Tuesday, March 13, 2018

Superannuation and skirting the shoals of bankruptcy **

Matthew Burgess - Superannuation and skirting the shoals of bankruptcy

The Federal Court's decision in Cunningham (Trustee) v Gapes (Bankrupt) [2017] FCA 787 (Federal Court, Collier J, 13 July 2017) (Cunningham) is vital guidance for all advisers in relation to the interplay between superannuation death benefits and the Bankruptcy Act 1966.

In particular, the case highlights the fact that a superannuation death benefit paid via a deceased estate to a bankrupt beneficiary is divisible amongst the creditors of the bankrupt.

At a minimum therefore, advisers should consider advising clients who have at risk potential beneficiaries to utilise a binding death benefit nomination (BDBN). The BDBN should mandate that any death benefit is paid directly from the superannuation fund to a beneficiary at risk of bankruptcy.

Testamentary trusts

One additional strategy that should be considered in the context of deceased estates generally, and specifically in relation to superannuation death benefits, is the use of comprehensive testamentary trusts.

As readers will be aware, 1 of the key reasons that testamentary trusts are often recommended is due to the asset protection offered by the structure generally, and in particular where a potential beneficiary is at risk of suffering an event of bankruptcy.

This approach can help protect beneficiaries, regardless of whether a BDBN is in place, or where a BDBN is implemented and mandates payment of the death benefits to the legal personal representative for distribution under the will.

Importantly, testamentary trusts also provide significant flexibility from a tax planning perspective, as compared to the benefits being paid directly to the bankrupt beneficiary. Previous posts have explored a number of the tax planning issues in relation to testamentary trusts (see for example Taxation consequences of testamentary trust distributions - Part I, Taxation consequences of testamentary trust distributions - Part II and Testamentary trusts and excepted trust income).

Unfortunately, we have seen a number of examples recently where no testamentary trust has been incorporated under a will, with superannuation death benefits passing directly to the estate and then in turn to a bankrupt beneficiary. In other words, creating the exact same factual matrix as existed in Cunningham.

Key issues to remember

In summary, the key issues to be aware of in this type of situation are as follows:
  1. Where a beneficiary is bankrupt at the time of the death of the willmaker, the bankruptcy legislation mandates that the bankrupt's entitlements are to pass to their trustee in bankruptcy. 
  2. If there are any assets remaining after the bankruptcy has been discharged, then the beneficiary is entitled to those assets. 
  3. The right to due and proper administration of the deceased estate is an asset that forms part of the bankrupt's estate, and therefore also vests in the trustee in bankruptcy. 
  4. If an executor of an estate seeks to avoid assets passing to a trustee in bankruptcy where a beneficiary is entitled personally under the will, the executor will themselves be personally liable. 
Importantly, each of the above issues can be legitimately avoided by the appropriate structuring of a testamentary trust into a will, prior to death.

Where testamentary trusts are not included under a will, best practice dictates that the executor should obtain a formal declaration from each beneficiary, before making distributions to them under the will, whereby each beneficiary confirms that they are in fact solvent.

If a beneficiary refuses to provide the declaration, then further searches should be made by the executor to minimise the prospect that the executor might become personally liable to a trustee in bankruptcy.

A case study example

One example of a factual scenario we have been recently 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.


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.

As usual, if you would like copies of any of the cases mentioned in this post please contact me.

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

** For trainspotters, ‘skirting the shoals of bankruptcy’ is a line from a song named ‘Accountancy Shanty’ by Monty Python from their 1983 movie ‘The Meaning of Life’, watch here – https://www.youtube.com/watch?v=7YUiBBltOg4

Image courtesy of Shutterstock

Tuesday, March 6, 2018

(Don’t ask me) why do trusts have vesting dates? **

As set out in earlier posts, and with thanks to the Television Education Network, today’s post considers the above mentioned topic in a ‘vidcast’ at the following link - https://youtu.be/rynjlLBormE

As usual, an edited transcript of the presentation for those that cannot (or choose not) to view it is below –

Arguably trust vesting as a concept is an area of the law where you can ask 4 different lawyers for a view and you will get 5 different answers as to where it actually came from.

The theory I enjoy the most and the one that probably resonates most closely to what is possibly the truth is that, historically, trusts or as known in early English law, 'uses' could last forever.

In other words, trusts were the same as the modern-day company. There was no ending date; a trust was a structure that could last in perpetuity.

The story goes that there were forms of death duties back in the early English law. What was happening was that wealthy families would arrange for an initial transfer of assets into a trust on death.

