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’.
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:
The member died without making any binding nomination for his superannuation benefits, although binding nominations were permissible.
The member had made a non-binding nomination to his wife, however she predeceased him.
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 -
dependants; or
legal personal representative (LPR).
The trustee of the super fund resolved to pay the death benefit to the member’s dependants, namely 3 adult children, in equal shares.
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.
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’.
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:
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;
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;
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’.
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:
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;
A company named ‘Inglis Research Pty Ltd’ acted as the trustee;
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;
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;
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’.
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:
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’.
The attorney document (as is often the case) also empowered the husband as attorney to act despite any benefit that may pass to him.
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.
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’.
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:
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
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.
2 of Lew’s children some years later were caught up in (separate) property settlements following the breakdown of their respective marriages.
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.
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’.
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 –
Dame Elisabeth Murdoch (Dame) had a life interest in the income of several family trusts settled by her husband in the 1930s.
The remainder interest was held by one or more of the Dame’s children or grandchildren.
For many years, the trustee of the relevant trusts was effectively the Dame, her son Rupert Murdoch and a third party.
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.
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.
The payment was couched as releasing the trustees from potential claims for breaches of trustee duties.
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.
The payment was said to be to help avoid the need for litigation amongst the family.
Around 65% of the $85m was then gifted by the Dame to Rupert and charities she was associated with.
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’.
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:
Loughnan was a lawyer and a co-executor and trustee of the estate of Mr McConnell (Ross).
Nadia McConnell (Ross’ wife) was the co-executor and trustee.
Ross’ accountant was also an executor.
Duckett Pty Ltd was the trustee of a family trust.
The sole shareholder of Duckett was Ross, who held two shares, and he and Nadia were its directors.
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.
After probate was granted, Nadia undertook a number of actions without reference to Loughnan, including relevantly -
in her role as sole director appointed herself as chairman of Duckett;
appointed her mother as an additional director of Duckett;
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.
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’.
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:
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).
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)'.
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).
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.
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.
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).
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’.
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:
the relationship between the father and the mother; or
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’:
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;
whether the step-children had any special needs, e.g. a disability;
the existence and ages of any children from the relationship of A and B at the settlement date;
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
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.
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 Thurston Moore song ‘Smoke of dreams’.
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’.
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:
money left to them in a will; and
other gifts made to them by persons who were alive at the time the gifts were made.
The Tax Office confirmed its view that:
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.
In contrast, the investment earnings from monies gifted to children by their living relatives were not excepted income.
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 ‘Paranoid android’.
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:
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.
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).
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'.
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:
using a specific power in the trust deed that allows the vesting date to be extended; and
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’.
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:
A principal under a trust deed had the ability to remove and appoint the trustee of the trust.
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.
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.
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:
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);
conversely, ancillary provisions should be able to be amended so long as there is a robust power of amendment in the trust deed;
this said, the trust deed may expressly prohibit certain amendments, thereby effectively ‘hard wiring’ those clauses;
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);
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);
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’.
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:
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
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:
no distributions are made to a SMSF from a discretionary trust; and
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’.
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:
access to the general CGT 50% discount (33% for unit trusts where units are owned by SMSFs);
the ability to issue units with different rights to income and capital;
no requirements for formal disclosure to ASIC and other regulatory bodies;
ensuring asset protection risks are isolated from other assets; and
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:
the trust’s income (regardless of whether it is distributed or not) is taxed at the corporate tax rate;
specifically, capital gains are taxed at the corporate tax rate, with no access to the general CGT discount;
there may be insufficient franking credits for intended distributions due to (for example) depreciation rules;
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
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’.
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’.
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’.
We have received some feedback about the following comment in a recent post, namely:
‘There is also a risk that if there is no valid default or gift over provision, then the assets of the trust pass on a resulting trust to the settlor. This outcome is at best problematic, particularly given that the settlor is often an unrelated third party such as an accountant or lawyer.’ (extracted from an earlier post)
The debate about whether discretionary trusts need provisions that detail how assets will be distributed in the event of a trustee failing to make a decision is longstanding, and arguably unresolved.
For those wishing to avoid being the subject of the next test case to resolve the issue, the conservative view appears to be that the lack of a default provision for capital means the trust may be held to be void. If this is the case, the invalidity will be deemed to be from the date of creation of the trust, however only if the trustee fails to make a determination to distribute all of the capital on or prior to the vesting day.
While it is often possible to amend a trust deed to insert a default provision for capital, this amendment can potentially result in capital gains tax and stamp duty being payable on the gross assets of the trust – generally an unacceptable risk.
Specific advice should always be obtained, however practically the approach adopted is often as follows:
continue to use the trust for the assets that it already owns;
take all reasonable steps to ensure that the trustee exercises its discretion prior to the vesting day to distribute the capital of the trust to any of the named beneficiaries;
where possible (once the lack of a default provision is identified), ensure that the trust does not acquire any further assets; and
if the group wishes to acquire further assets within a trust structure, a new trust should be established ensuring that it has none of the technical deficiencies the problematic trust deed contains.
