Why every will contains a testamentary trust (Not calling anyone a liar**)

While the popularity of comprehensive testamentary trusts has continued to grow significantly in recent years, strictly every valid will does contain a form of testamentary trust.

While the popular usage of the term 'testamentary trust' refers to a comprehensive discretionary trust embedded into a will instrument, testamentary trusts can refer to any arrangement set out under a will where the intended beneficiaries are not absolutely and immediately presently entitled.

The structure lasts only for the length of administration of the estate (ie normally only a few months).

They are not testamentary trusts as normally understood and do not offer any ongoing tax, asset protection or flexibility advantages.

The phrase for the clause establishing this form of ‘trust’ in a will is often along the lines of:

‘As to 50% of my Net Estate, UPON TRUST for my child once they attain the age of 25 years absolutely’

One (perhaps anecdotal) way to determine if a will has a comprehensive testamentary discretionary trust included is to apply ‘the weight test’.

That is, a comprehensive testamentary discretionary trust will usually is around 30 pages in length.

A ‘bare’ testamentary trust will is rarely more than 10 pages, and can often be as short as 2 pages.

Some examples of where basic or 'bare' testamentary trusts exist include:

1. where the beneficiary receives a direct gift that is subject to them attaining a certain age (for example, the clause set out above);
2. where a gift is given to a beneficiary who does not have legal capacity (for example, because they are under the age of 18, or are over the age of 18 and lack mental capacity); and
3. where a specific gift is given to a beneficiary, however the administration process of the estate has not been completed.

In relation to the first two categories, the Tax Office will generally allow the ultimate beneficiary to enjoy access to the excepted trust income provisions.

In relation to the last category however, the Tax Office generally only allows a maximum of 3 years whereby the excepted trust income provisions apply, and practically, we are aware of situations where they in fact only allow a maximum of 12 months.

The Taxation Ruling IT 2622 explains in more detail the Tax Office’s approach.

The case of Walker v Walker [2022] NSWSC 1104 similarly explores many of the key principles in this area - and indeed appears to support a conclusion that the administration process of an estate will be completed, at least for the purposes of present entitlement for tax, at a point in time even earlier than what the Tax Office has historically suggested in the IT.

That is a beneficiary may be held to have a vested and indefeasible interest to the income (and be specifically entitled) far earlier than might otherwise be assumed. Furthermore, executors may have a duty to ensure tax imposts are legitimately minimised by protectively making interim distributions to beneficiaries.

As usual, please contact me 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 Florence and the Machine song 'I’m not calling you a liar’.

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Journal** entries

Recent posts have considered various aspects of the leading cases where two parties owe mutual liabilities or obligations, and the ability to set off the liabilities against each other through a book entry.

It is however important to note that generally, journal entries of themselves have no legal effect.

Arguably the leading case in this regard is Manzi v Smith [1975] HCA 35.

The key quote out of this decision is as follows -

‘We were referred to cases in which a payment of money was held to have been made by means of entries in books of account. But in those cases the entries represented the agreement of the appropriate parties….

These decisions, quite clearly, are not authority for the proposition for which they were advanced, namely, that a payment of money was made by the making by the company of a journal entry in the books of account without reference to, or without the agreement of, the persons said to be the recipients of the money. The company's assertions in its books of account did not establish the indebtedness of the appellants or any payment of money in discharge of that indebtedness.’

The Tax Office similarly has confirmed that while book entries record transactions having legal consequences, they do not of themselves constitute transactions. In other words, a unilateral action by one of the parties, such as a mere entry in its books of account, does not change the liabilities between the parties.

This means that in any transaction it is important that there is a valid binding agreement (or agreements) supporting the existence of the arrangements to which any journal entries purportedly relate.

As usual, please contact me 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 Johnny Cash song 'The singing star’s queen'.

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Walking the line** - understanding what does ‘cashed' means

Last week’s post focused on the issue surrounding ensuring an SMSF maintains compliance following the death of a member.

One issue raised following that post related to how the superannuation rules work in the context of the requirement that a member’s benefits must be ‘cashed as soon as practicable’ after the death of a member, which is set out under the Superannuation Industry (Supervision) Regulations at regulation 6.21(1).

In particular, the question is whether a death benefit can be simply transferred to a surviving member’s account by way of journal entry.

In this regard, in most other areas of the law, where two parties owe mutual liabilities or obligations, they can be set off the liabilities against each other through a book entry (see our earlier post in relation to Spargo case).

The Tax Office has confirmed that the principle in Spargo’s case can also apply to SMSFs where there are mutual liabilities between the relevant fund and another party (see ATO ID 2015/2).

The Tax Office has confirmed in ATO ID 2015/3 however that a death benefit cannot be satisfied simply by way of journal entry, as death benefit dependants do not owe anything to the fund, that is there is no mutual liability to set off against the SMSF.

