Trusts In Australia For Non Residents And Offshore Trusts For Australian Residents

PROTECTING FAMILY WEALTH: RETIRING IN AUSTRALIA

By Robert Gordon, Barrister, St James Hall Chambers, Sydney

Presented at Legal Week “Private Client Legal Forum” Villa d’Este, Lake Como, Italy 9-11 November, 2006

Introduction

Until very recently, the tax regime in Australia was such that a decision to retire in Australia was more likely to have been made for non-income and capital gains tax reasons, as the income and capital gains tax climate was certainly colder than the weather.

However, one long standing positive was the absence since 1980 of any State or Federal death or gift duty, so that retirees from countries with inheritance tax may have sought to adopt an Australian domicile of choice, to escape the clutches of their country of origin inheritance tax.

Ironically, non-domiciles of the United Kingdom, find it an attractive to reside but not adopt a domicile of choice in the UK, in order to make use of the remittance basis of taxation applicable to non-UK domiciles.

The previously frosty income and capital gains tax climate has now changed significantly:

1. since 1999, capital gains made by individuals from holding assets for more than 12 months, was halved, as was a gain made by a trustee for a “presently entitled” individual beneficiary, without any reduction in the ability to “negatively gear” income producing assets and get a full tax deduction for interest expense;

2. the 2006 Budget resetting of the tax scales making the top marginal rate of tax for individuals “kick in” at a much more reasonable A$150,000;

3. the 2006 Budget announcements reforming the taxation of Australia superannuation (retirement funds), especially the ability to take out benefits tax free from complying superannuation funds once the member reaches the age of 60, even though they may still be working;

4. the abolition of Australian tax on the foreign investment income of “temporary residents” with effect from 6 April, 2006.

The topic of protecting family wealth on retirement in Australia, is analysed on the basis that taxation must be minimized to protect that wealth, and that the structures in which that wealth is held, must to the extent possible, protect that wealth from the family’s potential creditors. Those aims may sometimes, happily co-exist.

Foreign Income of Temporary Residents

It is perhaps the abolition of Australian taxation on the foreign source investment income of temporary residents that is going to excite the imagination of many prospective potential migrants.

As a permanent resident visa is not a simple matter for all but those with close family connections already in Australia, obtaining a temporary visa is usually a first step. However, a temporary (usually up to four years) visa is renewable, potentially without the loss of the temporary resident status for tax purposes.

Prior to enactment of the provisions, a ‘temporary resident' was proposed to be defined as someone who was an Australian resident for tax purposes for less than four years, who was on a temporary visa and had not applied for a permanent visa, and who had not been an Australian resident for tax purposes in the preceding 10 years. The final enactment was liberalized.

The provisions are largely contained in Div 768 of the 1997 Act. Section 995 of the 1997 Act is the “definitions section” and specifies:

“temporary resident , you are a temporary resident if:

(a) you hold a temporary visa granted under the Migration Act 1958; and

(b) you are not an Australian resident within the meaning of the Social Security Act 1991; and

However, you are not a temporary resident if you have been an Australian resident (within the meaning of this Act), and any of paragraphs (a), (b) and (c) are not satisfied, at any time after the commencement of this definition.

Legislative Note:

The tests in paragraphs (b) and (c) are applied to ensure that holders of temporary visas who nonetheless have a significant connection with Australia are not treated as temporary residents for the purposes of this Act.”

Necessarily, the person who qualifies as a temporary resident is one who otherwise would have been within the definition of “resident” under s6(1) of the 1936 Act:

“(a) a person…who resides in Australia and includes a person:

(i) whose domicile is in Australia, unless the Commissioner is satisfied that his permanent place of abode is outside Australia;

(ii) who has actually been in Australia, continuously or intermittently, during more than one-half of the year of income, unless the Commissioner is satisfied that his usual place of abode is outside Australia and that he does not intend to take up residence in Australia; or

(iii) who is:

(A) a member of the superannuation scheme established by deed under the Superannuation Act 1990; or

(B) an eligible employee for the purposes of the Superannuation Act 1976; or

[Note the Superannuation Act 1990 and 1976 deal with government employees only]

The concept of domicile is still largely governed by the common law (e,g. Udny v Udny (1869) LR 1), although in both Australia and the UK (Domicile and Matrimonial Proceedings Act 1973) there are statutory amendments dealing with the domicile of married women and the domicile of dependent children. Section 10 of the Australian Domicile Act 1982 codifies the common law to a certain extent, in that it provides:

“The intention that a person must have in order to acquire a domicile of choice in a country is the intention to make his home indefinitely in that country.”

Of course, in order to change one’s domicile of choice to Australia, it would be generally necessary to have the legal capacity through visa status to “make his home indefinitely” or “ends one’s days” in Australia (although see most recently Mark v Mark [2005] 3 All ER 912, which casts some doubt on the status of Solomon v Solomon (1912) WNNSW 68, and Puttick v A-G [1979] 3 All ER 463). This would require the taxpayer to convert to permanent resident status, in the case of a UK domicile, at least 3 years before the date of death in order to avoid UK IHT on world-wide assets: s267(1)(a) IHTA.

That a British person may find it easier to have evidence accepted of his acquisition of a domicile of choice in Australia rather than a country which is more alien in terms of language, culture, religion etc, although it is always a question of fact, can be seen in Casdagli v Casdagli [1919] AC 145 at 156-157 and Qureshi v Qureshi [1971] 1 All ER 325 at 339-340.

As seen above whether a person is a temporary resident depends upon whether a person is an Australian resident within the meaning of the Social Security Act 1991 as follows:

“7(1) In this Act, unless the contrary intention appears:

Australian resident has the meaning given by subsection (2)

.…permanent visa…[and] temporary visa… have the same meaning as in the Migration Act 1958.

