Changes to Foreign Surcharge: Discretionary Trusts with property in NSW or VIC

Discretionary trusts provide flexibility in relation to revenue and capital distributions. This is one of the reasons they are a common choice for families. However, when there is a potential foreign beneficiary, the discretionary trust can find itself facing additional costs in the form of foreign surcharges. Foreign surcharges are additional fees that various state jurisdictions impose on the duties and/or land taxes over and above the original impost.

The 2020 changes to foreign surcharge requirements mean that administration for Australian discretionary trusts became a lot more complex.  

Foreign Surcharges are subject to a complex array of rules

Each state and territory has its own rules for determining when a beneficiary is a “foreign person”. They also have their own rules for governing foreign surcharges, with some states even imposing clawback rules in the event a beneficiary later becomes a foreign resident. For this reason it is important to obtain specific advice for the relevant state or territory when a discretionary trust intends to purchase property. 

Ultimately, any discretionary trust that is determined to have foreign beneficiaries will be required to pay both the ordinary state duties and/or land tax, as well as the relevant foreign surcharge. For this reason most discretionary trusts aim to avoid having foreign beneficiaries. Where this is not practical for the purpose and primary aim of having the trust in the first place, the trustee must be aware of how having foreign beneficiaries will impact their financial considerations.

Changes for NSW discretionary trusts that own residential property

On 24 June 2020 the State Revenue Legislation Further Amendment Act 2020 came into effect in NSW. This Act changed the foreign person surcharges for both land tax and duties where residential land located in NSW was owned by a discretionary trust. 

The change means that a trustee is deemed to be a foreign person unless the trust deed explicitly excludes all foreign persons from being beneficiaries or potential beneficiaries. This clause in the trust deed must be irrevocable. This means an individual beneficiary who has children overseas, who are defined as foreign persons, would not be able to amend the deed to include their foreign child as a beneficiary. 

Non-compliant trusts, i.e. trusts that do not exclude both foreign persons, and potential foreign persons, as beneficiaries, will deem the trustee to be treated as a foreign trustee. The trust then becomes subject to the foreign surcharge rate of duty. 

In NSW the rate of foreign surcharge is presently 8% of dutiable transactions relating to residential land while for land tax the rate is 2%. These charges are payable in addition to ordinary rates. 

Retrospective Impact of the change in NSW

One of the most concerning things with the change in NSW is that the law applies retrospectively from 21 June 2016 for dutiable transactions, and from 2017 for land tax surcharges. 

If you don’t have any foreign beneficiaries then you have until 31 December 2020 to amend your trust deed to irrevocably remove both foreign persons and potential beneficiaries who could be foreign persons, if you wish to avoid the foreign surcharge. 

If you have previously not had foreign beneficiaries, but you do not wish to amend the trust deed because you will, or potentially will, have foreign beneficiaries, then you will need to consider if you are liable for any retrospective duties and land taxes.

Victorian changes

Victoria has also implemented some changes as of 1 March 2020. While these changes essentially have the same impact as in NSW, the law does not apply retrospectively.  

What should you do if you have a discretionary trust with property?

If you have a discretionary trust that holds property, or is intended to hold property then you need to assess the importance and likelihood of having beneficiaries who are foreign persons, or could potentially be foreign persons. This includes assessing your current trust deed, evaluating the goals and purpose of the trust, and reviewing the financial impact of having, or potentially having, foreign beneficiaries.

This may result in a change to your trust deed in order to intentionally exclude any foreign, or potentially foreign beneficiaries, or it may involve a change in your investment strategy. 

Australians Moving to the UK: A Brief Comparison of the Australian and UK Tax System

The Australian tax system is surprisingly different to the UK tax system.

This makes a simple comparison between the two challenging. 

Determining, from an individual taxpayer perspective, which country has higher taxes, isn’t straightforward. Both countries apply progressive rates of tax, as well as a range of potential adjustments and offsets.

