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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Assets excluded from the reach of a trustee in bankruptcy: welcome to the cheap seats**

Following on from recent posts it is important to remember that not all of a bankrupt’s property automatically vests in a trustee in bankruptcy.

A summary of the types of assets that do not vest in the trustee, and in turn are therefore not divisible amongst creditors, is set out in section 116 of the Bankruptcy Act and includes:

1. property held by the bankrupt in trust for another person;
2. the bankrupt's household property;
3. personal property of the bankrupt that has sentimental value for the bankrupt;
4. the bankrupt's property that is for use by the bankrupt in earning income by personal exertion, within certain limitations;
5. property used by the bankrupt primarily as a means of transport, within certain limitations;
6. policies of life assurance in respect of the life of the bankrupt or the spouse or de facto partner of the bankrupt;
7. certain superannuation payments, including under split orders following a family law property settlement;
8. the rights of the bankrupt to recover damages or compensation for (among other things) personal injury or wrong done to the bankrupt.

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 Wonder Stuff song ‘Welcome to the cheap seats’.

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Scissors (man)**, paper, rock – Family Law v Bankruptcy Act (part III)

Recent posts have considered various aspects of the interplay between the Family Law Act and Bankruptcy Act.

In 2006, Federal Magistrate John Walters, released a paper titled 'Some Aspects of the Interaction of Bankruptcy with Family Law' which set out a number of the key factors likely to be relevant in balancing the interests of spouses and a trustee in bankruptcy.

A summary of the factors mentioned is as follows, in the context that the overriding objective is to effect a just and equitable division of property between the parties to the marriage while also taking into account the legitimate interests of creditors -

1. has a party to the marriage acted recklessly, negligently or wantonly with matrimonial assets and reduced or minimised their value;
2. the non-bankrupt spouse's knowledge of the events leading to the other spouse's bankruptcy, including (for example) to what extent, the non-bankrupt spouse has either benefited from, or contributed to, the bankrupt spouse's insolvency;
3. when and how a relevant debt was incurred by the bankrupt spouse, and whether, for example, the debt was incurred in deliberate or reckless disregard of the non-bankrupt spouse's potential entitlement;
4. the factual circumstances surrounding the commencement or continuation of the property settlement proceedings – including, the perceived objective reasons, such as any strategic or tactical plan or initiative designed, in some way, to insulate the assets of the family (or a member of the family) from creditors;
5. whether and in what manner the creditor pressed or pursued – directly or indirectly – their rights in relation to the payment of the debt prior to bankruptcy, or prior to the commencement of proceedings in the Family Law Court, and whether the creditor did so in a timely fashion;
6. the overall conduct of all relevant parties, including the making of full and frank disclosure of their respective financial positions at all relevant times;
7. whether the debts were incurred pre or post separation; and
8. the overall financial circumstances of the non-bankrupt spouse and the children of the parties during the period since the incurring of the relevant debt or debts, and at the time of the property settlement proceedings (including the effect on the non-bankrupt spouse and the parties' children of the orders proposed by the parties to the proceedings).

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** For the trainspotters, the title of today's post is riffed from the XTC song ‘Scissor man’.

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Scissors, paper, rock – Family Law v Bankruptcy Act (part II): can’t shape up**

Last week's post provided an overview of the legislative changes requiring the family court to take into account the rights of creditors as part of any property settlement.

There have been a number of decisions that have applied the changed regime, a summary of a few of the key decisions and outcome is set out below.

1. Trustee of the Property of G Lemnos and Lemnos (2009) FLC 93-394 - the interests of unsecured creditors do not automatically prevail over the interests of the non-bankrupt spouse. The Court must balance the competing claims. Here the non-bankrupt wife was at least aware of the bankrupt husband's activities and therefore had to bear some of the responsibility owed to creditors.
2. Debrossard & Official Trustee in Bankruptcy [2011] FamCA 648 - Having analysed the contributions of the spouses it was clear that the non-bankrupt wife had contributed to creation of the available assets. The appropriate division of property was held to be 60:40 to the wife's benefit as between her and the husband. As the husband was bankrupt the matrimonial property was distributed 60:40 between wife and trustee in bankruptcy respectively.
3. Sutherland v Byrne-Smith [2011] FMCA 632 - a relatively complex factual matrix was further complicated by a lack of documentary evidence. Having considered the individual contributions made by the couple towards the property the court treated both parties as having contributed equally towards the property which was the main asset of the parties. Therefore 50% of property or sale proceeds from property passed to the non-bankrupt spouse with the balance 50% passing to the creditors of the bankrupt.

Next week's post will consider the main factors the courts appear to take into account in this area.

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 Wonder Stuff song ‘Can’t shape up’.

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Scissors, paper, rock – Family Law v Bankruptcy Act (part I): who goes first?**

Last week’s post looked at the interplay between the rights of spouses on a property settlement under the Family Law Act and the rights of creditors on the bankruptcy of a spouse.

Since 2005, the Family Law Act has required that the court consider 'the effect of any proposed order on the ability of a creditor of a party to recover the creditor's debt, so far as that effect is relevant'.