While, there would be tax payable on that initial transfer of assets into the trust (that is, the death duty) once the asset was inside the trust, it was effectively protected from tax forever.

In other words, from a tax perspective, it was sheltered because there would be no further transfer of the asset on later deaths and therefore no further revenue to the monarchy.

The allegation was that King Henry VIII (after it took the revenue authorities about a hundred years to work it out) eventually was unimpressed that the revenue was drying up.

The reason that tax collections were drying up was because all the wealthy families were putting their assets into trusts and then effectively just skipping the death tax and making it an elective tax for later generations.

The solution, as is often the case in the structuring area, was to create the revenue outcome by imposing a limit on the life span of trusts.

Hence, you’ll see in many trust instruments, particularly earlier trust instruments, this idea of the 'life in being' of King Henry VIII or some other member of the royal family.

This is because the rule imposing the limit was set as the life in being as at the date of establishment of the trust plus 21 years. In most states (other than South Australia, which effectively has no statutory limit) the life in being approach has been replaced with a maximum period of 80 years.

** For trainspotters, ‘Don’t ask me why’ is song by Billy Joel from 1980, learn more here –


Tuesday, February 27, 2018

BDBNs v reversionary pensions – it’s not enough to debate **

Matthew Burgess BDBNs v reversionary pensions – it’s not enough to debate

Last week’s post (Scissors, paper, rock (you win again) – BDBNs v pensions **) considered the situation where there is a binding death benefit nomination (BDBN) in place for superannuation savings that are also the subject of a reversionary pension

As with many areas of potential conflict, the starting point for an answer to this type of situation will be the terms of the trust deed and pension documents.

In the absence of a clear answer in the legal documents (and as mentioned briefly last week), the Tax Office’s position appears to have been confirmed via a National Tax Liaison Group (Superannuation Technical Sub-group) in March 2010.

The minutes confirm as follows:
‘There are no SIS Act or SISR provisions that are relevant to determining which nomination an SMSF trustee is to give precedence where a deceased pension member had both a valid reversionary nomination and a valid BDBN in existence at the same time of the member’s death.

While section 59 of the SIS Act and Regulation 6.17A of the SISR place restrictions on superannuation entity trustees accepting BDBNs from a member, as explained in SMSF Determination SMSFD 2008/3, the Commissioner is of the view that those provisions do not have any application to SMSFs.

It must also be remembered that section 59 of the SIS Act and regulation 6.17A of the SISR are necessary because of the general trust law principle that beneficiaries cannot direct trustees in the performance of their trust.

The ATO’s view is that a pension that is a genuine reversionary pension, that is, one which under the terms and conditions established at the commencement of the pension reverts to a nominated (or determinable) beneficiary must be paid to the reversioner.

It is only where a trustee may exercise its discretion as to which beneficiary is paid the deceased member’s benefits and/or the form in which the benefits are payable that a death benefit nomination is relevant.’
** For trainspotters, ‘It’s not enough to debate’ is a line from a song named ‘Weenie Beenie’ on the first Foo Fighters album in 1995, listen here – https://www.youtube.com/watch?v=oI1xAkzHgXc

Image courtesy of Shutterstock

Tuesday, February 20, 2018

Scissors, paper, rock (you win again) – BDBNs v pensions **

Matthew Burgess Scissors, paper, rock (you win again) – BDBNs v pensions

An issue that has been the subject of some debate over time is what takes priority where a valid binding death benefit nomination (BDBN) is in place, however the relevant member dies while in receipt of a pension which was established with a reversionary beneficiary.

Best practice dictates that both documents should ideally articulate which has priority, although often there is however ambiguity.

Where however there is limited guidance addressing the issue, it is generally accepted that the reversionary pension will take precedence over the BDBN.

The reasons for this include:
  1. A valid reversionary pension would automatically remove the deceased member’s death benefits from a fund, and therefore, any BDBN will have no assets to attach to. 
  2. The Tax Office has confirmed via its national tax liaison group committee that the preferred interpretation (subject to any specific provisions to the contrary) is that the pension does take priority. 
  3. Practically, in the client specific situations that we have seen, the approach adopted has always been that the reversionary pension takes priority. 
** For trainspotters, ‘You Win Again’ is song by legendary band the Bee Gees, learn more (including about mullet hair styles, circa 1987) here – https://www.youtube.com/watch?v=KZY9oYSSjFI

Image courtesy of Shutterstock

Tuesday, February 13, 2018

(To be) specific asset BDBNs **

Matthew Burgess - (To be) specific asset BDBNs

As highlighted in previous posts, there are a myriad of issues that should be taken into account before a binding death benefit nomination (BDBN) will be held to be valid (see for example - http://blog.viewlegal.com.au/2012/02/superannuation-and-binding-death.html, http://blog.viewlegal.com.au/2014/03/death-benefit-nominations-read-deed.html, http://blog.viewlegal.com.au/2014/03/double-entrenching-binding-nominations.html).