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 Cold Chisel song 'Forever Now’.
Previous posts have considered the issues about varying a trust that has not power to vary.
Previous posts have also looked at various aspects concerning the ability to vary trust instruments.
One iteration that is important to remember relates to attempts to vary problematic power of variation.
In other words, if a trust instrument has a variation power that is considered too narrow to achieve wider objectives, is it possible to use the pre-existing variation power to vary that clause of the trust instrument and create a wider power or variation?
As explained by the mantra ‘read the deed', the answer to this question will often depend on the exact terms of the trust instrument.
Very broadly however, the position appears to be as follows:
If there is a restriction on how the variation power may be exercised, it is generally not possible to vary the power to remove that restriction.
In other words, a trustee cannot implement steps indirectly to achieve something that is prohibited via direct action.
The reason for this conclusion is largely based on the rule that a trustee has an overriding duty to comply with the terms of the trust instrument as articulated on the settlement of the trust.
The corollary is also true – i.e. if the power of variation expressly contemplates itself being varied, then the trustee should be able to do so.
As is almost always the case with the trust deeds, there are a number of related potential issues that should be considered depending on the factual matrix.
For example, if a particular trust instrument prohibits distributions to a certain person, but not to a trust of which that person is a potential beneficiary, would a ‘back to back’ distribution from the initial trust to the second trust and then to the relevant person constitute a breach of trustee duties?
There is certainly case law to support an argument that where a trustee takes steps to achieve an ulterior purpose, this can constitute a ‘fraud on the power', which means the arrangements may be held to be void by a court.
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 Midnight Oil song 'Dreamworld’ – inspired by the Cavill Hotels and Star Hotel mentions last week and the icon line ‘the breakfast Creek Hotel is up for sale’.
Last week’s post considered one of the leading cases in relation to a failure to follow the specific requirements of a trust instrument when appointing a beneficiary.
In that case, the failure to validly appoint a beneficiary caused significant difficulties due to subsequent purported distributions of income to the party.
In summary, it was held as follows:
The attempted distribution of income to an invalidly appointed ‘beneficiary' is a nullity.
On this basis, the distribution can be set aside as void ‘ab initio' – in other words, the distribution itself is taken to never have occurred (this aspect of the decision relied on an earlier case of Re Cavill Hotels Pty Ltd [1998] 1 QdR 396.
Where a purported distribution of income fails, the entitlement of valid potential beneficiaries will depend on the relevant original distribution minute initially.
If the relevant distribution minute does not address who receives a failed distribution, then the default provisions, if any, under the trust instrument will apply.
The ability for any default clause under a trust instrument to operate effectively will depend upon whether they do in fact trigger a distribution within the relevant income year. As profiled in an earlier post, some trust deeds do not operate effectively in this regard.
There is also a risk that if there is no valid default or gift over provision, then the assets of the trust pass on a resulting trust to the settlor. This outcome is at best problematic, particularly given that the settlor is often an unrelated third party such as an accountant or lawyer.
Practically, a trustee would need to reimburse the trust (or each underpaid beneficiary) to the extent of the invalid distribution from their own assets.
Trustee Exposure also potentially extends to other losses, for example overpaid income tax that may have become unrecoverable from the Tax Office (eg due to being out of time).
While in theory the trustee would be entitled to recover amounts it personally compensates the trust for from the overpaid beneficiary, practically if that beneficiary does not have assets, recovery attempts may fail.
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 Cold Chisel song 'Star Hotel’ – inspired by the Cavill Hotels case mentioned above.
Previous posts have looked at various aspects of trust related strategies recommended by accountant Steve Hart, that over time caught the attention of the Tax Office.
Previous posts have also considered various aspects of the mantra ‘read the deed'.
Recently, I was reminded of a decision, which highlights the importance of both of these concepts, namely the decision in Idlecroft Pty Ltd V Commissioner of Taxation [2004] FCA 1087.
The factual matrix in this matter was relatively complex. Arguably, the key aspect related to a purported nomination of a beneficiary.
The relevant clause in the trust instrument gave the principal of the trust the power to nominate beneficiaries by notice in writing to the trustee.
Under the purported written nomination, the principal did sign the document, however it was noted in the instrument that the signature was in his capacity as a director of the trustee company.
The court held that the document failed to satisfy the requirements under the trust deed for the principal to provide the trustee with written notification of the appointment of beneficiary.
In turn, this meant that the subsequent distributions of income to the beneficiary, who was not in fact validly appointed, failed.
Next week’s post will summarise some of the consequences of this failure.
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 White Stripes song '7 Nation Army’.
