Land tax on SMSF assets.

Land tax is a tax payable by owners of land on the value of all taxable land they own as at midnight on 31 December of each year in NSW.  The rate for the 2014 tax year is $100 plus 1.6% of the land value between the threshold ($412,000) and the premium rate threshold ($2,519,000) and 2% of the land value above the premium rate threshold. No land tax is payable on the combined value of land below the threshold.

SMSF & Holding Trust

Trustees of superannuation funds fall under the category of ‘owners’ and may be liable to pay land tax on land owned directly by the Fund.  On the plus side, complying SMSFs are entitled to the zero rate threshold.

As for holding trusts, they are treated as fixed trusts for land tax purposes which means the land tax threshold is also available on properties held by a holding trustee.

It is also worth noting that while both the holding trustee and the SMSF trustee will be considered taxpayers, the SMSF trustee generally pays the land tax assessment of the holding trustee.  This payment then results in a credit for the amount of tax paid on behalf of the holding trustee which in turn will be applied against the tax assessment payable by the SMSF trustee.

Trust

For a trust to be able to enjoy the benefit of the Land Tax threshold it must qualify as a fixed trust as defined in section 3A(3B) of the Land Tax Management Act 1956 (NSW).

If you want to know whether your trust meets the necessary requirements, the first step is to look at the provisions contained in the trust deed and consider whether the following criteria are met:

• the beneficiaries are presently entitled to the income of the trust (subject only to the payment of proper expenses by and of the trustee relating to the administration of the trust);
• the beneficiaries 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, and
• the beneficiaries cannot have their income, corpus and winding up entitlements removed, restricted or otherwise affected by the exercise of any discretion or by the failure to exercise any discretion.

In short, the trust needs to be a passive trust whose sole purpose is to hold real estate.

Discretionary and Family Trust

Because the trustee has a discretion in allocating income and corpus in a discretionary or family trust these types of trusts do not qualify for the land tax threshold.

Unit Trust

A unit trust is capable of qualifying for the benefit of the threshold but only if the trust deed is clear on the eligibility factors.  The NSW Office of State Revenue has given guidance on how the deed can be amended if necessary.

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Not all trusts are the same…

All deeds are not the same.  A deed to establish a discretionary trust is different to a deed to establish a unit trust.  A deed to establish a family trust is different to a deed to establish a superannuation fund.

Sometimes unit trust deeds have to be crafted for their particular purposes.  A vanilla unit trust deed may not provide the best land tax outcome for NSW land tax purposes.  A vanilla unit trust deed may not be the best form of a deed for SMSF investments, as the unit trust may not be a fixed trust for non-arm’s length income purposes.

A recent case has illustrated the downside of simply selecting a deed based solely on price.  The taxpayer wanted to invest in real estate and, for asset protection purposes, have the real estate held in trust for the taxpayer.

The taxpayer acquired a discretionary trust deed.  This type of deed was used as it was the least expensive way of acquiring a trust deed.  The taxpayer wished to on-lend to the trust borrowed money and also to claim a tax deduction for his interest expense.  The taxpayer was aware that he could not claim a deduction for the interest merely because he was one of the beneficiaries of the trust.

Consequently, the taxpayer had prepared a document which was signed by the trustee of the trust by which the trustee was bound to allocate all trust distributions to the taxpayer unless the taxpayer “renounced” the distributions.   This document was signed immediately after the trust deed was signed.

The taxpayer borrowed the money and on-lent the borrowed money to the trustee of the discretionary trust.  The taxpayer claimed a deduction for these interest expenses and also received distributions from the trust.

The ATO challenged the taxpayer’s entitlement to claim deductions for the interest expense. The issue turned upon the nature and effect of the document which was signed after the trust was established.  In the AAT, the Tribunal held that the document was neither an effective amendment to the discretionary trust deed nor could it be treated as an effective exercise of the trustee’s discretion to allocate trust distributions to the taxpayer.

This finding by the Tribunal broke the nexus between the interest expense incurred by the taxpayer and the trust distributions.  In short, the taxpayer was not entitled to a deduction for the interest he incurred.

The decision does show that not all deeds are fungibles and sometimes deeds must be specially crafted for their intended purpose.  The result for the taxpayer would have been different if either the trust deed was not a discretionary trust deed or if the document which was signed after the trust was established did constitute a valid amendment to the trust deed.

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