These amendments were largely as a result of the 'Jodee Rich Strategy' which saw the One.Tel founder allegedly seek to transfer significant assets to his wife under a property settlement entered into only days before he was at risk of commencing bankruptcy. At the time the transfers would have defeated creditors despite the clawback rules under the Bankruptcy Act which were unavailable for transfers under a property settlement.

Specifically the amendments introduced the following changes:

1. creditors were given the right to apply to set a property settlement agreement;
2. creation of a new act of bankruptcy for situations where a person becomes insolvent as a result of a transfer or transfers made under a property settlement;
3. extension of the claw back provisions under the Bankruptcy Act to allow the recovery of property transferred under a property settlement.

In a practical sense the provisions require the court to firstly consider the respective contributions made by each of the parties to the marriage and then also factor in the interests of creditors. Importantly however, the interests of creditors are not given more or less weight than the other factors the court must take into account.

Given that the legislation provides no particular guidance on how the court is to resolve disputes between non-bankrupt spouses and a trustee in bankruptcy, the case law in this area has evolved to develop the key principles.

Next week's post will summarise some of the key themes from the leading cases.

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 Ned’s Atomic Dustbin song ‘Who goes first?’.

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Out of time?** - The specifics of the Jodee Rich amendments

Previous posts have looked at the interplay between the rights of spouses on a property settlement under the Family Law Act and the rights of creditors on the bankruptcy of a spouse.

The amendments to the Family Law Act and the Bankruptcy Act made in 2005 radically changed how the Family Court is able to treat property interests where one or both of the parties to the marriage became bankrupt.

In particular, the Family Law Act permits the court to make whatever orders it considers appropriate, including -

1. altering the interests of the bankruptcy trustee in the vested bankruptcy property of a party involved in a family law property settlement;
2. ordering a relevant bankruptcy trustee to transfer property for the benefit of either or both the parties to the marriage or a child of the marriage; and
3. taking into account the effect of any proposed order on the ability of a creditor of a party to recover the creditor’s debt.

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 Blur song ‘Out of time’.

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When exactly is a director being a reasonable (man)**?

Posts over the last 2 weeks have looked at various aspects of the business judgment rule, leveraging the lessons explained in the decision of ASIC v Mariner Corporation Ltd [2015] FCA 589.

This case also explains when a director will be held to have acted reasonably as part of relying on the business judgment rule.

In particular, the court confirmed that the reasonableness of a director's belief should be assessed by reference to the:

1. importance of the business judgment to be made;
2. time available for obtaining information;
3. costs related to obtaining information;
4. director or officer’s confidence in those exploring the matter;
5. state of the company’s business at that time and the nature of competing demands on the board’s attention;
6. evidence available as to whether or not material information is reasonably available to the director.

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 National song ‘Reasonable Man’.

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Avoid being on your own** (A safe Harbour in the Mariner, Part II)

Last week’s post summarised the leading Corporations Act case of ASIC v Mariner Corporation Ltd [2015] FCA 589. This post further considers the business judgment rule in more detail.

While the key principles in relation to the business judgment rule have remained largely constant for many years, ASIC v Mariner was the first case where the rule would have been successfully relied upon if the directors had been found to have breached their directors’ duties.

The business judgment rule, under section 180(2) of the Corporations Act 2001 (Cth) provides that a director will discharge their duties whenever a decision is made in good faith, for a proper purpose, after a director fully informs themselves that the decision is reasonable and rational.

Importantly, pursuant to section 189 of the Corporations Act, a director may rely on information provided by a co-director, if they do so in good faith, after having made an independent assessment of it

At a practical level, the ability of a director to rely on the business judgment rule will depend largely on the records kept in relation to a decision. This means comprehensive meeting and diary notes in relation to board decisions are critical.

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 Blur song ‘On your own’.

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Happy** to be a safe Harbour in the Mariner?

Today's post considers the decision in ASIC v Mariner Corporation Ltd [2015] FCA 589.

The case is particularly important because it highlights the interaction between directors’ duty and liability where a company breaches a Corporations Act 2001 (Cth).

ASIC brought the case against Mariner and three of its directors alleging the directors had breached their directors’ duties of care and diligence by failing to comply with the takeover provisions under the Corporations Act. ASIC also argued the directors breached their duties regardless of whether the company itself had breached the Corporations Act.

ASIC argued the directors’ primary breach was in relation to their duty of care and diligence, under section 180 of the Corporations Act.

The court held that directors owe their duties to the company. As such, the key issue is whether actions taken by the directors jeopardised the company’s interests.

Here the evidence showed that the directors had considered the risk to the company of their decision and reasonably concluded that the benefit outweighed the risks. This meant there was no breach of section 180 of the Corporations Act.

The case is also important because it was the first time that the so-called ‘business judgment rule’ would have been successfully relied upon if the directors had been found to have breached their directors’ duties.

Next week’s post will explore the key issues in relation to the business judgment rule.

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 Ned’s Atomic Dustbin song ‘Happy’.