Therefore, death benefits must actually be paid to the death benefit dependant by the transfer of ownership of assets out of the SMSF.

The Tax Office also confirms that the Superannuation Industry (Supervision) Regulations do not allow for payments to be made to members by way of journal entry.

In particular, regulation 6.17(2) requires payments to be transferred out of the SMSF.

Unfortunately, this requirement for formal payment can in a practical sense trigger unnecessary transaction costs as well as complicating and delaying the death benefit payment process.

As usual, please contact me 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 Johnny Cash song 'I walk the line'.

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Birth, school, work, death** - SMSF trustee compliance on member death

Ensuring an SMSF continues to satisfy the rules in relation trusteeship following a member’s death can be problematic, particularly when specific strategies have not been implemented as part of a comprehensive estate plan.

As is well understood, a complying SMSF must have all individual trustees as members and vice versa.

Where an individual member dies the superannuation legislation allows 6 months for an SMSF to ensure compliance. Often, for funds that are established as 2 member funds, this is achieved via the appointment of a corporate trustee, with the remaining member as the sole director.

The superannuation rules also allow a grace period for non-compliance from the date of death until just before the death benefits commence to be paid, where the legal personal representative (LPR) can act as the replacement trustee.

Most modern SMSF trust deeds reflect the superannuation legislation and have a discretionary provision that automatically appoints the LPR as the trustee on the death of the member.

While there can be confusion about the way the rules work, the conservative position is that the 6 month grace period starts on the death of the member. Therefore, regardless of when the death benefit commences to be paid, the trusteeship must be valid no later than 6 months following the date of a member’s death.

Practically, as set out in earlier posts, these rules further highlight the benefits of having a corporate, as opposed to individual, trustee.

As usual, please contact me 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 Godfathers song 'Birth, School, Work, Death'.

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What is so special ** about 'vested' interests?

Following on from last week's post, a related issue often comes up in the context of how wills are crafted.

In particular, wills often provide that a gift to a beneficiary is subject to the person not having already 'died or dying before attaining a vested interest'.

The decision in Serwin v Dolso [2020] NSWSC 370 explores this phrase in some detail.

In the case the relevant beneficiary survived the willmaker by 30 days (as required under the various state based succession laws) and long enough to receive the distribution of some personal items, but not long enough to receive a physical distribution of the gift anticipated by the will. This was because at the time of the beneficiary's death most aspects of the administration process remained incomplete (for example there were outstanding debts, assets yet to be collected and tax affairs unresolved).

The court confirmed that the words ''attaining a vested interest'' could have one of 3 meanings, namely:

1. that they are tautologous and mean the same as 'if the beneficiary dies before, or does not survive the willmaker';
2. that they mean 'vested in possession'; or
3. that they mean 'before the estate is fully administered and available to be distributed'.

While confirming that the exact provisions of a will are also critical, here the 'vested interest' phrase was held to mean “before the estate is fully administered and available to be distributed”.

In other words, the addition of the words 'vested interest' meant that merely surviving the willmaker was insufficient.

That is, a reference in a will to attaining a vested interest will usually be held to mean something more than merely surviving the willmaker, even if the period of survivorship exceeds 30 days (see Arnott v Kiss [2014] NSWSC 1385 and Kinloch v Manzione [2022] ACTSC 76, a case where CGT Event K3 was also likely triggered, given the relevant beneficiaries appeared to be non-residents for Australian tax purposes).

Furthermore, it was confirmed that, similar to the situation of a beneficiary under a discretionary trust, a residuary beneficiary under a will has no equitable interest in the assets of a deceased estate.

Rather, the only right which a residuary beneficiary has is to compel the due administration of the deceased estate by the executor. The trust created by every will (regardless of whether testamentary trusts are created) is to preserve the assets, to deal properly with them, and to apply them, in the due course of administration, for the benefit of those interested.

Relevantly, the Tax Office adopts a similar approach, and generally only allows a maximum of 3 years for the administration of an estate to remain in place (during which time the concessional excepted trust income provisions can apply).

As explained in other View posts however, we are aware of situations where the Tax Office only allow a maximum of 12 months to administer an estate.

As usual, please contact me 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 Garbage song 'Special'.

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The fine line (& time)** between being entitled … and not

An often over looked aspect of estate planning related to the payment of death benefits from a superannuation fund.

While with a gift under a will a beneficiary who dies after the willmaker, but before the distribution is made, will still (through their own estate) be entitled, this generally is not the case with superannuation benefits.

Arguably the leading case in this area is Webb v Teeling [2009] FCA 1094.

In summary the factual scenario was as follows -

1. a member of a super fund had passed away, validly nominating a dependant to receive the death benefit;
2. the dependant was alive at the time of the member’s death;
3. the dependant however subsequently died before the death benefit was paid and their legal personal representative (LPR) sort payment to the originally nominated beneficiary's estate.

