Tuesday, June 23, 2015

Tax equalisation provisions

One issue that comes up from time to time in estate planning exercises is the use of 'tax equalisation' provisions in wills.

Generally speaking, the approach is to seek to ensure that the after tax benefit received by each beneficiary is equal.

For a myriad of reasons, this style of clause is rarely appropriate, for example:
  1. often a client will only want to take into account the tax position in relation to a particular asset (for example, superannuation). This can lead to significant imbalances in relation to other assets in the estate – most classically, a family home which, like superannuation, can often be received tax free by a beneficiary;

  2. while there are embedded tax attributes in relation to certain assets, there can also be embedded tax attributes with the recipient – for example, if a beneficiary is a non resident at the date they receive the asset, this can trigger a completely different tax outcome as compared to a beneficiary who is an Australian resident;

  3. where assets are to pass via a testamentary trust, this can cause a wide range of potential tax differentials, many of which may be unknown for a significant period of time;

  4. similarly, to the extent that there are assets held in related entities (for example, family trusts or private companies), there may be a wide range of potential tax ramifications which again may be unknown for a significant period of time;

  5. the calculations in relation to the net position of each beneficiary can potentially be limitless – for example, additional payments made to one beneficiary to compensate for the fact that they received assets that may have a latent tax liability may themselves cause a further tax liability, which then would trigger a further payment, which of itself would cause a further tax liability; and

  6. most clauses in this area are also crafted with reference to precise tax provisions at a particular moment in time – invariably those tax rules will have changed by the time the will actually comes into effect.
In light of the above difficulties, it is therefore normally preferable to simply set out directions in the memorandum of directions to the trustees of the estate to ensure that they seek specialist advice at the point of administering the will to ensure that the optimal legitimate tax outcome is achieved for the estate (and therefore the underlying beneficiaries) as a whole.

Image credit: 401(K) 2012 cc