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Refinancing rules: ensure you & your client feel good**

One issue that arises regularly in relation to the taxation of trusts is the incurring of interest expenses by a trustee for external borrowings used to discharge an obligation to pay a monetary distribution to a beneficiary such as a credit loan or unpaid present entitlement (UPE).

The Tax Office has confirmed that the interest expense incurred in this style of situation will not be automatically deductible, even if the borrowed funds allows the trust to retain income producing assets.

Instead, in order for the interest to be deductible, the borrowings must be shown to be ‘sufficiently connected’ with the assessable income earning activity.

The leading case in this area is that of FC of T v. JD Roberts & Smith 92 ATC 4380 (Roberts & Smith). The principles in that decision were further expanded on in the Tax Office Ruling TR 2005/12.

Based on the principles outlined in the Ruling and Roberts & Smith, it is clear that whenever a trust is refinancing any existing loans or UPEs care should be taken to ensure there is the requisite connection to income producing activities; as opposed to, for example, making distributions to beneficiaries.

The key criteria is whether it can be shown that the objective purpose of the trustee in borrowing the funds is to refinance the outstanding amount, however the Tax Office’s position is that each situation will depend on the particular facts of the case.

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 Gorillaz song ‘Feel Good Inc’.

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You got the power** to make superannuation an estate asset?

The decision in Stock (as Executor of the Will of Mandie, Deceased) v N.M. Superannuation Proprietary Limited [2015] FCA 612 is another reminder of the fact that superannuation death benefits are not an estate asset.

Broadly the background was as follows:

1. The member died without making any binding nomination for his superannuation benefits, although binding nominations were permissible.
2. The member had made a non-binding nomination to his wife, however she predeceased him.
3. The trust deed for the fund provided that if there was no binding nomination the trustee retained the discretion to pay a death benefit to the member’s -
1. dependants; or
2. legal personal representative (LPR).
4. The trustee of the super fund resolved to pay the death benefit to the member’s dependants, namely 3 adult children, in equal shares.
5. The LPR challenged the distribution on the basis of comments in the member’s will, including the fact that two of the adult children had entered into a settlement agreement with their father 20 years earlier confirming they would have no entitlement under his estate.
6. Under the member’s will, his estate made provision for grandchildren and the child who was not a party to the settlement the other two children had entered into.

In rejecting the LPR’s challenge it was confirmed that superannuation is not an asset of an estate and a trustee is not bound to follow the directions of a will.

In particular, even if superannuation is specifically mentioned in a will, this does not make it an asset subject to the terms of the will. While a trustee may review a deceased member’s will, it is not the role of a super fund trustee to attempt to resolve issues relating to their estate.

Rather, a trustee must independently determine the distribution of a death benefit, unless there is a valid binding death benefit nomination.

It was also confirmed that in making a determination, a super fund trustee need only show that their decision is fair and reasonable. Any court review of a trustee decision therefore did not need to analyse the trustee’s processes or reasoning.

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 Gorillaz song ‘We got the power’.

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This is the one** important case on language you need to know this week (the 'income and profits' decision)

Following on from last week’s post, another case that applied some aspects of the reasoning in the decision profiled last week is Wilson & Anor v Chapman & Anor [2012] QSC 395.

Broadly the background was as follows:

1. Under the terms of a will, a beneficiary who was essentially a life tenant of a trust under the will was entitled to the ‘income and profits’ of the assets of the trust;
2. On the basis that the use of the word ‘profits’ must have meant the willmaker wanted the beneficiary to receive more than simply income, the court considered whether both realised and unrealised capital gains fell within the concept;
3. Acknowledging that for tax purposes a realised capital gain is effectively treated as income, the court also held that at least under the terms of the trust in this will, ‘profits’ included the net income and the net realised capital gains, but not unrealised capital gains.

Practically, a key reason why ‘profits’ did not include unrealised capital gains was the fact that it would be impossible to determine at what points to make the calculation and the trustee had no ability to distribute the unrealised gains under the trust instrument. Similarly there was nothing that would allow the trustee to factor in unrealised losses.

Weight was also put on the fact that the will was drafted by a lawyer so the inclusion of the word ‘profits’ must have been due to the willmaker’s intention to provide something more than only income to the life tenant.

More generally the case is a reminder of the need to ensure care is taken in drafting any will, particularly in relation to the interplay between tax and trust law principles.

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 Stone Roses song ‘This is the one’.

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Estate Planning and Beneficiary Loan Accounts: Fools gold**

The decision in Clark v Inglis [2010] NSWCA 144 remains a key case in relation to the interplay between beneficiary loan accounts and estate planning.

Broadly the background was as follows:

1. Dr Inglis established a trust in 1982 (Trust) with himself, his four children from his first marriage, his one child from his second marriage and his second wife Helen Margaret Inglis (Helen) as potential beneficiaries;
2. A company named ‘Inglis Research Pty Ltd’ acted as the trustee;
3. The main asset class of the Trust was a listed share portfolio that for many years was generally carried in the accounts of the Trust at cost;
4. Many years after the establishment of the Trust, and a change in the method of preparing the trust accounts, ‘income’, although unrealised, from the increase in value of shares was distributed to various beneficiaries creating (in relation to Dr Inglis) a credit loan account of more than $1 million;
5. Under Dr Inglis’ estate plan his personal wealth was gifted under his will to Helen, while control of the Trust and its assets was given to the children of his first marriage.

