Tuesday, June 27, 2017

Unit trusts and fixed trusts


One area that seems to be receiving an increasing amount of interest from the Tax Office in recent times concerns the distinction between a unit trust and a fixed trust.

Often, the differences between these two types of trusts can be quite subtle and the interpretation of the trust deed can be critical in this regard.

As has been mentioned in numerous previous posts, the starting point in any trust related matter is to read the trust deed.

Where a trust deed is reviewed and the instrument does not reflect the intention of the parties, it is generally possible to convert what would otherwise be a unit trust into a fixed trust for tax purposes (and vice versa) without any adverse tax or stamp duty consequences.

Obviously, care does always need to be taken in this regard, and due to the potentially significant tax differences between the ownership structures, particularly in relation to issues such as trust losses, capital gains tax events and valuation requirements. It is therefore generally recommended that the trustee obtains specific written advice before implementing any intended change.

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Tuesday, June 20, 2017

Taxpayer 2 v Commissioner 1 – the continuing story of streaming franking credits via trusts


For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

The recent case of Thomas & Anor v FCT [2017] FCAFC 57 (as usual, if you would like a copy of the decision please contact me), contains some particularly interesting comments in relation to the distribution of franking credits by the trustee of a discretionary trust, including the ability to stream franking credits as a separate class of income.

It follows the well-publicised decision of the Queensland Supreme Court in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417. That decision held that franking credits could form part of the income of a trust estate for trust law purposes and be streamed to particular beneficiaries.

There then followed the Commissioner's subsequent (successful) application in Thomas v FCT [2015] FCA 968 (see the following post - http://blog.viewlegal.com.au/2015/09/at-last-some-clarity-with-streaming-of.html), which concluded that franking credits were not net income of the trust and therefore could not be "streamed" independently from the net income.

Facts and original decision

In brief, the trustee of Thomas Investment Trust purported to distribute the trust's income in several consecutive financial years as follows:
  • Around 90% of the franking credits and foreign income and 1% of the remaining net income to an individual beneficiary. 
  • The balance of the net income to a corporate beneficiary. 
In the original decision, the taxpayer successfully obtained a declaration from the Supreme Court of Queensland in relation to the proper construction of the trust resolutions distributing the income in the manner summarised above.

In particular, the taxpayer commenced proceedings seeking directions under s 96 of the Trusts Act 1973 (Qld) as to the manner in which the trust deed and trust distribution resolutions should be interpreted.

The Commissioner was notified of the application but informed the taxpayer's solicitor that it did not consider it appropriate for the Commissioner to be a party to the proceedings.

The Court granted the orders requested by the taxpayer, largely on the terms requested, which included that the proper construction of the trust deed and resolutions resulted in the majority of the franking credits passing to an individual, notwithstanding that the balance of the net income went to the corporate beneficiary.

Commissioner's appeal

Following the decision above, the Commissioner challenged the effect of the distributions and in essence, argued that the franking credits could not be distributed to a beneficiary independently of the franked dividend to which those franking credits related.

The judgment issued by the Federal Court rejected the earlier conclusion of the Queensland Supreme Court and provided significant guidance in relation to the streaming of franked dividends and franking credits.

In particular, it confirmed that Div 207 recognises and permits a trustee to stream some or all of a franked dividend to one or more beneficiaries to the exclusion of others, subject to the requisite powers under the trust deed.

However, the Court held that, while franking credits will generally have a clear commercial value to a beneficiary (as a result of the beneficiary's ability to claim a tax offset from the credit), a franking credit is not "income" for trust law purposes.

Consequently, although franking credits constitute statutory income for the purposes of the gross-up provisions, they are a notional, statutory creation in this regard and do not constitute "ordinary income" under trust law principles.

As a result, the Court held the operation of Div 207 makes it clear that franking credits can only "attach" to the franked dividend and cannot be streamed as a separate class of income, notwithstanding any other provision that may indicate to the contrary within the trust instrument and found in favour of the Commissioner.

Taxpayer's subsequent appeal

The taxpayer's appeal Thomas & Anor v FCT [2017] FCAFC 57 essentially hinged on the nature of the original decision issued by Applegarth J in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417.

The taxpayer argued that the nature of the orders issued by Applegarth J regulated the rights of the beneficiaries and the trustee and had conclusively determined each beneficiary's share of the trust's net income.

In particular, the Full Federal Court noted:

"The application before his Honour [(ie Applegarth J)] required the Court to make sense of what may, perhaps not unfairly, be described as confused resolutions. The resolutions purported to do something and an ultimate intention could fairly be discerned however ineptly the two resolutions may have been drawn.

However the rights of the beneficiaries flowing as against the Commissioner from Div 207 of the 1997 Act depended wholly upon the effect of the rights created as between the trustee and the beneficiary by whatever the resolutions may have achieved.

