of the fee is generally the same as the foreign owner will have paid when making a foreign investment application for residential property with the FIRB.
The ATO is able to issue an infringement notice if a person fails to keep the required records for the timeframe specified (five years) or fails to lodge a vacancy fee return by the due date. If a foreign person fails to submit a vacancy fee return or retain required records then they may be liable to a civil penalty of 250 units.
Further, a failure to submit the vacancy fee return will result in a deemed vacancy for that dwelling in the 12 month period (vacancy year). These measures are designed to encourage compliance with the vacancy fee regime. Any unpaid vacancy fees for a property may be recovered as a debt or by the creation of a charge over Australian land owned by the foreign person.
Further information is available by contacting the ATO’s foreign investment inquiry line on 1800 050 377 (within Australia) or +61 2 6216 1111 (from overseas).
The ATO held a webinar not long ago on the annual vacancy fee. See a recording of this free webinar here.