Income taxes are lower in the UK due to the progressive rates of tax applying at higher levels of taxable income, but as the UK also has much higher medical contribution taxes than Australia, the UK taxpayer may end up with a higher overall tax burden.

In Australia, income tax is assessed on the taxable income of a taxpayer which is assessable income less allowable deductions while in the UK specific “allowances” may reduce the different types of income before that income is taxed. 

Australian resident taxpayers have a standard tax free threshold, regardless of the type of income or income level, while UK taxpayers have access to different allowances (tax free amounts) that can vary based on income level and the type of income they are earning.

The following table highlights some fundamental differences between the two tax systems:

Australian SystemUK Tax System
Assessable IncomeProgressive rates of tax applied to taxable income.Progressive rates of tax applied to taxable income- but different rates apply to capital gains and different types of income have allowances deducted before taxes are assessed.
Tax Free componentStandard tax free threshold applies to all taxpayers on the first $18,200 of their income, regardless of the source of this income.A personal allowance is deducted from the taxpayer’s income before tax is assessed. This allowance is increased for married taxpayers and blind taxpayers, but is reduced for high income earners. Additional allowances are separately applied to different types of income, such as capital gains and investment income. 
Public HealthFlat rate of medicare levy applies to all taxpayers unless they are exempt. Variable rate of health insurance taxes applies, depending on income type and amount of income. This is paid by both the employer and the employee. 
Personal benefits provided by an employerPersonal benefits are taxed to the employer as fringe benefits. There are a range of concessions and exemptions that may be applied. Personal benefits are taxed to the employee, at the value of the benefit. There are some benefits that are exempt. 
Residency An individual who resides in Australia, or an Australian citizen who doesn’t setup a permanent home outside of AustraliaPhysically present in the UK for a specified period of time during the tax year
Individual Taxpayer’s Tax year1 July to 30 June6 April to 5 April
PAYG SystemPAYGW (Pay As You Go Withholding) means employers withhold some of an employee’s wage to be paid to the tax office. This helps cover the individual taxpayer’s annual tax assessment. Any excess PAYGW becomes a tax refund. PAYE (Pay As You Earn) is similar to Australia’s PAYGW system. When too much PAYE has been withheld then an individual can apply for a tax rebate (tax refund) for the excess. 
Who is Required to Lodge a Tax ReturnAll Australian residents and any non-residents with any Australian sourced income are required to lodge a tax return (some exclusions apply for residents who earn under the tax free threshold and have no PAYGW to claim, and for non-residents who only earn certain types of income, such as interest income covered by PAYGW under the DTA). Most employees’ taxes are covered by their company’s payroll system, meaning they don’t need to lodge a tax return. Tax returns may need to be lodged where:

– Income other than employment income is earned (above the allowance)
– Foreign income was earned
– You are a higher rate taxpayer (annual income over 100,000 pounds)
– You need to claim a tax rebate for excess PAYE

Residency

Australian residency is generally dependent on whether an individual actually resides in Australia, however Australian citizens may continue to be Australian tax residents while temporarily residing overseas. There are a number of tests that can be used to help determine residency.

UK residency is based on the number of days an individual is physically present in the UK during the tax year. For more complex situations that do not meet the automatic test, other factors may apply.

Tax Rates

Both Australia and the UK apply progressive rates of tax ranging from 0% to 45%.

However, while Australia has a standard initial tax free threshold for all taxpayers, the UK utilises a system of allowances that taxpayers deduct from their income before tax is assessed. The amount of allowance changes depending on a range of factors, and different allowances are applied for different types of income, such as employment income, investment income and capital gains.

Medicare/ NHS

Australians pay a flat rate of medicare (2%), unless they are exempt. High tax payers pay an additional medicare levy surcharge of up to 1.5%, unless they pay for private hospital health insurance. 