One issue that can arise is whether a BDBN can apply to specific assets, as opposed to simply nominating a percentage of total assets, which is the standard approach for most nominations.

The generally accepted position seems to be that given there is nothing in the superannuation legislation that prevents distributing specific assets under a BDBN, so long as the trust deed for the fund does not prohibit it, the approach is permissible.

If a specific asset BDBN is desired, it will also be necessary to ensure practical issues such as the following are addressed –

  1. the relevant asset must be segregated to the account of the member making the BDBN;
  2. compliance with all aspects of the BDBN rules under the trust deed;
  3. the various issues that should be factored into any BDBN, including changes in the values of assets, the wider estate plan, what is to occur if the intended recipient predeceases the person making the BDBN and the revenue consequences; and
  4. finally, the scenario where the asset the subject of the specific asset BDBN is sold prior to the member’s death should also be contemplated.

** For trainspotters, ‘To be specific’ is a line lifted from the song ‘Fidelity Fiduciary Bank’ from Mary Poppins, see here – https://www.youtube.com/watch?v=XxyB29bDbBA

Image courtesy of Shutterstock

Tuesday, February 6, 2018

When one is no more fun – another tip on changing trustees **

Matthew Burgess When one is no more fun – another tip on changing trustees

As highlighted in previous posts, there are a myriad of issues that should be taken into account in relation to any decision to change the trustee of a trust (see for example - Changing trustees of trusts – Simple in theory … not so simple in practice).

One critical issue under the Trusts Acts in most states is the rule that where there are two or more individual trustees appointed initially of a trust, the retiring trustees will continue to be liable unless replaced by:
  1. at least two individual trustees; or 
  2. a ‘trustee corporation’. 
For the purposes of these rules the ‘trustee corporation’ must be a formal trustee company, as opposed to a private propriety company.

Importantly, the trust instrument may override these rules and allow trustees to be discharged, even when replaced by a single trustee.

Often however trustees will be changed without the required permission in the trust instrument, completely ignorant of the Trust Acts rules, meaning the retiring trustees unknowingly continue to be liable.

For obvious reasons we therefore generally recommend an amendment to any trust deed that does not expressly override the Trusts Acts requirement, however this is approach is also subject to the standard mantra ‘read the deed’ as often deeds will not in fact permit this type of variation.

In situations where a variation is not permitted, one work around that helps in some (but unfortunately not all) states is to appoint (say) one individual trustee and a propriety company of which the individual trustee is the sole shareholder and director.

** For trainspotters, ‘More Fun’ is song by legendary Australian band Radio Birdman, learn more here – https://www.youtube.com/watch?v=xcZc5d0Wnws

Image courtesy of Shutterstock

Tuesday, January 30, 2018

Fairytale of Canberra** - The Tax Office plays Secret Santa as the long awaited guidance on trust vesting gets released

Matthew Burgess The Tax Office plays Secret Santa as the long awaited guidance on trust vesting gets released

As it seems is tradition, the Tax Office has delivered another substantive release on a long-standing issue in the last month of the calendar year with the publication on 13 December 2017 of Draft Taxation Ruling TR 2017/D10.

Subject to being issued as a final ruling, Draft TR 2017/D10 arguably resolves many of the uncertainties surrounding trust vesting.


In summary, the key conclusions from the draft ruling are as follows:
  • While a trustee may be able to extend an approaching vesting date during the life of the trust to the maximum period available at law (generally 80 years), it is unable to be extended after the trust has vested without a court order. 
  • Upon the vesting of a discretionary trust, the trustee holds the trust property for the absolute benefit of the takers-in-default named in the trust deed. 
  • The vesting of a trust will not necessarily, of itself, result in a CGT event. However, this is dependent on the terms of the trust deed and subsequent steps, such as the transfer of assets to the beneficiaries by the trustee, which may result in a taxable event. 
  • While the trustee of a discretionary trust may distribute income between the range of beneficiaries in its discretion during the life of a trust, following vesting, all income is deemed each year to be distributed to the takers-in-default in proportion to their vested interests in the property of the trust. 
The Tax Office's conclusions in the ruling appear to be largely uncontroversial, although it is interesting to note it has finally explicitly acknowledged that the vesting of a trust will not, by itself, result in any CGT event in many circumstances.