Among other issues in contention following the death of Dr Inglis, the children from his first marriage challenged the legitimacy of the steps that created a credit loan to his benefit from the Trust.

The Court held that while the accounting approach was perhaps imprudent, it was permissible under the trust deed and there was nothing under the accounting standards that prevented the arrangements.

In this regard it was noted that the trustee had the specific right under the trust deed to re-categorise income and capital and distribute unrealised income in its discretion.

This meant that there had been no breach of trust by the trustee and the debt owing by the Trust to the estate was enforceable and effectively an at call loan, repayable on demand to Helen.

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 Stone Roses song ‘Fools Gold’.

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The powers of an attorney: being under the thumb**

An issue that often arises is the exact extent of the powers an attorney may exercise on behalf of a donor.

One of the leading cases in this area is Taheri v Vitek [2014] NSWCA 209.

In summary the key aspects of the case were as follows:

1. The wife appointed her husband under a power of attorney and granted the husband the standard ability ‘to do on my behalf anything I may lawfully authorise an attorney to do’.
2. The attorney document (as is often the case) also empowered the husband as attorney to act despite any benefit that may pass to him.
3. The husband later used his appointment as attorney to sign on behalf of his wife and guarantee a purchase of land by a company the husband was sole director of.
4. The wife subsequently attempted to avoid her obligations under the guarantee on the basis that the document and wider transaction did not benefit her.

The court held that the wife was bound to comply with the guarantee, regardless of whether the transaction was for her benefit. The decision was primarily based on the term in the appointment document that allowed the husband to act even if the transaction did not benefit his wife.

It was however also confirmed that even if the appointment of attorney document does not specifically confirm an attorney can act against the interests of the donor, the attorney’s actions may still be binding. The reason for this general approach of the courts is to ensure certainty for third parties who reasonably rely on the apparent authority of an attorney.

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 Rolling Stones song ‘Under my thumb’.

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Letting little fury things ** like the tax tail wag the dog

Given the theme of ‘famous tax cases’ in recent posts, it seemed appropriate to revisit the tax aspects of the case involving the family of famous retailer Solomon Lew (Lew), in Solomon Lew & Ors v Adam Priester & Ors [2012] VSC 57.

Broadly the situation was as follows:

1. Based on tax advice about an impending tax change (which was ultimately never implemented), certain distributions were made by a trust ultimately controlled by Lew to each of his children
2. The potential change was proposed in the late 1990’s and was known as the ‘profits first rule’ which would have seen a mandatory requirement that any distribution from a trust would presumed to be of profits and therefore taxable.
3. 2 of Lew’s children some years later were caught up in (separate) property settlements following the breakdown of their respective marriages.
4. The former spouses claimed the outstanding loans were assets of Lew’s children and therefore able to be subject to orders of the Family Court.
5. Lew argued that his children did not have any beneficial interest in the loan accounts due to agreements entered which resulted in the amounts in fact being held by the children on a trust for Lew and his wife Rose.

While the exact outcome as to whether the loans were in fact assets of the children appears to be unknown (it is assumed the cases must have settled out of court or the decisions de-identified), the fact that the former spouses were able to mount the arguments is a reminder that the wider commercial implications of any tax planning strategy should always be considered carefully.

Similarly, in the high profile case of Cardaci v Filippo Primo Cardaci as executor of the estate of Marco Antonio Cardaci [No 5] [2021] WASC 331, in a situation where historically payments to a beneficiary were categorised as distributions of capital or income, a subsequent unilateral attempt by the trustee to commence treating the amounts as loans was rejected by the court.

This was ultimately on the basis that the trustee had not adequately or sufficiently explained how or why the change in characterisation occurred, nor was there any express or implied loan agreement in relation to the payments.

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 Dinosaur Jnr song ‘Little fury things’.

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Yeah right** - because before Rinehart, there was Murdoch

While the Rinehart decision received significant attention in relation to many issues, including the tax consequences of ending a trust, the tax principles of another famous case are worth remembering, namely the decision in Murdoch v Commissioner of Taxation [2008] FCAFC 86.

Broadly the situation was as follows –

1. Dame Elisabeth Murdoch (Dame) had a life interest in the income of several family trusts settled by her husband in the 1930s.
2. The remainder interest was held by one or more of the Dame’s children or grandchildren.
3. For many years, the trustee of the relevant trusts was effectively the Dame, her son Rupert Murdoch and a third party.
4. It was however noted that the Dame was likely influenced in her role to accept the investment decisions due to the very strong personality of her son Rupert.
5. A Reorganisation Agreement under which Dame surrendered her life interests under each of the Trusts were entered into, with the consideration a lump sum payment of more than $85m.
6. The payment was couched as releasing the trustees from potential claims for breaches of trustee duties.
7. In particular, the investment policy that had been adopted (apparently at Rupert’s strong recommendation) was overwhelming weighted to shares in Murdoch family companies that produced capital growth, but comparatively small dividend income. This investment approach essentially benefited the remainder beneficiaries, at the expense of the Dame as life tenant.
8. The payment was said to be to help avoid the need for litigation amongst the family.
9. Around 65% of the $85m was then gifted by the Dame to Rupert and charities she was associated with.
10. The payment was funded by the sale of pre capital gains tax shares and was essentially received tax free by the Dame.