The rights to be created by the trustee as against the Commissioner were a matter wholly within the control of the trustee and it was in the jurisdiction of the Supreme Court to make declarations concerning the proper construction of what the trustee had done pursuant to a domestic trust."

The Court went on to say:

"The Commissioner was not obliged to participate in that proceeding, and may not be bound by the construction of Div 207, but the Commissioner is bound by a declaration concerning the effect of the resolutions if the declaration conclusively determines that a beneficiary has a share of the trust's net income for a year of income that is covered by s 97(1)(a) of the 1936 Act."

Consequently, the Court found in favour of the taxpayer for the income years in which the original orders had been granted (2005-2008) and, "reluctantly", also for the 2009 resolutions, which had not been expressly considered by Applegarth J.

Although the taxpayer was successful, the Court appeared unimpressed by the reasoning of Applegarth J in his original decision on a number of occasions.

For instance, Pagone J commented:

"Applegarth J's declaration in 1(b)(iii) is, perhaps surprisingly, that the resolutions which the trustee had made in the years ended 30 June 2005 to 30 June 2008 had conferred upon each of the beneficiaries a vested and indefeasible interest in the distributable income consistent with the intended flow of franking credits."

More bluntly, Pagone J said:

"It is difficult to embrace the conclusions of Applegarth J ... The franking credit distribution resolution is explicable only by a fundamental confusion in the mind of the person drafting the resolution … Applegarth J, however, was persuaded …"

Perram J also noted:

"Like Pagone J, I am, with respect, sceptical about the construction of the resolutions adopted by Applegarth J, but that scepticism simply does not matter whilst the declaration remains on foot. It is what it is. That it might be attended by reasoning which may be erroneous is irrelevant whilst it exists."

It seems clear from the decision that the taxpayer has enjoyed an extremely fortunate outcome, essentially leveraging the interplay of a number of technicalities to engineer an unlikely win.

Indeed, it can also arguably be assumed that, with the aid of hindsight, the Commissioner would be regretting his decision not to be included as a party to the original application to the Queensland Supreme Court.

Position in relation to streaming franking credits

While the case is at face value a victory for the taxpayer, it far from authority for the conclusion that franking credits can be streamed as a separate class of income from the dividends giving rise to those credits.

Indeed, in the absence of construction orders like those granted here by Applegarth J in the Queensland Supreme Court, the correct interpretation of Div 207 is that outlined by Greenwood J in Thomas v FCT [2015] FCA 968.

That is that while franking credits constitute statutory income for the purposes of the gross-up provisions, they are a notional, statutory creation in this regard and do not constitute "ordinary income" under trust law principles.

Pagone J makes this abundantly clear by stating that the trust resolutions here, and in turn Applegarth J's analysis:

"…proceeded upon the same misunderstanding of the proper operation of Div 207; that is, upon the misunderstanding that franking credits could be distributed separately."

Lessons

Ultimately, as explained in our previous post (see - http://blog.viewlegal.com.au/2015/09/at-last-some-clarity-with-streaming-of.html), there are a number of lessons that can be taken from these decisions.

Certainly, as a starting point, there is the need for the Government to prioritise the long awaited re-write of the legislation governing the taxation of trusts in order to simplify what continues to be an unnecessarily complex area of the taxation law.

As set out previously, the other key lessons include the following:
  • As regularly highlighted in this Bulletin, it is critical to "read the deed" before purporting to exercise trust powers, particularly in relation to trust distributions. 
  • While reading the trust deed (including all valid variations) is necessary, it will not be sufficient by itself. There are a myriad of related issues that need to be considered that may impact on the intended distribution, aside from whatever powers are set out in the trust instrument. Examples include renunciations and disclaimers by beneficiaries, purported changes that are not permitted under the relevant trust instrument and the effective narrowing (for tax purposes) of permissible beneficiaries due to the impact of family trust and interposed entity elections. 
  • The wording of the distribution minute or resolution will be critical for determining the consequences of the distribution. Terms like "income" and "net income" will be defined differently depending on the trust instrument (even deeds that have been sourced from the same provider) and failing to understand those distinctions can result in inadvertent adverse outcomes for the trustee and beneficiaries. 
  • Distribution resolutions must also be crafted with reference to the trust instrument, trust law principles, the ITAA 1936 and the ITAA 1997. For example, with increasing regularity, we are seeing trust deeds that require distributions take place before they are otherwise needed under the ITAA. 
  • Trustees should act with significant care when dealing with "notional" amounts such as franking credits, to ensure the intended tax and commercial objectives are achieved. 
  • Trustees have a duty to ensure they are aware of their rights and responsibilities under the trust deed and the limitations under the ITAA 1936 and the ITAA 1997. A failure to discharge this duty can mean a trustee is personally liable. 
Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/

Tuesday, June 13, 2017

How soon is now ** (or ‘as soon as practicable’)?