Arguably the key reason for the relatively uncontroversial nature of the draft ruling stems from a failure to consider many of the fundamental issues the industry has been grappling with for some years.

Indeed, the main position adopted by the Tax Office on a potentially controversial issue is its rejection of the argument that a vesting date may be extended by implication where the vesting day has lapsed and all parties have behaved in a manner which is consistent with the vesting day having been extended.

Relevant CGT Events

As is generally understood, the relevant CGT events upon the vesting of a trust are A1, E1 and E5, as summarised below. The draft ruling confirms that (subject to the terms of the relevant deed), it is possible none of these events will occur on the vesting of a traditional discretionary trust.

CGT event A1

Section 104-10 of the ITAA 1997 defines when CGT event A1 occurs and reads:

(1) CGT event A1 happens if you dispose of a CGT asset. 
(2) You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. 

In the context of a trust vesting, CGT event A1 will be triggered if the trustee transfers an asset to a beneficiary by way of an in specie distribution in satisfaction of that beneficiary's entitlement.

In other words, it is not the vesting itself which would trigger the CGT event. Rather, it is the subsequent disposal of the asset by the trustee which results in CGT event A1 arising.

CGT event E5

CGT event E5 is defined in s 104-75 of the ITAA 1997 which reads:

(1) CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee (disregarding any legal disability the beneficiary is under). 
(2) The time of the event is when the beneficiary becomes absolutely entitled to the asset. 

At face value, CGT event E5 is the most applicable event arising upon the vesting of a trust, as it could be thought that a beneficiary would become "absolutely entitled" to the trust assets either as a result of a positive determination by the trustee or as a consequence of the default provisions under the trust deed.

However, as discussed in more detail below, the concept of "absolute entitlement" is complex and at times, contentious.

Consequently, it is generally seen (and apparently now accepted by the Tax Office in Draft TR 2017/D10) as unlikely that CGT event E5 will occur automatically upon the vesting of a trust.

CGT event E7

Section 104-85 of the ITAA 1997 defines when CGT event E7 occurs and reads:

(1) CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital. 

As CGT event E7 only applies where a beneficiary has an interest in the trust capital, it will rarely apply in the context of the vesting of a discretionary trust.

CGT event E5 and absolute entitlement

As outlined above, CGT event E5 was traditionally regarded as the CGT event most likely to apply upon the vesting of a trust.

However, Tax Office rulings and cases prior to the release of Draft TR 2017/D10 cast significant doubt on the correctness of this position.

Specifically, CGT event E5 applies where a beneficiary becomes "absolutely entitled" to the assets of a trust.

The meaning of the term "absolutely entitled" is subject to significant contention and debate as evidenced by the ongoing failure of the Tax Office to issue a final version of TR 2004/D25 (2004 is not a typo; the draft TR has remained unfinalised for well over a decade).

Saunders v Vautier (1841) EWHC Ch 82

The 19th century English decision Saunders v Vautier set the groundwork for the concept of absolute entitlement.

In that judgment, Lord Langdale MR held:

"I think that principle has been repeatedly acted upon; and where a legacy is directed to accumulate for a certain period, or where the payment is postponed, the legatee, if he has an absolute indefeasible interest in the legacy, is not bound to wait until expiration of that period, but may require payment the moment he is competent to give a valid discharge."

The judgment has been interpreted as meaning that where a beneficiary who has attained the age of 18 has a vested and indefeasible interest in a trust asset, they can issue a call to the trustee requiring the transfer of the asset to them.

The principles of this case are akin to that of absolute entitlement. Where a beneficiary has a vested and indefeasible interest in a trust asset sufficient for them to require the trustee to transfer the asset to them, they are likely to be absolutely entitled to that asset.

Draft TR 2004/D25

In summary, Draft TR 2004/D25 takes the position that absolute entitlement over a single asset will only arise where a single beneficiary has all the interests in that asset.

Following that line of argument, the draft ruling concludes that if more than 1 beneficiary has an interest in a particular asset, no beneficiary will be absolutely entitled to that asset.

Applying this to a discretionary trust which generally vests with multiple beneficiaries each being entitled to a percentage of the trust assets, Draft TR 2004/D25 implies that none of those beneficiaries would be absolutely entitled as against the trustee (unless each beneficiary had an entitlement to a discrete asset).