In confirming the extremely onerous fiduciary duties of a trustee (see the post from last week) the court confirmed that Rupert had breached his obligations, even though there was no lack of good faith or particular damage to the Dame.

The court relied particularly on the principles of the case Phipps v Boardman [1967] 2 AC 26, which held that this style of claim was not for a reimbursement of the income shortfall.

The payment was therefore on capital, not income, account as a claim against the profit made by Rupert and in essence a constructive trust over assets of the trust.

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 Dinosaur Jnr song ‘Yeah, right’.

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Fiduciary duties: they are out there**

Fiduciary duties are generally seen as the most onerous of all legal duties and where they apply they require a person to act solely in another party's interests.

One case often referred to that highlights the extent of fiduciary duties is Loughnan v McConnell [2006] QSC 359.

Broadly the situation was as follows:

1. Loughnan was a lawyer and a co-executor and trustee of the estate of Mr McConnell (Ross).
2. Nadia McConnell (Ross’ wife) was the co-executor and trustee.
3. Ross’ accountant was also an executor.
4. Duckett Pty Ltd was the trustee of a family trust.
5. The sole shareholder of Duckett was Ross, who held two shares, and he and Nadia were its directors.
6. Under the will, the shares in Duckett were to be held by the trustees of the will on trust for Henry McConnell (the son of Ross and Nadia) if he was living on 1 August 2021.
7. After probate was granted, Nadia undertook a number of actions without reference to Loughnan, including relevantly -
1. in her role as sole director appointed herself as chairman of Duckett;
2. appointed her mother as an additional director of Duckett;
3. Duckett then resolved to vary the deed for the trust to (among other things) make Nadia the appointor of the trust and allow her to remain a beneficiary even if she remarried. The trust deed prior to the amendment excluded Nadia as a beneficiary if she remarried and gave the appointor powers to Nadia and Loughnan jointly.
4. Under the trust deed as amended, Nadia then by further deed removed Duckett as trustee and in its place appointed NEM Investments Pty Ltd of which she was sole director.

Loughnan made an application to court for directions concerning the trust and in particular unwinding the steps Nadia had unilaterally taken. The court confirmed that proceedings against Nadia should be commenced by Loughnan on the basis that she had breached her fiduciary duties as an executor and trustee of the estate.

The court also observed however that the primary concern was Nadia’s failure to disclose her intentions and that if consent of the co-executors had been obtained the actions would not have been reviewable.

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 Dinosaur Jnr song ‘Out there’.

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Step (child) on** ... and the list of people entitled under an estate

 

Last week's post considered some of the key issues, from a will drafting perspective, about whether a step child is entitled under a deceased estate.

The case of the Superannuation Complaints Tribunal in D19-20\023 provides a useful explanation of the wider position at law in relation to step children, including from a superannuation perspective.

In summary the decision confirms:

1. There is some support for the position for general law purposes, and in particular family provision (or testator family maintenance applications) that someone does not cease to be a ‘step-child’ of a person when their natural parent pre-deceases the person, if the marital relationship between their natural parent and the person was in place at the date of the natural parent’s death (see Scott-Mackenzie v Bail [2017] VSCA 108).
2. That is, the relationship of step-parent and step-child is one of affinity and does not cease merely because of the death of the natural parent. In other words 'once a step-child of the deceased, always a step-child of the deceased (providing the relationship of the deceased with the natural parent was not earlier dissolved otherwise than by death)'.
3. In contrast, there are also cases that conclude the relationship of ‘step-child’ ceases automatically on the death of the natural parent (see Re Burt (1988) 1 Qd R 23, Re Moreton (1996) 2 Qd R 174, Basterfield v Gay (1994) 3 Tas R 293 and Connors v Tasmanian Trustee Limited (1996) 6 Tas R 267).
4. For superannuation purposes, historically the Tax Office is on record as holding that a child only remains a stepchild while the relevant parents are a couple, for example see ATO ID 2011/77 where it was decided that a person ceases to be a 'stepchild' for the purposes of being a 'dependant' of the member under regulation 6.22 of the superannuation regulations, when the legal marriage of their natural parent to the member ends.
5. There is however support for the broader concept of ‘step-child’ - that is a relationship of affinity between the step-parent and step-child that can continue beyond the death of the natural parent.
6. In the factual matrix here, the Tribunal was satisfied that the step-daughter and the deceased member continued to have a sufficiently close relationship after the earlier death of the spouse of the member (who was the natural parent of the step-daughter).
7. As a result the natural daughter of the spouse of the member remained the step-child of the deceased member and in turn fell within the definition of ‘child’ at the date of the deceased member’s death. Therefore she was a ‘dependant’ for the purposes of both the trust deed of the fund and the superannuation legislation.

