The hidden cost of purchasing property in a trust: The Foreign Investment Review Board regime

The hidden cost of purchasing property in a trust: The Foreign Investment Review Board regime

It’s not uncommon for individuals to seek to acquire property through their trust. In fact, this can be an ideal path to add value for young beneficiaries that are unable to enter a tough property market. However, many would be unaware that they could see significant costs of more than 50 per cent of the property’s market value if any beneficiaries of the trust are foreign residents, should they fail to comply with the Foreign Investment Review Board (FIRB) regime.

What is the FIRB regime?

According to Australia’s foreign investor notification and approval regime for the acquisition of real property located in Australia, where certain transactions are proposed or entered into by ‘foreign persons’, there is an obligation to notify the FIRB for approval.

The FIRB is a federal government authority that has the duty to assess such notifications and decide whether they are permitted to proceed. Its purpose, which is not uncommon in other countries, is to ensure that nationally important assets (particularly primary production and security-sensitive property) remain Australian-controlled.

Given this aim, it is unusual that transactions surrounding assets that aren’t considered nationally important are prohibited from proceeding. Nevertheless, the obligation to notify the FIRB of all relevant transactions still stands, and significant penalties can apply for non-compliance.

Although compliance with the regime is clear in most cases, requirements can become murky in the context of trusts.

Determining whether a trust will be considered a foreign investor

A significant proportion of acquisitions of real property located in Australia are made in trusts. This is done for many potential reasons, including asset protection, tax efficiency, and succession planning.

For the purposes of the FIRB, a ‘foreign investor’ will include a trust in which an individual who is not ordinarily a resident in Australia holds a substantial interest. In this context, a person holds a substantial interest in a trust where they hold a beneficial interest in at least 20 per cent of its income or property (whether alone or together with their associates).

In the case of unitised, fixed, or even some hybrid trusts, this is relatively easily determined, whether by reference to the relevant trust deed, unit certificate, or unitholders agreement etc.

In the case of other trusts (particularly discretionary trusts, where a trustee has the power to distribute income or property of the trust to beneficiaries), each beneficiary is inherently deemed to hold a beneficial interest in the maximum percentage of income or property of the trust. This is because the trustee has the ability to, hypothetically, distribute this maximum amount to them. Under most modern Australian discretionary trust deeds, the beneficial interest will be 100 per cent.

This means that, for many trusts in which there is a beneficiary that is not an Australian resident, the trust is considered a ‘foreign investor’ and the FIRB must be notified for approval.

It's understandable that many would fail to realise that their trust inadvertently qualifies as a ‘foreign investor’. Let’s look at the following example to see why.

The Maggie Trust Scenario

In this example, an Australian resident trust, ‘The Maggie Trust’, is established by the usual method of a nominal cash amount by a settlor.

The principal beneficiary of the Maggie Trust is Maggie, an Australian citizen, who migrated to Australia from Argentina several years ago.

The other beneficiaries of the Maggie Trust are determined by their relation to Maggie, e.g. her parents, siblings, and cousins, many of whom are residents of Argentina.

The trustee of the Maggie Trust is Maggie, who is vested with the power to distribute any part of the income and/or capital to any one or more of its beneficiaries, at any time, in her absolute discretion.

For the purpose of acquiring rental income, Maggie proposes to use some of the capital of the Maggie Trust to acquire a residential property in the suburbs of Sydney for approximately $1.5 million.

In this case, Maggie will be obliged to notify the FIRB of the proposed acquisition before it occurs. This is because the Maggie Trust is deemed a foreign person, as a result of the fact that Maggie could make distributions of its income and/or capital to members of Maggie’s family in Argentina (even if this is considered by Maggie and her family to be an unlikely event).

The implications of the ‘foreign investor’ determination

The notification is made by completing and submitting certain information to the FIRB in the appropriate form. The submission must be accompanied by the payment of a non-refundable fee which has a minimum value of $4,200 and may be as much as $1.119 million, depending on the value of the property.

A failure to comply with notification requirements may result in penalties. In the case of acquisition of real property, this will be equal to the greater of either 50 per cent of the consideration for the acquisition, or 50 per cent of the market value of the acquired interest in the property, as well as prosecution action.

How to avoid unnecessary compliance costs

Fortunately, it may be possible to avoid this outcome by amending the trust deed before the relevant transaction or acquisition occurs (although it will always depend upon the terms of the relevant trust deed). Typically, this would entail inserting provisions that state that the beneficiaries of the trust (notwithstanding anything else contained in the deed) exclude any individual or entity who is a ‘foreign person’ for these purposes. Notably, such a provision need not be irrevocable.

Of course, it is vital to consider and be mindful of:

  1. Whether this would cause the trust to be ‘resettled’ (i.e. to come to an end, which may have adverse capital gains tax and transfer/stamp duty outcomes)
  2. Whether it would impact any other existing provision (e.g. those purporting to mitigate against the imposition of foreign person transfer/stamp duty and land tax surcharges)
  3. Whether it would impede or otherwise adversely affect any personal or family objectives for the trust
  4. That the drafting/amendment of trust deeds and advice on the application of laws such as those governing the FIRB regime are legal services that should only be performed by appropriately qualified legal practitioners.

Unfortunately, the risks and compliance responsibilities associated with FIRB notifications pose a concern for trustees of typical trusts and can easily be missed by those that are uninformed. In most cases, FIRB matters are omitted from broad financial advice, and could come as a surprise to many whose advisers fail to properly address the intended purpose of a client’s trust, whether new or existing.

How can BDO help?

BDO provides expert tax, strategic and financial advice to assist with the establishment, operation, and oversight of trusts. This includes:

  • Administration
  • Accounting and auditing requirements
  • Governance and compliance functions
  • Distributing funds
  • Independent asset valuations
  • Investment strategy review
  • Ongoing investment management.

To find out more about managing or setting up a trust, or for further support navigating the FIRB regime, reach out to a Business Services or Private Wealth adviser today.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact the BDO member firms in Australia to discuss these matters in the context of your particular circumstances. BDO Australia Ltd and each BDO member firm in Australia, their partners and/or directors, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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