Furthermore, the draft ruling takes the view (at paragraphs 16-19) that:
  • a beneficiary can be absolutely entitled to an asset even though they hold their interests in it as trustee for 1 or more others; 
  • the existence of a mortgage or encumbrance over the asset in favour of a third party does not prevent the beneficiary from being absolutely entitled; 
  • the existence of a trustee's lien (and ability to sell the assets of the trust) to enforce a right of indemnity against a trust asset will not prevent a beneficiary from being absolutely entitled to the asset; and 
  • a beneficiary can still be absolutely entitled to an asset for CGT purposes where they are suffering a legal disability (such an infancy or insanity). 
The correctness of a number of points contained in the draft ruling are subject to significant conjecture, perhaps none more so than the ramifications of the trustee's right of indemnity out of trust assets.

This point was tested in the decision of FCT v Oswal [2012] FCA 1507 ("Oswal"). Interestingly, this decision is not mentioned in Draft TR 2017/D10, despite an opposite conclusion being reached in Example 7 (which concludes that where a trust vests with a sole capital beneficiary, that beneficiary becomes absolutely entitled to the trust assets and CGT event E5 occurs).

FCT v Oswal [2012] FCA 1507

The Oswal case involved the trustee of a discretionary trust who decided to make 2 beneficiaries entitled to specific assets of the trust, being shares in a company.

The Tax Office put forward several alternative positions regarding the exercise of the power by the trustee, namely that it triggered 1 of:
  • CGT event E1 (creation of a trust); 
  • CGT event E5 (creation of absolute entitlement); or 
  • CGT event A1 (disposal). 
By contrast, the taxpayer argued that the determination by the trustee did nothing more than establish "a separate fund of assets under the umbrella of the trust" and that the determination did not trigger any of the CGT events listed above.

The Federal Court determined that CGT event E1 (creation of a trust) was triggered by the determination and a subsequent application by the taxpayer for leave to appeal the decision was denied by the Court.

The most significant comments in the judgment however perhaps related to the arguments regarding CGT event E5.

Justice Edmonds found that CGT event E5 could not arise, because the beneficiaries could not become absolutely entitled to trust assets where the trustee had a lien over the assets in respect of its right to be indemnified for trust liabilities out of trust assets.

Adopting the Court's view in Oswal, it seems the beneficiaries of a discretionary trust will rarely (if ever) be absolutely entitled against a trustee when a trust vests, as the trustee will always have a common law right of indemnity out of trust assets, able to be satisfied via an equitable lien.

While draft TR 2017/D10 does not explore any of the above arguments, it does still reach largely the same conclusion. It is hoped that before the final ruling is issued, the Tax Office does explain the reasons for concluding that CGT event E5 does not occur on the vesting of a trust and the inconsistency between the Oswal decision and the Example 7 in the draft ruling is addressed.

Some of the missing answers

The draft ruling does not attempt to address a range of questions that would seem to be critical to include before the ruling is finalised.

For example:
  • In what circumstances will a power of variation be deemed to be too narrow to allow an extension of a vesting date? 
  • If a power of variation expressly permits retrospective amendments, why will this not allow a vesting date to be extended after it has passed (the draft ruling is blunt in its view that a trust vesting date can never be extended once it has passed)? 
  • If there are no default beneficiaries, will the trustee of the trust be taxed on all income and capital gains derived (at the top marginal rate, with no CGT discount) pending the assets of the trust being distributed? 
  • Alternatively, if there are no default beneficiaries, does the Tax Office instead believe that the assets of the trust pass on a resulting trust to the settlor? 
  • Can a trustee resolve to amend the jurisdiction of the trust to South Australia, and thus have any vesting date essentially abolished? 
  • If an individual default beneficiary of a vested trust dies before the trustee distributes the assets to them, do those assets pass in accordance with their will, without tax consequence due to Div 128 of the ITAA 1997? 
  • What approach will the Tax Office have in relation to lost trust deeds, where it is impossible to confirm the date of vesting? 

Draft TR 2017/D10 provides some welcome clarity to the Tax Office's view in relation to trust vesting, although much of the guidance it provides is subject to the qualification that the issue "requires a close consideration of the effect of vesting as specified in the deed" and is subject to language such as "…it may be the case…".

Perhaps however these comments are merely the Tax Office using its language to restate the mantra featured regularly in this blog post, namely – Read the Deed.

Furthermore, as flagged above, there are a number of fundamental issues that have not been considered at all; a disappointing outcome given how long it has taken for the draft ruling to be released.

Without being deliberately trite, it is hoped that the final version of Draft TR 20017/D10 does not suffer the same delays as Draft TR 2004/D25.

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

** For trainspotters, ‘Fairytale of New York’ is song by legendary Irish band The Pogues, featuring Kirsty McColl, see here – https://youtu.be/j9jbdgZidu8

Image courtesy of Shutterstock