I fought the law … **

As set out in last week's post, this week's post considers some possible solutions to the issues that arose in the Domazet decision.

The first work around is probably the easiest and the best one in some respects. Simply, the No.2 trust could have included a clause that said, “Our trust automatically ends the day before the No.1 trust.” This one sentence would have arguably avoided the issue.

The second idea would have been to amend the trust deed for No.1 trust and remove the prohibition. In other words, amending the terms of the No. 1 trust instrument so that it required any other recipient trust end before the No.1 trust.

This idea, would have essentially relied on the wait and see rule which has been explored in previous posts.

The third idea is that the No.1 trust could have skipped distributing to No.2 and simply distributed directly to the relevant beneficiary. Many might however say, “Well Matthew, that sounds nice, but I suspect there would have been a lot of wider tax planning strategies that were being utilised by the No.2 trust.” Thus, there should be an asterisk next to this idea because in many instances this style of approach may not have actually worked.

The fourth idea is in fact what they actually did in the Domazet case, which is they applied to the court for rectification.

The rectification adopted the first approach outlined above (that is the variation to amend the vesting date of the No. 2 trust).

Thus, while the taxpayer 'won', they had all the issues that go with a rectification. They had pain, they had suffering, they had delays, they had vastly increased costs, and they had significantly more attention.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, see early punk outfit The Clash perform the Sonny Curtis (of 'The Crickets' fame) song 'I fought the law and the law won'.

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Trust distributions and the Domazet decision – it’s a miracle !**

Domazet is arguably, one of the highest high profile trust vesting-related cases. As usual, if you would like a copy of the decision please contact me.

The factual matrix in board terms was as follows.

The original trust was set up in the 1970s, named here as the No. 1 trust.

Many years later there is a desire to distribute to another trust (named here as the No.2 trust). The No.1 trust was set up in the 1970’s. The No.2 trust set up in the 2010s - in other words, many years later.

The provisions in the trust deed for the No.1 trust provided that distributions to another trust as beneficiary were possible, as long as the receiving trust ended before the vesting date of the No.1 trust.

Here, No.1 trust, or the trustee and its advisers assumed that the vesting date of the No.2 trust would be 80 years.

The reason they assumed that is because the Australian Capital Territory (ACT) had at one point introduced the statutory 80-year perpetuity period and the No. 1 trust was established in the ACT.

It was therefore assumed that the legislation applied. The problem was that they had misunderstood the way the statutory limit had been implemented.

In particular, each Australian jurisdiction implemented the 80 years statutory limit at different points in time. The adviser for the No.1 trust was Queensland-based.

The Queensland legislation had come in before the No.1 trust was set up. So, they just assumed that would be the case in the ACT. In fact, the ACT legislation came in after the No.1 trust was set up.

They then amended the No. 2 trust to ensure it ended with 80 years of the No. 1 trust being set up.

What this meant in the practical sense was that when the distributions took place, the No.2 trust in fact had a vesting date after the No.1 trust because the No. 1 trust did not with certainty have an 80 year life.

This was a big problem because it meant that distribution was void according to the terms of the No. 1 trust.

What that meant was that the No.1 trust would be assessed, as if there was no trust distribution at all, which triggers a flat rate of tax of 48.5 cents. To the extent there were any capital gains, the 50% general discount would also be completely ignored.

Next week's post with consider some possible solutions given the factual matrix here.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Culture Club song 'It's a Miracle’.

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Take the money and run – interest deductions and succession planning **

Last week, we had cause to revisit a Tax Office ruling that is often overlooked in the context of family and business succession plans.

In particular, we were reviewing the handing on of control of a family trust, where as part of the overall arrangement, the intention was to pay down the credit loans owed by the trust to the parents of the individual taking control.

The trust was intending to use external bank funding in order to finance the pay down of the loans to the parents.

In this particular scenario, the conclusion was reached that the interest on the borrowing expense should be deductible – this conclusion was reached on the basis of Tax Ruling 2005/12.

The ruling is worth reviewing whenever interest deductibility is in issue as there are a number of fairly similar situations where the interest expense would not in fact be deductible, according to the analysis of the Tax Office.

As usual if you would like a copy of the ruling please contact me.

** For the trainspotters, ‘Take the Money and Run’ is a song by The Steve Miller Band from 1976.

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Within you; without you - When is a Trust not in fact a Trust? **

 

The ability of third parties to attack arrangements on the basis they are void because they are a sham has been looked at in previous posts (please contact me if you would like access to these and can not easily locate them).

Arguably one of the leading cases which explores the ability of a trustee in bankruptcy to attack trust assets using the rules in relation to sham transactions is Lewis v Condon; Condon v Lewis [2013] NSWCA 204. As usual, please contact me if you would like a copy of the decision.

Although the facts were somewhat complex, at the centre of the dispute was a trust that had been established by a lady who subsequently became bankrupt and admitted that the structure facilitated ‘her purpose to deceive her former husband, the Family Court and to avoid tax’.

In considering whether the assets of the trust were exposed to attack from a trustee in bankruptcy on the basis that the trust was a sham the Court held relevantly as follows –

1. Before any trust will be held void as a sham, it is necessary to show that there was an intention that the structure created not bear its apparent legal consequence. That was not the case here;
2. Even where a trust is established with an admitted purpose of deceiving, this is not enough to mean it is a sham, indeed here such an intention was in fact ‘entirely consistent with the creation of a genuine discretionary trust’;
3. Once it was established that the trust on creation was not a sham, subsequent events cannot turn the structure into a sham.

