The Federal Court's decision in Cunningham (Trustee) v Gapes (Bankrupt) [2017] FCA 787 (Federal Court, Collier J, 13 July 2017) (Cunningham) is vital guidance for all advisers in relation to the interplay between superannuation death benefits and the Bankruptcy Act 1966.
In particular, the case highlights the fact that a superannuation death benefit paid via a deceased estate to a bankrupt beneficiary is divisible amongst the creditors of the bankrupt.At a minimum therefore, advisers should consider advising clients who have at risk potential beneficiaries to utilise a binding death benefit nomination (BDBN). The BDBN should mandate that any death benefit is paid directly from the superannuation fund to a beneficiary at risk of bankruptcy, ideally as a lump sum (given that a pension stream will be subject to the threshold income limits).
Testamentary trusts
One additional strategy that should be considered in the context of deceased estates generally, and specifically in relation to superannuation death benefits, is the use of comprehensive testamentary trusts.
As readers will be aware, 1 of the key reasons that testamentary trusts are often recommended is due to the asset protection offered by the structure generally, and in particular where a potential beneficiary is at risk of suffering an event of bankruptcy.
This approach can help protect beneficiaries, regardless of whether a BDBN is in place, or where a BDBN is implemented and mandates payment of the death benefits to the legal personal representative for distribution under the will.
Importantly, testamentary trusts also provide significant flexibility from a tax planning perspective, as compared to the benefits being paid directly to the bankrupt beneficiary. Previous posts have explored a number of the tax planning issues in relation to testamentary trusts (see for example our posts on 13 May 2014 and 27 October 2015).
Unfortunately, we have seen a number of examples recently where no testamentary trust has been incorporated under a will, with superannuation death benefits passing directly to the estate and then in turn to a bankrupt beneficiary. In other words, creating the exact same factual matrix as existed in Cunningham.
Key issues to remember
In summary, the key issues to be aware of in this type of situation are as follows:
- Where a beneficiary is bankrupt at the time of the death of the willmaker, the bankruptcy legislation mandates that the bankrupt's entitlements are to pass to their trustee in bankruptcy.
- If there are any assets remaining after the bankruptcy has been discharged, then the beneficiary is entitled to those assets.
- The right to due and proper administration of the deceased estate is an asset that forms part of the bankrupt's estate, and therefore also vests in the trustee in bankruptcy.
- If an executor of an estate seeks to avoid assets passing to a trustee in bankruptcy where a beneficiary is entitled personally under the will, the executor will themselves be personally liable.
Where testamentary trusts are not included under a will, best practice dictates that the executor should obtain a formal declaration from each beneficiary, before making distributions to them under the will, whereby each beneficiary confirms that they are in fact solvent.
If a beneficiary refuses to provide the declaration, then further searches should be made by the executor to minimise the prospect that the executor might become personally liable to a trustee in bankruptcy.
As usual, if you would like copies of any of the cases mentioned in this post please contact me.
The above post is based on the article we had published originally in the Weekly Tax Bulletin.
** For trainspotters, ‘skirting the shoals of bankruptcy’ is a line from a song named ‘Accountancy Shanty’ by Monty Python from their 1983 movie ‘The Meaning of Life’.
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