Unit Trusts and Land Tax - Changes in NSW

In its 2006 Budget, the NSW government foreshadowed changes which every unit trust holding NSW land should consider. The changes are an increase in the land tax rate to 1.7% and the abolition of the tax free threshold for some unit trusts. This has happened because the 2005 High Court decision in CPT Custodians v Karingal had significant ramifications for the assessment of land tax on unit holders in unit trusts. Julian Smith

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NSW Treasurer's announcement

In his 2006 State Budget speech delivered on 6 June 2006, the NSW Treasurer announced the following changes to the application of the Land Tax Management Act 1956 ( NSW Act) with respect to the taxation of unit trusts:

• Increases in tax rate

  A unit trust will be taxed as a special trust if:

  1. The trust deed restricts the beneficial interests of a unit holder; and
  2. as a result, does not confer on the unit holder the necessary elements of 'ownership' of trust property.

  Special trusts will be assessed at the rate of 1.7% on the combined taxable value of the land and, importantly, disregarding the land tax threshold of $352,000.

• Trust to be taxed at increased rate instead of unit holder

  Individual unit holders will no longer be taxed as land owners under the NSW Act if the trust deed:

  1. restricts the unit holder's beneficial interest; and
  2. does not amount to 'freehold ownership in possession' of trust property for the purposes of the NSW Act.

The High Court decision in CPT and Karingal is summarised below. The Treasurer acknowledged that the decision changed the taxation of commercial unit trusts so that almost all unit trusts would be 'special trusts' and subject to higher rates of land tax.

NSW Land Taxâ?? after the changes

After the changes, if the trust deed does not confer on unit holders an equitable interest in each trust asset, then they will not be considered to be 'legal owners' for the purposes of NSW land tax legislation. The unit trust will then be assessed as aâ?? special trust'.

To avoid this, the trust deed will need to confer on unit holders something more than the usual equitable interest in all the trust's assets, and no interest in particular asset. To do this, the deed will need to:

1. confer fixed entitlements to income and capital distributions - this is standard;
2. state that the unit holders are presently entitled to all of the income from the land owned by the trust (less the trustee's expenses) - this is not standard; and
3. enable unit holders to wind-up the trust and distribute the land or net proceeds of the sale of the land - this is quite common, but not standard.

'Special trusts' will be assessed at the rate of 1.7% on the combined taxable value of the land disregarding the land tax threshold. (The land tax threshold for the 2006 land tax year is $352,000; for the 2007 land tax year is $356,000.) Individual unit holders in special trusts will not be taxed as land owners under the NSW Land Tax Act.

Transitional and Family Unit Trust Relief

The NSW 2006 State Budget contains the following statements with respect to concessions and transitional measures available for unit trusts:

Family unit trusts:

• To assist families holding land valued up to $1 million in a family unit trust, the Government will revert to the previous tax treatment by applying the tax free threshold.
• Unit trusts will qualify for a concession if they have previously been assessed as fixed trusts and at least 95 per cent of the units are owned by members of the same family.

Other unit trusts:

• The NSW Government will also allow all unit trusts which have previously been taxed as fixed trusts, 12 months grace to restructure their holdings into a fixed trust. This allows them to retain access to the land tax threshold without incurring State taxes on the restructuring transactions.
• Also, if a unit trust is restructured and becomes a fixed trust before 31 December 2007, then it will be reassessed for the 2006 tax year. This means it will get the benefit of the land tax threshold and an appropriate refund.

Should unit trust deeds be altered?

The trust deeds in CPT Custodians v Karingal contained specific clauses which prevented the unit holders from being categorised as equitable owners of any specific trust asset. Most unit trust deeds contain a provision to this effect and for good reason - allocating a specific asset or part of a specific asset to each unit holder is problematic. For example, it may lead to a reduction of the trustee's autonomy in dealing with assets, and it affects the flexibility of arrangements by which the unitholding or investment structure changes.

Therefore, it is only possible to work out if it is necessary to alter the deed on a case by case basis and taking into account:

1. whether the unit trust holds or intends to hold land;
2. how much of a burden land tax is as an expense of the trust;
3. the importance of flexibility to the trust's structure; and
4. whether any amendments to the trust's deed may have stamp duty or CGT implications (although there is a limited stamp duty exemption available).

Background - CPT and Karingal case [1]

On 28 September 2005, the High Court of Australia handed down an important decision on the taxing of unit trusts under the Land Tax Act 1958 (Vic) ( Victorian Act).

Karingal and CPT were the registered proprietors of land in their capacity as trustees for separate unit trusts. The terms of the trust deeds allowed for:

• distribution of periodic income entitlements to the unit holders; and
• on winding-up of the trusts, the distribution of proceeds among the unit holders.

The Victorian Revenue Commissioner issued assessments on the unit holders (not the trustees) on the basis that their ownership of units in the unit trusts was an interest sufficient to classify them as property owners for collection of land tax. When aggregated with the unit holder's other land holdings, issuing such an assessment leads to a greater overall land tax liability.

After a series of lower court decisions, the High Court had to decide whether the unit holders were either legal or equitable 'owners' of the land for the purposes of the Victorian Act.

The High Court held that, under the trust deeds, the rights of the beneficiaries were not of a kind that made the unit holders "owners" of the trust property within the meaning of the Victorian Act. Therefore, the Commissioner could not levy land tax on the relevant unit holders — only on the trustee.

Consequences of the decision

The decision deemed that unit holders were not the owners of trust land for the purposes of the Victorian Act because:

• the trust deeds only provided unit holders with an interest in the trust assets as a whole
• the trust deeds did not confer on the unit holders any ownership interest in a particular trust asset (as would have been required by the High Court for the purpose of the Victorian Act).

The decision meant that the Commissioner could no longer aggregate a unit holder's equitable or legal interest in a unit trust with any other equitable or legal interest which the unit holder may have for land tax assessment purposes. Unless, that is, the trust deed confers on unit holders a fixed beneficial interest in the trust's land.

More information

For more information, contact Maddocks on (03) 9288 0555 and ask for Michael Taylor-Sands or Julian Smith.

[1] Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53