The decision also confirmed that in a practical sense, a new trustee holds office from the time of their appointment replacing the previous trustee and not from the time trust property is formally transferred.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For trainspotters, ‘Within you; Without you’ is the only George Harrison written song on the Beatles release ‘Sgt Peppers Lonely Hearts Club Band’.

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Prenups v Wills – winner takes all? **

Previous posts have explained the various aspects of binding financial agreements (often referred to as 'prenups').

On a number of occasions recently, we have had cause to review binding financial agreements in the context of wider estate plans, and in particular, have had to consider whether, in the event of a death of a spouse, the binding financial agreement takes priority or whether the will applies.

As is the case in many estate planning areas, the rule of thumb to remember is that the issue must always be reviewed on a case by case basis.

This said, generally, a prenup should at least expressly set out whether it is intended to apply on the death of either spouse. Ideally, the document should be crafted in any event to complement the provisions of the estate plan. In some situations the provisions can also regulate what should occur if one of the spouses seeks to challenge the provisions of their former spouse’s estate plan.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For trainspotters, ‘Winner takes it all’ is song by Abba from 1980.

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Half your age, plus seven**

Many family lawyers will relay that there appears to be a disproportionate level of relationship difficulties where there is a significant gap in the ages of the spouses - hence the above quoted rule of thumb to ensure the age gap is no more than half you age, plus seven years.

In Alderton v C of T [2015] AATA 807) the rule of thumb was breached by around 10 years (the de facto husband, Trapperton, was 42 to and the de facto wife, Alderton, was 18 when the relationship commenced).

Alderton was financially dependent on Trapperton.

For some years, a trust that Trapperton was trustee of made distributions to Alderton. Alderton had no knowledge of the existence of the trust nor that withdrawals from her debit card and online banking were in fact trust distributions.

After the relationship ended, a trust return was filed that based on the distributions caused an assessment for Alderton.

Alderton then, some years later, attempted to disclaim the income she had, unwittingly, received from the trust.

The Tax Office, and in turn the court, ignored the attempted disclaimer and Alderton remained liable to pay the tax assessed.

The fact that Alderton had no knowledge of the conduct or operations of trust was irrelevant as to her liability to pay tax on the distributions she had effectively been made presently entitled to.

As set out in earlier posts (please contact me if you would like access to these and can not easily locate them) in order for a disclaimer to be made retrospectively, it must be done so within a reasonable period of time from the beneficiary first becoming aware of the relevant interest that they wish to disclaim.

The disclaimer must also be an absolute rejection of the gift. Here, although the disclaimer was likely made 'in time', Alderton had in fact used the funds distributed to her and was therefore unable to provide an effective disclaimer.

This conclusion stood despite the court questioning the 'discreditable' conduct of the trustee in taking advantage of Alderton's naivety.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Taylor Swift song 'Seven'.

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When tomorrow comes** - A bankruptcy case study example

Following last week’s post, this week we explore one example of a factual scenario we have been asked to assist with that highlights the importance of advisers working collaboratively in this area to deliver value to clients is as follows:

1. An accountant had provided a written recommendation to a willmaker that testamentary trusts should be included in their will for asset protection purposes - this advice included a specific recommendation in relation to 1 beneficiary who had a history of financial misadventure in business activities.
2. The advice was provided to the willmaker's long-standing, although unspecialised, lawyer who dismissed the recommendation for testamentary trusts on the basis that it was an 'unnecessary complication that accountants and financial planners push as part of their product sales'.
3. At the time of the willmaker's death, the relevant son was indeed bankrupt.
4. In working to discharge their duties, the executors of the will asked us to assist in obtaining probate of the will and also confirm that they were obliged to pay the bankrupt beneficiary's entitlements to the trustee in bankruptcy. We were able to obtain probate and also confirm the duty that the executor was obligated to pay to the trustee in bankruptcy.
5. The executors also sought advice from specialist litigation lawyers as to whether the accountant or the lawyer could be potentially liable for failing to ensure that the willmaker included a testamentary trust in their will.
6. The specialist litigation advice suggested that the prospects of recovering any damages were in fact quite low for the bankrupt beneficiary.
7. The primary reason for this was that if a testamentary trust had been used, then the bankrupt beneficiary would have simply been 1 of many potential beneficiaries, and the only 'asset' that they would have received would have been the right to due administration of the testamentary trust. This right to due administration would arguably have no monetary value and therefore the damages awarded on suing the lawyer and accountant would have probably only been nominal.

The above conclusion was not ultimately tested through the court system. It would therefore seem an unnecessarily risky approach for advisers to dismiss the benefits of testamentary trusts for bankrupt beneficiaries on the basis that they may not be liable if their advice is later shown to be inappropriate.

Key points to note

The need to take active steps to protect assets and wealth, as well as concerns with the overall effectiveness of the steps taken, are not new concerns.

Arguably however, those concerns have never been taken more seriously by a greater number of people than they are currently, particularly in relation to superannuation death benefits.

The recent case law in this area is a timely reminder of the need to ensure comprehensive asset protection strategies are implemented as part of an integrated tax and estate planning exercise.

The above post is based on the article we had published originally in the Weekly Tax Bulletin.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Eurythmics song ‘When tomorrow comes'.

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