It was held that the death benefit could not be paid to the LPR of the deceased dependant because they were neither:

1. a dependant of the deceased member; or
2. the deceased member’s LPR.

With the aid of hindsight, the workaround in similar situations is to ensure that if the nominated beneficiary dies before the death benefit is paid, the funds should pass (ideally under a binding nomination) to the LPR of the member.

The member's will should then direct the amount specifically to the intended recipients and can do so without restriction as the superannuation rules will have been complied with by the initial payment to the member's LPR.

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

** for the trainspotters, ‘Fine Time’ is a song from New Order.

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Just because there's knocking** for a testamentary trust statutory will doesn't mean the court will answer

Last week’s post considered a leading statutory (or court ordered) will case that approved a will incorporating testamentary trusts.

The decision in a further case in this area, namely Re RD [2021] QSC 65, highlights however that much will turn on the exact factual matrix as to whether a proposed testamentary trust will is approved by a court.

Relevantly in this case the court had to decide between 2 radically different draft wills submitted, one with 5 testamentary trusts, and the other with none (and all gifts passing directly into the names of the intended beneficiaries). Relevantly, the percentage allocations between each main beneficiary were identical under both 2 wills.

The lawyer proposing the testamentary trust will argued that “a properly advised person in possession of a substantial trust fund, would be concerned to ensure that the substantial inheritance they leave be held in a protected testamentary trust structure for the protection of their chosen beneficiaries”, which would include “asset protection from third parties such as other spouses, or from other sources, whether during the beneficiary’s lifetime, or after their death, if they have already inherited”.

In contrast the lawyer proposing the simple will provided the following context which the court accepted:

1. The main beneficiaries under the wills all argued that they did not believe the incapacitated person would want to have 'tied up' the wealth in a testamentary trust with no fixed entitlement.
2. As the proposed testamentary trusts were wholly discretionary, any benefit that would flow to the intended beneficiaries would be “merely an expectation or hope” (see Bowers v Bowers [2020] NSWSC 109).
3. The potential beneficiaries of the testamentary trusts were much broader than the immediate family – which was contrary to the comments of the lawyer proposing the testamentary trust will that there was a need to ensure that people who were effectively strangers to the incapacitated person, and who had not contributed in any way to his well-being, should not benefit.
4. Although there may have been some asset protection benefits, the testamentary trust will involved:
1. unnecessary complexity in its administration over the lifetime of the beneficiaries;
2. significant costs being incurred by the estate over the lifetime of the trusts, by reason of the fees incurred by the executor and trustee (Perpetual Trustees), in its management of the trusts over a prolonged period of time;
3. uncertainty as to what the beneficiaries might receive from the estate, given the discretionary nature of the trusts, such that they might not receive any more than some proposed specific pecuniary gifts; and
4. uncertainty as to whether there would be sufficient funds in the estate on death to give effect to the proposed specific pecuniary gifts.
5. Therefore, the complexity, additional cost and uncertainty as to what the beneficiaries might receive under the testamentary trust will proposed outweighed any potential asset protection benefits.
6. The draft testamentary trust will also contained a number of anomalies which would have required amendments by the court.

The court ultimately confirmed:

1. The central issue for the court’s determination in statutory will cases is what will would the incapacitated person probably have made, if they had capacity.
2. The cases where testamentary trust wills have been approved, such as the one mentioned in last week's post (Doughan v Straguszi [2013] QSC 295) were distinguishable both because of the facts involved, and because in each case the approval of a will incorporating testamentary trusts was supported by the likely beneficiaries.
3. It was likely that the incapacitated person here would have (if they had capacity) taken into account and given considerable weight to the views expressed by his mother and his father (who both opposed a testamentary trust will).
4. It was therefore unlikely that a reasonable person with capacity, would favour a convoluted will under which five testamentary trusts are imposed on his favoured beneficiaries, as opposed to a straightforward, simple will, benefiting those family members directly.

Separately, the court also confirmed that the execution of a non-lapsing binding death benefit nomination (BDBN) was an act in relation to a financial matter within the meaning of section 33(2) of the Guardianship and Administration Act 2000 (Qld) (see another case explored in previous posts, namely Re SB; Ex parte AC [2020] QSC 139). The incapacitated person's administrator (effectively his enduring attorney) was therefore able to sign the BDBN on his behalf.

The signing of such a BDBN was critical because the bulk of the incapacitated person's assets were held via superannuation and therefore to achieve the estate planning objectives 100% of his superannuation death benefits needed to be paid to his legal personal representative (to then be dealt with in accordance with the statutory will).

As usual, please contact me 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 Rolling Stones song ‘Can't you hear me knocking?'.

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