Last week’s post considered the phrase ‘as soon as practicable’ in light of the 2017 superannuation changes (see - Estate planning and the 2017 super reforms – the six post death strategies you must be aware of).

Regulation 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) requires death benefits to be cashed ‘as soon as practicable’ following the death of a member.

Unfortunately, ‘as soon as practicable’ is not defined in the Regulations and has not been otherwise defined.

Generally in our experience the Tax Office has historically expected death benefits to be paid within 6 months of a person's death, or earlier if possible.

While perhaps not directly relevant, part of the reason for this approach is likely to be because under section 17A(4) of the Superannuation Industry (Supervision) Act 1993 (Cth), any replacement trustee (or replacement director of a corporate trustee) must resign within 6 months of the death benefits commencing to be paid. In other words, 6 months is legislated in a manner that is arguably analogous to the concept of ‘as soon as practicable’.

This said, if there are objectively reasonable circumstances preventing payment for more than 6 months, this is unlikely to cause a breach of the rules, so long as the payment occurs as soon as practicable once the relevant circumstances have been resolved.

Some examples of where a payment after 6 months may still meet the ‘as soon as practicable’ test include -
  1. it may be that probate of a member's estate is seen as required before paying a death benefit, and generally probate will take longer than 6 months; 
  2. if there is a risk that an estate may be challenged or the potential recipients of a death benefit challenging the trustee's decision, confirming that the risk has passed will generally take longer than 6 months; 
  3. similarly, if there is an actual challenge to a deceased estate this may warrant delaying paying of a death benefit; 
  4.  if there is uncertainty about the validity of any purported binding death benefit nomination this may take longer than 6 months to resolve; 
  5. the nature of the assets in a fund may make distributions within 6 months impossible, for example illiquid assets such as real estate or investments in platforms that have large penalties for early withdrawal; 
  6. it may also be that the values of assets that are will form part of the cashing take an extended period to value; 
  7. surrounding circumstances, such as poor health of a surviving fund member may also justify a payment commencing later than 6 months. 
Interestingly, the 2017 superannuation reform legislation permits a reversionary beneficiary 12 months to decide if they wish to cash their benefit before it is automatically credited to their transfer balance. This allowance may (again by analogy) support the argument that a death benefits payment within 12 months will meet the ‘as soon as practicable’ test, even without other explanatory reasons.

** for the trainspotters – check out iconic 1980s new wave band The Smiths perform ‘How soon is now?’ here - https://www.youtube.com/watch?v=hnpILIIo9ek


Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/

Tuesday, June 6, 2017

Estate planning and the 2017 super reforms – the six post death strategies you must be aware of


Last week’s post considered 11 of the key strategies that need to be taken into account from an estate planning perspective in light of the 2017 superannuation changes (see - Estate planning and the 2017 super reforms – the 11 things you must be aware of).

Each of the issues flagged were primarily focused on pre-death estate planning strategies.

There are however a number of post-death issues in light of the 2017 superannuation changes that should be considered from an estate planning perspective, namely:
  1. Death benefit pensions can now be rolled over to a new fund (under the previous rules, this was very difficult). 
  2. Reversionary beneficiaries will now have up to 12 months from the death of the member to determine whether or not they wish to cash a benefit before it is credited to their entitlements and if the amount will result in the beneficiary exceeding their $1.6 million transfer balance cap, the excess amount must be paid as a lump sum benefit. 
  3. Where there is no reversionary pension, the pre-existing requirement that benefits be paid ‘as soon as practicable’ remains in place. Whether this phrase can be read in the context of the new amendments to mean (say) within 12 months remains open to debate. Next week’s post will consider in more detail the appropriate interpretation of this phrase. 
  4. Where no specific strategies have been implemented and a member passes away, it may be possible to establish a post-death superannuation proceeds trust. Generally, a post-death superannuation proceeds trust can allow infant beneficiaries to gain access to adult tax rates on income received. 
  5. This said, there are a number of technical requirements that must be met and the range of circumstances where the structure is available and appropriate is relatively narrow and should generally be seen as an alternative of last resort (previous posts have explained the various issues in this regard further, see - Why superannuation proceeds trusts should only be an avenue of last resort and Superannuation proceeds trusts: Tricks and traps). 
  6. When dealing with an SMSF, control of the fund continues to be critical and prior to implementing any of the approaches above, steps should be taken to ensure the SMSF is compliant with the SIS Act and trust deed (in particular, by ensuring any required changes to the trustees or directors of the corporate trustee are processed within the required timeframes). 
The above post is based on the article we recently had published in the Weekly Tax Bulletin.

Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/


Image courtesy of Shutterstock