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 Happy Mondays song ‘Step On’.

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A drafting lesson: waiting for you in the shadows**

Recently we were reviewed a clause in a trust deed that confirmed the beneficiaries were ‘any and all of the children, grandchildren or great grandchildren of the mother and the father.

The drafting approach is a common one, and can lead to 2 starkly different interpretations, namely either all of the children, grandchildren and great grandchildren of:

1. the relationship between the father and the mother; or
2. each of the father and the mother (i.e. including children from other relationships).

Generally the position adopted by the courts is that where a phrase is capable of more than one correct grammatical interpretation the construction that conforms with current usage should prevail, while also having regard to the circumstances surrounding the establishment of the trust.

One of the leading cases is Boranga v Flintoff (1997) 19 WAR 1.

The case confirms that the primary task of courts is to discern the intention of the settlor from the words of the relevant trust deed, with reference to the position as at time the deed was entered into.

In this case the following facts were considered to be relevant in determining whether step-children would be included as beneficiaries under the phrase 'the children of A and B’:

1. the ages of the stepchildren at the time the trust was established and whether the step- children were dependants of A or B at the time;
2. whether the step-children had any special needs, e.g. a disability;
3. the existence and ages of any children from the relationship of A and B at the settlement date;
4. the ages of A and B at the settlement date and whether it was likely there would be any further children from the relationship of A and B; and
5. the pattern of trust distributions and whether the step-children received distributions from the trust.

Having factored in each of the above issues, it was held that the phrase 'the children and remoter issue of the said A and the said B’ included children of either A or B – in other words stepchildren were included.

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** For the trainspotters, the title of today's post is riffed from the Thurston Moore song ‘Smoke of dreams’.

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SMSFs and non-geared unit trusts: bulletproof**

While there are some, narrow exceptions, generally an SMSF is only able to invest in an ungeared unit trust and subject to strict requirements set out in the Superannuation (Supervision) Regulations (namely regulation 13.22C).

The provisions of regulation 13.22C are detailed and prescriptive and if there is any intention to access the concession regard should be had to the exact requirements.

One issue that often arises for SMSFs that do have a partial ownership interest in a trust that otherwise complies with regulation 13.22C is whether the SMSF can acquire additional units in the structure from a related party.

Generally such an acquisition by an SMSF is prohibited under the in-house asset rules, however there is an exemption from those rules in relation investments in trusts that comply with regulation 13.22C.

Furthermore there is an exemption from the prohibition that also applies against SMSFs acquiring assets from related parties for ownership interests in trusts that comply with regulation 13.22C.

The exceptions operate to specifically permit the acquisition of shares in companies or units in unit trusts, so long as all provisions of regulation 13.22C are satisfied at the time of the acquisition and on an ongoing basis.

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 Radiohead song ‘Bulletproof’.

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Accessing excepted trust income – avoid being a paranoid android**

Estate planning best practice dictates to ’begin with the end in mind’ and ensure a person's documentation achieves their objectives, for example, by including a testamentary trust.

This said, as previous posts have highlighted, it is possible to establish a trust following a person's death such as an estate proceeds trusts, superannuation proceeds trust or a special disability trust.

When considering the use of ‘post death testamentary trusts’ it is important to ensure income derived from gifted property to the structure does in fact create excepted trust income.

The Tax Office has provided useful guidance in this regard in Private Ruling 50621.

In the situation of this Ruling, minor children had each received gifts of money from 2 sources which were then invested on their behalf by a relative.

The 2 sources of the gifts were:

1. money left to them in a will; and
2. other gifts made to them by persons who were alive at the time the gifts were made.

The Tax Office confirmed its view that:

1. The investment earnings derived from monies that were sourced from a deceased estate (whether due to an absolute gift under a will or due to the intestacy rules) held in trust for minor beneficiaries were excepted income.
2. In contrast, the investment earnings from monies gifted to children by their living relatives were not excepted income.

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** For the trainspotters, the title of today's post is riffed from the Radiohead song ‘Paranoid android’.

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Can you or can't you (explain)** if you can amend a power to amend

Posts over recent weeks have considered various aspects of the extent of authority created for a trustee by a general power of variation under a trust deed.

Another useful case in this area is the decision in University of Adelaide v Attorney-General (SA) [2018] SASC 82.

Relevantly, the court confirmed that:

1. Where a power of amendment has been included in a trust deed, there must be compliance with any procedural or substantive restrictions on its exercise.
2. As a general principle of construction of trust deeds, a 'trustee cannot utilise its power of amendment of the trust deed to remove restrictions on its power of amendment' (see Retail Employees Superannuation Pty Ltd v Pain [2016] SASC 121).
3. Even in the absence of express restrictions, it would seem implicit that a power of amendment cannot be exercised to amend itself (see a case featured in a number of previous posts, namely Jenkins v Ellett [2007] QSC 154).

Despite the above conclusions, the decision in the case of Re McGowan & Valentini Trusts [2021] VSC 154 (as also featured in other View posts) essentially distinguished the above summary.