In the UK both the employer and the employee are required to pay a contribution towards national health insurance, at rates varying from 0% up to 13.8%.

Capital Gains

Both Australian and the UK impose a capital gains tax.

In Australia capital gains are simply added to an individual taxpayer’s assessable income and taxed at the marginal rate at which the income falls. Assets that have been owned for more than 1 year can be discounted by 50% before being included as assessable income. Other exemptions may also be applied to reduce or rollover capital gains.

The UK tax system gives taxpayers an annual allowance for capital gains. Any capital gains up to the allowance each year are tax free. Like Australia, there are also other exemptions that may be applied to reduce or rollover certain capital gains. 

In the UK, capital gains are taxed at a different rate to other income, and residential property is taxed at different rates to other assets. Higher/additional rate taxpayers pay 28% on residential property and 20% on other chargeable assets. Basic rate taxpayers will pay either 10% or 20% on capital gains, unless it is on residential property, in which case the rate is either 18% or 28% (depending on the size of the gain and the taxable income of the taxpayer.

Both countries have an exemption for the sale of an individuals’ main residence.

Inheritance tax

Australia does not have an inheritance tax.

Neither inheritances nor deceased estates attract any specific form of tax. Any property or investments that are inherited will attract taxes in the same way as any property or investments that were acquired personally and subsequently sold. (There are some provisions for inheriting a main residence that allow the main residence exemption to be carried over).

The UK has a standard inheritance tax rate of 40% above the tax free threshold (the standard tax free threshold is currently 325,000 pounds).

Where everything is left to a spouse, civil partner, charity or community amateur sports club, there is normally no inheritance tax to pay. When your home is given to your children (including adopted, step, and foster children), the threshold can increase to 500,000 pounds.

If an individual who is married (or in a civil partnership) passes away with an estate that is worth less than their threshold, then the unused portion of their threshold can be added to their partner’s threshold for when they die.

The inheritance tax may be reduced to 36% on certain assets if at least 10% of the net value of the estate is left to charity in the will. There are some other reliefs and exemptions to help reduce inheritance taxes on gifts donated prior to death, business relief, and agricultural relief.

Australian and UK Tax Systems

Each tax system has a range of complexities that are unique to the respective country.

In some ways the basic Australian tax return is more straightforward for the individual taxpayer.

On the other hand, the UK system’s use of deductible allowances for different types of income, provides for a range of tax planning avenues that are not available to Australians.

Since the tax systems between each country are so different, and residency changes can trigger complex tax issues, it is important to seek expert advice in both countries when making a move between Australia and the UK.

Why Living Abroad For Six Months Doesn’t Automatically Mean You’re No Longer An Australian Tax Resident

When it comes to tax residency, the six month rule is quite simple to understand: live in a country for at least six months, or 183 days, and you’re considered a tax resident of that country. 

The simplicity in this rule explains why it is a common way of determining when an individual taxpayer is considered to be a tax resident of the country they are living in. In fact, for some countries, this is exactly how they determine tax residency.

For this reason it can be natural to assume that if you live overseas for at least six months then you are a tax resident of that country and no longer a tax resident of Australia. This is particularly the case if that country specifically states that they consider you to be a tax resident when you are living in their country for at least six months.

Why You May Still Be Considered An Australian Resident While Living Overseas

If you are an Australian citizen then Australia is your default home country in relation to tax residency. This means that it’s not just about meeting the tax requirements of the other country to be classed as a foreign tax resident for Australian tax purposes.

Under Australian tax laws an Australian citizen, who has been living as a tax resident, continues to be an Australian tax resident until they make a permanent move overseas. A permanent move overseas requires them to effectively cut ties with Australia. Typically the move overseas must be for a minimum of two years, and you must be setting up a permanent home in your new country (not just travelling around, or staying in hotels).

The Impact Of Double Tax Agreements

A double tax agreement (DTA) between two countries may contain provisions that help determine which country has taxation rights when an individual’s tax residency status is not clear cut.