Posts over recent weeks have considered the issues about varying a trust that has no, or an inadequate, power to vary.
An iteration on the theme is set out in the decision of Budumu Pty Ltd [2021] NSWSC 522.
In this case a power to vary was granted under the trust instrument, however it was only able to be relied on during the life time of 2 named (primary) beneficiaries; both of whom had died by the time the variation was required.
Court approval was therefore needed, and granted, in order to ensure the trust avoided the land tax surcharge in relation to foreign beneficiaries.
A further example is provided in the decision of Casibond Pty Ltd: In the matter of George Tsivis Family Trust [2021] NSWSC 320. In this case, a trust deed had no formal power of variation, however did have the following provision:
'(The Trustee may) generally, determine all matters as to which any doubt, difficulty or question arises in relation to the Trust Fund and every such determination shall bind all parties interested in the Trust, but nothing in this sub-clause shall prevent the Trustee or any person interested in the Trust Fund from applying to the Court.'
This provision was held to be insufficient to allow the trustee to avoid the application of the foreign beneficiary surcharge, however again the court approved steps allowing the desired outcome.
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 Hunters and Collectors song 'Run, Run, Run'.
Posts over the last couple of weeks have considered the issues about varying a trust that has not power to vary.
Previous posts have also looked at various aspects concerning the ability to vary trust instruments.
One iteration that is important to remember relates to attempts to vary problematic power of variation.
In other words, if a trust instrument has a variation power that is considered too narrow to achieve wider objectives, is it possible to use the pre-existing variation power to vary that clause of the trust instrument and create a wider power or variation?
As explained by the mantra ‘read the deed', the answer to this question will often depend on the exact terms of the trust instrument.
Very broadly however, the position appears to be as follows:
If there is a restriction on how the variation power may be exercised, it is generally not possible to vary the power to remove that restriction.
In other words, a trustee cannot implement steps indirectly to achieve something that is prohibited via direct action.
The reason for this conclusion is largely based on the rule that a trustee has an overriding duty to comply with the terms of the trust instrument as articulated on the settlement of the trust.
The corollary is also true – i.e. if the power of variation expressly contemplates itself being varied, then the trustee should be able to do so.
As is almost always the case with the trust deeds, there are a number of related potential issues that should be considered depending on the factual matrix.
For example, if a particular trust instrument prohibits distributions to a certain person, but not to a trust of which that person is a potential beneficiary, would a ‘back to back’ distribution from the initial trust to the second trust and then to the relevant person constitute a breach of trustee duties?
There is certainly case law to support an argument that where a trustee takes steps to achieve an ulterior purpose, this can constitute a ‘fraud on the power', which means the arrangements may be held to be void by a court.
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 White Stripes song 'Little Room’.
Posts over recent weeks have considered various issues about courts varying a trust deed that has no sufficient power of variation.
One of the cases mentioned was the decision in Cecil Investments Pty limited [2021] NSWSC 211.
This decision (as well as TNB 878 Pty Limited – Brunskill Family Trust [2022] NSWSC 527) is also useful as it confirms that there have been a number of cases where it is has been held tax savings or advantages form a basis of expediency in the management and administration of trust property - one of the key tests that generally need to be satisfied.
In particular the decision lists the following examples:
Re A.S. Skyes and the Trustee Act (1974) 1 NSWLR 597: “… the powers conferred on the Court should not be withheld merely because their exercise is sought to enable the avoidance of a revenue impost…”
Stein v Sybmore Holdings Pty Ltd [2006] NSWSC 1004: “As well, the minimisation of the capital gains tax and stamp duty on the trust property provides a separate basis upon which the conferring of the power is expedient.”
Application of NSFT Pty Ltd [2010] NSWSC 380: “modernisation of the trust deed ... with consequential tax benefits, is expedient in the management or administration of the property vested in the trustee…”
Barry v Borlas Pty Ltd [2012] NSWSC 831: the scope of the court's powers includes preserving trust property and making it financially productive “…which included planning to minimise the impact of tax and duty on the trust property…”
Soo v Soo [2016] NSWSC 1666: "… there are numerous decisions of this Court to the effect that the tax effective administration of a trust is a matter to which regard may properly be had in considering whether or not to exercise discretion".
The above summary largely reflects the conclusions in Kearns v Hill (1990) 21 NSWLR 107, another case featured in other View posts.
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 Earth, Wind and Fire song 'Let's Groove’.
Last week's post considered the issues about varying a trust that has no power to vary, under the regime in New South Wales.
While in other states, for example Queensland, it is generally accepted there is a relatively wide power available to the courts to assist with amending trust deeds that do not have robust provisions, the rules in New South Wales are far more restrictive.
One further example in this regard is the decision in Application of Country Road Services Pty Ltd (In the matter of the Browne Family Trust) [2019] NSWSC 779.