This was on the basis that where there is an extremely wide power of amendment in a trust deed it should be read and interpreted according to its natural meaning, notwithstanding what might otherwise be a general principle of construction.

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 riffed from The Who and the song 'I Can't Explain'.

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Coming home** by extending trust vesting dates

As mentioned in last week’s post, the need to ‘read the deed’ is critical on a number of levels, particularly in relation to the vesting date of a trust.

A previous post also explores when a court may approve the extending of a vesting date for a trust.

The two other main pathways that may assist in this regard are:

1. using a specific power in the trust deed that allows the vesting date to be extended; and
2. using the variation power (if it is broad enough).

Whether a general power of variation will be broad enough was considered in the case of Andtrust v Andreatta [2015] NSWSC 38.

Essentially the decision confirms that where a trust deed contains a power to vary the trust, it should be assumed that the power includes the ability to extend the vesting period, subject to the perpetuity period rules.

In particular, it was held:

‘It does not seem to me to be stretching language unduly to say that a trust to distribute or hold income up until a defined date, and upon that date to distribute capital, is “varied” if that defined date is extended. Thus, as a matter of language, it seems to me that the power to vary the trusts set out in the deed should be taken to include a power to vary them by extending the time for which they are to endure.’

In other words, as explored in other View posts, any variation power should generally be construed widely and beneficially, including in relation to the ability to extend a vesting date even if there is no specific power to do so (see cases such as Kearns v Hill (1990) 21 NSWLR 107 and Nisus Pty Ltd [2022] NSWSC 369).

However, where there is not a sufficiently wide power to vary a trust in relation to the vesting date (or indeed no power to vary at all), the conservative view is that court approval is required.

This said, as explored in other View posts, variation of the terms of a trust may be able to be achieved with the unanimous consent of the beneficiaries if all are in being, sui juris and absolutely entitled (see the rule in Saunders v Vautier (1841) 4 Beav 115). In this style of situation it may also be prudent to have the settlor be a party to the variation deed, if they are alive and have capacity.

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 Fine Young Cannibals song ‘Johnny come home’.

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Embrace the ceremony** and ‘read the deed’

As highlighted in previous posts, the need to ‘read the deed’ before making any variation to a trust deed is critical – and a case that remains a leading example of the mantra is Jenkins v Ellett [2007] QSC 154.

Broadly the background in this case was as follows:

1. A principal under a trust deed had the ability to remove and appoint the trustee of the trust.
2. The principal purported to relay on a power of variation to remove himself as principal and name a replacement, which effectively changed the schedule to the trust deed that automatically appointed the principal’s legal personal representative (LPR) as his replacement on death.
3. When the LPR of the principal purported to exercise the principal powers following the death of the original principal and was challenged, the Court held that the previous attempted variation was invalid, effectively confirming the LPR’s authority to act as the principal.
4. The attempted variation was held to be invalid because the relevant power in the trust deed was crafted so that it could only be used in relation to the ‘trusts declared’, and in particular did not extend to varying the schedule to the trust deed.

Generally the decision here is cited as authority for a number of principles including:

1. If an attempt is made to made to amend fundamental provisions (such as appointor powers or indeed the amendment power itself), there must be a specific ability to do so under the trust instrument. This said, if the power to vary under a deed is wide, this can allow a trustee to change an appointor without their consent; and without destroying the substratum of the deed (see Cihan v Cihan [2022] NSWSC 538, a case explored in other View posts);
2. conversely, ancillary provisions should be able to be amended so long as there is a robust power of amendment in the trust deed;
3. this said, the trust deed may expressly prohibit certain amendments, thereby effectively ‘hard wiring’ those clauses;
4. furthermore, the exercise of a power of amendment must comply with any restrictions on the exercise of power, for example the need to obtain prior consent from a principal or appointor. The case of Re Cavill Hotels P/L [1998] 1 Qd R 396 (which has featured in previous posts) is also often quoted in this regard);
5. any power of variation should be construed widely and beneficially, such that (as one example), even if there is no specific power to amend or extend a vesting date, a wide power of variation will give this ability (see Nisus Pty Ltd [2022] NSWSC 369);
6. in situations where the purported amendment is not within the powers under the deed (or has the consequence of destroying the ‘substratum’ of the trust) it will be held to be invalid and ineffective; see for example Kearns v Hill (1990) 21 NSWLR 107.

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 New Order song ‘Ceremony’.

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SMSFs and non-arm’s length income: right here; right now**

One issue to remember with SMSFs is that any income derived by an SMSF as a beneficiary of a trust can be subject to penalty tax.

In particular, income earned other than through holding a fixed entitlement, is non-arm’s length income, and will be taxed according to the non-arm’s length income provisions of the Tax Act at a flat rate of 47%.

Income derived by a superannuation fund as a beneficiary of a fixed trust will also be non-arm’s length income if:

1. the fund acquired the entitlement under a scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at arm’s length; and
2. the amount of the income is more than the amount that the fund might have been expected to derive if those parties had been dealing at arm’s length.

To avoid the impact of the non-arm’s length income rules, it is therefore vital for SMSFs to ensure that:

1. no distributions are made to a SMSF from a discretionary trust; and
2. where a SMSF owns units in a unit trust, the unit trust is a fixed trust for tax purposes.