For example, this might happen when an individual goes to a country that treats them as a tax resident after six months living there, however, under Australian tax laws they are also still treated as a tax resident. The DTA, through the tie-breaker provisions, helps determine in which country the individual taxpayer should be treated as a tax resident.

DTA typically gives weight to the country where the person has their permanent home, by virtue of birth or choice. In practice this means there is an expectation that the country in which an individual is a citizen, particularly if they clearly intend to return to their home country, retains more rights than a country they are temporarily living in. Beyond this, DTAs tend to consider where an individual’s personal and economic ties are stronger.

Unclear Situations

Most people find themselves in clear situations. They are either an Australian tax resident or a foreign tax resident, based on the country that they are a permanent resident. However, since individual circumstances can be very unique, there are plenty of situations that are not so clear cut.

Consider a situation where an individual lives in multiple countries, moving from one to another through the year. Or there are situations where an individual moves to one country, intending to remain there permanently, only for an unexpected issue to arise that results in them changing their mind and relocating to another country.

The Pandemic

COVID-19 has resulted in many people staying in countries for significantly longer periods than they ever planned. Conversely, many Australian expats have returned home to Australia to ride out the pandemic, despite previously intending to remain living overseas.

Since each situation is different, it is impossible to give clear, generic advice on these grey areas. The special circumstances of COVID-19 mean that even some Australians who were holidaying overseas have been unable to return home to Australia as planned. Their time overseas does not automatically cause them to become a foreign tax resident, especially where their intent and actions remain to return to Australia as soon as they are able to.

Others who have been living overseas for many years have returned to Australia for a prolonged period due to the pandemic. Their time in Australia does not automatically mean they resume Australian tax residency, however this requires them to be intending to return to the country they consider home as soon as possible. As the pandemic continues, it becomes more difficult to ascertain what “as soon as possible” means, and what actions would indicate a change in circumstances and intent.

Six Months Living Overseas

We cannot treat six months living overseas as automatically resulting in a change of tax residency. It should be understood that a change of tax residency will only occur if an Australian moves overseas for a period no shorter than six months, and a permanent place of abode is established. The subtle difference means that a stay of less than six months can clearly be understood to be temporary and would not change tax residency, while an overseas move that is expected to last more than six months requires review to determine if, and when, there is an actual change in tax residency. 

Australian Moving to the UK: How Do I Treat Non-UK Sourced Income?

One of the top questions we are asked by Australians who are moving to the UK, is “how am I taxed on my non-UK sourced income in the UK?”

Since a UK non-resident would only be taxed on any UK sourced income, this question is predicated on the basis that the Australian is moving to the UK on a permanent basis. A permanent move means that they are ceasing to be an Australian tax resident and instead will be considered a UK tax resident.

In general, just like Australia, the UK taxes residents on their worldwide income. This means that UK tax residents have to pay tax on any income they earn, regardless of where the income is sourced. However, there is a clause for what they consider “non-domiciled” residents, whereby taxes are instead paid on a remittance basis. Since many Australians moving to the UK would fall into the definition of a “non-domiciled” resident, this is an important question. We cover what this means below. 

Australian Tax Rules on Non-Australian Sourced Income

For comparison, let’s consider the Australian rules on residency. Most people are aware that as an Australian tax resident you are required to pay Australian income tax on income you receive, regardless of where it is sourced. However there are certain exceptions for individuals who are temporary residents. Once you cease to be an Australian resident you are only required to pay Australian income tax on income that has an Australian source.

The UK operates on a similar basis, however their exemption for “temporary” residents is measured and treated differently than Australia’s exemption.

UK Residency Rules

In general, tax residents of the UK are liable for income tax in the UK, on their worldwide income. This means that it doesn’t matter where the income is sourced, it is included in the resident’s tax return.