7(2) An Australian resident is a person who:

(a) resides in Australia; and
(b) is one of the following:
(i) an Australian citizen;
(ii) the holder of a permanent visa;
(iii) a special category visa holder who is a protected SCV holder [which can only apply to persons who were resident on 26 February, 2001].”

Visa Categories

The Migration Act 1958 provides at s30:

“ Kinds of visas

(1) A visa to remain in Australia (whether also a visa to travel to and enter Australia) may be a visa, to be known as a permanent visa, to remain indefinitely.

(2) A visa to remain in Australia (whether also a visa to travel to and enter Australia) may be a visa, to be known as a temporary visa, to remain:

(a) during a specified period; or
(b) until a specified event happens; or
(c) while the holder has a specified status. “

For persons over 55 years of age (a spouse can be any age), but with no dependents, the Investor Retirement (Subclass 405) visa may be appropriate. It requires the retiree to have assets that can be brought to Australia worth a minimum A$750,000 and to make a “designated investment” in the sponsoring State or Territory (which cannot be NSW or ACT) of A$750,000, and that the retiree have an annual minimum income of A$65,000 (which may be a pension). The retiree must have no intention of working full-time in Australia, but is allowed to work for 20 hours per week while in Australia. Whilst it is not a pathway to permanent residence, it is extendable if eligibility continues. For truly independent retirees, these requirements are not particularly onerous. See http://www.immi.gov.au/visitors/special-activity/405/how-the-visa-works.htm

For persons less than 55 years of age with business plans, a State/Territory Sponsored Business Owner (Provisional) (Subclass 163) may be appropriate. It is a pathway to permanent residence. See http://www.immi.gov.au/skilled/business/163/how-the-visa-works.htm

It should be noted that these types of visas invariably require the holder to have their own private health insurance and deny access to social security.

2006 Budget Tax Scale

Whilst the marginal rates for resident taxpayers for the tax year ending 30 June, 2007 are still high by Asian standards, they are now compare probably marginally more favorably than higher taxing European countries. In fact, the top marginal rate was dropped by 2% and the level at which the top rate is applied was increased by A$55,000, which is a dramatic change. The current scale is:

Whilst the upper rate of taxation in the UK is 40%, the effect of the National Insurance Contribution (roughly 11% for employees and much less for the self-employed), which doesn’t directly accrue to the benefit of the individual taxpayer, makes the effective rate considerably higher. It cannot be directly compared to the Australian minimum superannuation contribution of 9% (which in any event only applies to employees), as the superannuation contribution accrues directly to the benefit of the taxpayer’s retirement fund, rather than to fund a State pension. The flexibility of Australian superannuation is explored below.

Under the UK/Australia double tax agreement, which follows the OECD model, a resident of Australia is subject to tax on a UK pension, only in the country of residence.

Dual residence is resolved in Article 4:

“1 For the purposes of this Convention, a person is a resident of a Contracting State:

(a) in the case of the United Kingdom, if the person is a resident of the United Kingdom for the purposes of United Kingdom tax; and

(b) in the case of Australia, if the person is a resident of Australia for the purposes of Australian tax…

2 A person is not a resident of a Contracting State for the purposes of this Convention if that person is liable to tax in that State in respect only of income or gains from sources in that State.

3 The status of an individual who, by reason of the preceding provisions of this Article is a resident of both Contracting States, shall be determined as follows:

(a) that individual shall be deemed to be a resident only of the Contracting State in which a permanent home is available to that individual; but if a permanent home is available in both States, or in neither of them, that individual shall be deemed to be a resident only of the State with which the individual's personal and economic relations are closer (centre of vital interests);

(b) if the Contracting State in which the centre of vital interests is situated cannot be determined, the individual shall be deemed to be a resident only of the State of which that individual is a national;

(c) if the individual is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall endeavour to resolve the question by mutual agreement.”

2006 Superannuation Changes

Perhaps the most relevant change to the superannuation (retirement) system for persons who are at first to be temporary residents, is due to the fact that any employment related income will continue to be subject to marginal rates as above. The 2006 Budget has enhanced the usefulness of “salary sacrifice” as a means to reduce the tax liability on such employment income.

It has been a long standing feature of the Australian tax landscape for employee’s to “salary sacrifice” into Australian complying superannuation funds (concessionally taxed retirement funds). This had the effect of avoiding tax on that part of the salary sacrificed, but was not hugely attractive as contributions by the employer were subject to a contributions tax on their way into the fund of 15%, and for high income earners, and additional superannuation surcharge of 15%. So if a taxpayer was subject to the top marginal rate then, of 47% plus Medicare levy of 1.5%, the salary sacrifice was effectively only a deduction of 18.5%, and there was more tax to pay when the member retired and took their entitlement.

From 1 July, 2005 the superannuation surcharge was abolished. The 2006 Budget changes continue to allow those aged over 50 at 1 July, 2007 to have their employer make a tax deductible contribution of A$100,000 p.a. on their behalf (until 2012), and on accessing super benefits after age 60, there is no tax on the withdrawal. Nor is there any longer a requirement to retire from the workforce to access the super entitlement.

It has also been a long standing feature of the Australian tax landscape, that employees could set up a “self managed superannuation fund” (SMSF) so the investments made by the fund could be controlled by the members. Entitlements of employee could be “rolled over” to the SMSF from the employer controlled fund, in the past only with the employer’s consent, but since 1 July, 2005, when the “Choice of Superannuation Fund” regime became effective, usually without the employer’s consent. As the contributions tax is still at 15%, and the top marginal rate is now 45%, the saving from salary sacrifice is now 30% or 31.5% if the taxpayer is subject to the Medicare levy.