In this case a desired amendment to a trust deed to appoint a related trust (that had losses) to allow distributions to it was rejected as not being 'expedient' (as required by the legislation in New South Wales).
The court confirmed that:
The variation of the terms of a trust (including by way of conferral of some new power on the trustee) is not something within the ordinary and natural province of a trustee’s powers (unless the trust deed otherwise grants the relevant power).
It is neither something that is ‘expedient’ that a trustee should do nor, fundamentally, something that is done ‘in management or administration of’ trust property.
Rather, a trustee’s function is to take the trusts as it finds them and to administer them as they stand.
A trustee should not be concerned to question the terms of the trust or seek to improve them.
Thus, even where the trust instrument itself gives the trustee a power of variation, exercise of that power is not something that occurs “in the management or administration of” trust property. It occurs in order that the scheme of fiduciary administration of the property may somehow be reshaped.
Ultimately, the Court’s power to amend a trust deed in New South Wales cannot be used to subvert the beneficial disposition in the trust instrument.
Similarly therefore, a request to amend a trust deed to extend the perpetuity period was held to be another example of the kind of order not authorised by legislation in New South Wales (see Cisera v Cisera Holdings Pty Ltd [2018] NSWCA 286), even though the trust was due to vest in around 7 years and would likely trigger significant capital gains tax costs at that point.
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 Simple Minds song ‘New Gold Dream’.
Pursuant to the Trusts Acts (and similar legislation) in most Australian states, there is an inherent power for a court to make variations to trust instruments.
This power can be extremely important where there is no, or a very narrow, power of variation in a trust instrument.
One of the leading cases in this area is Re Dion Investments Pty Ltd [2013] NSWSC 1941.
In broad terms, the case involved a trust deed setup in 1973, which the trustee was wanting to amend so as to be able to better manage the trust property. The relevant legislative provision in New South Wales gave the court the power to amend a trust instrument so long as it was ‘expedient' for the management or administration of trust property.
In rejecting a request to amend the deed by inserting a comprehensive variation power (which in turn would have allowed the trustee to make such changes to the trust deed as it deemed appropriate from time to time), the court confirmed:
The legislative provisions did not allow the court to simply insert into the deed a comprehensive power of variation.
Only specific powers (in contrast to wide discretionary powers) with respect to a particular dealing will be granted under the legislation.
It was however permissible for the court to confer particular and limited powers in relation to certain issues such as how to account for income and capital gains and related tax driven provisions.
Despite not originally crafting its variation request along the lines that the court said was permissible, the trustee was permitted to make further submissions in accordance with the court’s recommendations for immediate approval.
Interestingly, in the subsequent decision of Re Dion Investments Pty Limited [2020] NSWSC 1661, the court authorised a further variation to ensure the ‘foreign person’ land tax surcharge could be avoided. This was in light of the fact that the trust deed did not give the trustee the ability to exclude foreign persons as beneficiaries. In particular, the relevant power of variation was limited to 'trusts' (granted to persons who had all died and therefore had lapsed), not the ‘powers’ – a distinction explored in many previous View posts.
The court confirmed that the requirements in the legislation were all met, namely:
There needs to be a 'proposed dealing', being a 'sale, lease, mortgage, surrender, release, or disposition, or any purchase, investment, acquisition, expenditure, or transaction'.
The dealing must be in the Court’s opinion 'expedient'.
The dealing must be incapable of being effected because of an absence of power.
Relevantly the court confirmed that the existence of a tax advantage can form the basis of the ‘expediency’ in the management and administration of trust property requirement; here the land tax saving was over $100,000. This conclusion was reached notwithstanding that the order would adjust or even destroy the rights of some (potential) beneficiaries to the extent that they met the definition of a 'foreign person'.
The same outcome was granted in the case of Cecil Investments Pty limited [2021] NSWSC 211, where the trust deed permitted only a variation to the 'powers' not 'trusts.
This case also confirmed that previous attempted variations to the trust deed were invalid as they breached the limitation set out in the power of variation against anything that purported to change beneficiaries who were takers-in-default of appointment.
As has been explained in numerous previous posts, a comprehensive power of variation is arguably one of the most important aspects of any trust deed.
It is important to keep in mind that the legislation is worded differently in each State, for example the Queensland Courts have a wider power than in NSW. Reference should therefore always be had to the specific wording of the legislation in the relevant jurisdiction.
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 Black Rebel Motor Cycle club song 'Salvation’.
by%20Matthew%20Burgess.jpg "View Legal blog - This is the one important case on language you need to know this week (the 'income and profits' decision)by Matthew Burgess")
%20on%20...%20and%20the%20list%20of%20people%20entitled%20under%20an%20estate%20by%20Matthew%20Burgess.jpg "View Legal blog - Step (child) on ... and the list of people entitled under an estate by Matthew Burgess")