In the UK you are automatically considered a tax resident when either one of of the following applies:

  • You spend over 183 days in the UK during the tax year.
  • Your only home was in the UK (owned, rented or lived in for at least 91 days, with at least 30 days spent there in the tax year).

Conversely you are automatically considered a non-resident if either of the following applies:

  • You spent under 16 days in the UK (or 46 if you haven’t been classed as a UK resident for the previous 3 tax years). 
  • You worked on average 35 hours a week abroad, and spent less than 91 days in the UK, of which less than 31 days you were working in the UK.

Keep in mind that in instances where an individual would be considered dual tax residents of Australia and the UK, then the tie breaker rules in the Double Tax Agreement require consideration to determine which country has taxing rights on the different sources of income.

However, while the general rule is that tax residents are assessed on their worldwide income, there is, as indicated previously, an exception. This exception is for tax residents whom the UK considers to be “non-domiciled residents”.

Non-domiciled UK Residents

Non-domiciled residents are individuals, including Australian citizens, who are only living in the UK for the short to medium term.

A UK resident who has a permanent home outside of the UK is considered to have a domicile in that other country. This doesn’t necessarily have to be a specific, physical house, but more so that the ties to their home country mean that this country is considered to be their ‘permanent’ home. When an individual has a permanent home outside of the UK they are considered to be a “non-domiciled” tax resident of the UK.

In the UK a ‘domicile’ is typically the country in which your father permanently resided when you were born. For instance, the country in which you are a citizen by descent. However, this may not be the case if you have legitimately and permanently moved to another country, with no intention of returning to your original home country. This would mean that your ‘domicile’ changes to the new country in which you begin to permanently reside.

“Remittance” Rules on Taxes on Non-UK Sourced Income for Non-domiciled Residents

For non-domiciled residents, non-UK sourced income is treated differently depending on the total amount of the non-Uk sourced income. 

Under 2,000 Pounds

If you are a “non-domiciled” UK resident then you ignore all foreign income and gains if that income is under 2,000 pounds for the tax year and you do not bring that income into the UK. You must have a bank account in your home country, and the funds from that income must stay back in the home country instead of being transferred into the UK. If this is the case then you don’t have to do anything about your foreign income when lodging a tax return.

However, if the income you earn from overseas sources exceeds 2,000 Pounds, or you bring any income into the UK, then you must report that income in a self-assessed tax return.

Over 2,000 Pounds

When the non-UK sourced income exceeds 2,000 pounds (or the income is brought into the UK), the income can’t just be ignored. The rules under which foreign income is taxed in the UK, for non-domiciled residents, is the ‘remittance basis’. This essentially means that you have a choice on how you treat the reported income.

Choice of how UK Taxes are Sorted Out

Choice 1: You can Simply Choose to Pay UK Taxes on the Income. 

If you choose this option then you will be assessed for income tax on your foreign income. If tax is paid on the Australian sourced income (or may be taxed elsewhere if it is income relating to another country), there are a number of rules that ensure you are not taxed twice on this income. In some cases this will result in a reduction to your UK taxes. 

Choice 2: You can Claim the ‘Remittance Basis’.

If you choose to be taxed on the remittance basis, then you only have to pay tax on any of the income that you actually bring into the UK.

However, in a trade off for this consideration, you will lose any tax-free allowances for income tax and capital gains. You will also be required to pay an annual charge if your residency in the UK exceeds a certain timeframe. This annual charge is 30,000 pounds if you have resided in the UK for at least 7 of the past 9 years, or 60,000 pounds if you have resided in the UK for at least 12 of the past 14 years.

The remittance basis may be a great option if you are living in the UK for less than 7 years, however, beyond this you would need to assess your situation to determine your optimal position.

Seek Appropriate Advice for your Situation

Since the remittance basis can get complicated it is best to talk to a UK tax adviser for specific advice. You need to consider your own position, your long term intentions, and where you hold your investments, including rental properties, that are generating taxable income.