From a planning perspective, given the Medicare and other surcharges, there may in fact be a saving on overall tax payable by triggering the non-arm’s length income rules by (for example) distributing from a family trust to a SMSF and capping the tax rate at 47%.

It is also relevant to note that the non-arm’s length income rules may apply where a SMSF allows its fixed entitlement to remain as an unpaid present entitlement, as this generally does not reflect an arm’s length arrangement.

When allowing unpaid present trust entitlements in favour of a SMSF, it is therefore necessary to ensure that interest on those unpaid distributions is paid by the trust at market rates as would be the case if the SMSF and trust were dealing with each other at arm’s length.

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 Fatboy Slim song 'right here, right now’.

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SMSFs and public trading trusts: More** lessons from days gone by

A unit trust is often an attractive investment vehicle for taxpayers, as it can offer many similar benefits to a corporate structure, with the following additional benefits not available to companies:

1. access to the general CGT 50% discount (33% for unit trusts where units are owned by SMSFs);
2. the ability to issue units with different rights to income and capital;
3. no requirements for formal disclosure to ASIC and other regulatory bodies;
4. ensuring asset protection risks are isolated from other assets; and
5. no requirements for a formal audit.

In particular, unit trusts are often viewed as the preferred structure for holding capital appreciating assets where there are unrelated third party investors.

Traditional unit trusts provide that the beneficial interest in the trust property is held in proportion to the units held by each unitholder.

It is important however to understand that under the Tax Act, a unit trust may be deemed (for tax purposes) to be a ‘public trading trust’.

Where a unit trust is deemed to be a public trading trust, the trust is taxed as if it were a company, and all of the tax advantages outlined above will effectively be lost. For example:

1. the trust’s income (regardless of whether it is distributed or not) is taxed at the corporate tax rate;
2. specifically, capital gains are taxed at the corporate tax rate, with no access to the general CGT discount;
3. there may be insufficient franking credits for intended distributions due to (for example) depreciation rules;
4. if the trustee of the trust is unaware that it is in fact a public trading trust, it may be held that all distributions are unfranked dividends causing significant excess tax to be paid; and
5. there will be a timing delay for the unitholder in receipt of income, as the tax paid by the unit trust is refundable via a franking credit when the unitholder ultimately lodges its tax return.

A unit trust may be deemed to be a public trading trust where it is a ‘public unit trust’ (a term defined under the Tax Act).

Historically, a unit trust could be deemed to be a public trading trust where one or more SMSFs held a right to 20% or more of the income or capital of the trust and a number of other technical rules were satisfied.

Changes in 2016 however removed the 20% tracing rule for public trading trusts for SMSFs. This means, a unit trust where units are owned via one or more SMSFs should never be taxed as a company.

Generally unit trusts owned by SMSFs avoiding being treated as a company for tax purposes will be a preferred outcome.

There are however a range of issues that need to be managed, including the non-arm’s length income rules that may mean that if the unit trust is not ‘fixed’ (an issue explored in many other View posts), any income derived by the SMSF will be taxed at penalty rates.

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 Sisters of Mercy song 'More’.

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All of this; and nothing** - Default beneficiaries and bankruptcy

Following on from the posts over the last few weeks, it is important to be aware that some commentators argue that the interest of a default beneficiary constitutes property that may vest in the trustee in bankruptcy if a default beneficiary is declared bankrupt.

It has generally been argued that the interest of default beneficiaries is of a different character from that of a discretionary object and may well be property of a bankrupt (see - Dwyer v Ross (1992) 34 FCR 463).

However, it has also been argued that the interests of takers in default do not have a vested interest in the assets of the trust until the trust vests, and until that event occurs, the assets of the trust have not been the subject of an effective appointment.

That is, such interests can be deferred or taken away at any time prior to vesting or termination of the trust and, accordingly, such interests are ‘mere expectancies’ in respect of property that is not capable of vesting in a trustee in bankruptcy.

The preferred position adopted by the cases remains that a default beneficiary does not have an interest in trust assets that amounts to property that is attackable by a trustee in bankruptcy.

This said, it is always appropriate, when establishing a trust, to consider carefully who should be nominated as the default beneficiaries to ensure that the assets of the trust do not become unnecessarily exposed to claims against those beneficiaries if the law in this area changes.

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 Psychedelic Furs song 'All of this and nothing’.

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A room without a door** - Default income provisions for family trusts

Following last week’s post, another issue that arises relatively regularly in relation to family trusts is the trust deed not containing a default provision for the distribution of trust income.

While there are many competing arguments, the preferred position appears to be that the absence of such a clause should not make the trust invalid.

This said, without the inclusion of a default income provision, it will generally be the case that a failure by a trustee to validly distribute income in any particular year will mean that the income is accumulated and the trustee will be taxed.
An earlier post, explains that where the trustee is liable to tax this will generally be at the maximum rate of personal tax – that is including the Medicare levy and similar surcharges and without access to the general 50% CGT discount.

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 Psychedelic Furs song 'Love my way’.

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