When cross owned insurance policies are Glorious

In business succession arrangements, cross owned insurance policies are rarely, if ever, utilised. Avoiding the use of cross owned policies is driven by a range of commercial reasons and the fact that invariably adverse tax consequences are unnecessarily triggered as the desired commercial outcomes can normally be achieved utilising self owned policies that almost always deliver favourable tax outcomes.

One scenario where cross owned insurance arrangements historically provided significant potential benefit however related to where a self-managed superannuation fund (SMSF) borrows funds via an instalment trust arrangement to acquire an asset which forms a substantial part of the total value of the fund.

An example of how this approach (which was given in principle support by the Tax Office historically) worked is as follows:

1. The SMSF establishes an instalment trust and borrows funds from a third party to acquire an asset.
2. The (say) only two members of an SMSF are concerned that on the death of one of them, the ability to pay out the member’s entitlement may be impossible to achieve without selling the underlying asset (i.e. neither member’s account balance is large enough to represent the entire value of the acquired asset).
3. If the members took out self-owned insurance policies, this would obviously not assist, given that the exiting member would effectively be entitled to an even greater share of the total assets of the fund.
4. In contrast, if permissible under the trust deed for the SMSF, if cross owned policies were implemented, then the remaining member’s balance would be the one that increases and the cash from the insurance policy could be used to pay the death benefit, while the continuing member would effectively have their member balance represented entirely by the asset originally acquired via the instalment trust.

Despite the above, since 1 July 2014, the view of the Tax Office has been that the superannuation rules do not allow SMSFs to provide insurance for a member, unless the insured event is consistent with one of the following conditions of release:

1. death;
2. terminal medical condition;
3. permanent incapacity; and
4. temporary incapacity.

The Explanatory Memorandum associated with the amended rules made it clear that the proceeds of an insurance policy must be released to the member who is the insured under the policy.

This means that cross-insurance arrangements where the proceeds of an insurance policy are paid to someone other than the insured under the policy are not permitted. 

** for the trainspotters, the title today is riffed from the Breeders song ‘Glorious’. 

View hear (sic):

Stamp duty concessions for business succession: it is (not) just a game**

As we have touched on in previous View posts, each Australian state has a different set of stamp duty rules.

In a very general sense, the broad themes under each state’s legislation are similar.

As is often the case however the detail of particular provisions can provide quite stark contrasts.

This week, I had a timely reminder of the differences between states in relation to the stamp duty concessions available for the transfer of assets under a succession plan from (say) parents to their children.

Under the New South Wales legislation, there are a number of flexibilities with this concession, including (in certain circumstances) the ability to transfer assets out of a company into the individual names of the children of the shareholders.

In contrast, the Queensland legislation (which is in fact broadly modelled on the New South Wales legislation) has no equivalent exemption.

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 Regurgitator song ‘Black Bugs’.

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SMSF borrowing arrangements and business succession: a modern life** story

We recently had an adviser seeking guidance in relation to business succession arrangements where business property was to be purchased by two parties via their self-managed superannuation funds, with a limited recourse borrowing arrangement.

The three main approaches that we explained are as follows, noting that the preferable solution depends on the exact commercial circumstances:

1. As the intention with the borrowing arrangements is normally that they are self-funded, some business owners choose to leave the structure in place and have an unfunded agreement (for example, a unit holder’s agreement) regulating how the parties will conduct themselves if one of the principals passes away.
2. In other words, the deceased’s estate would treat the ownership interest in the building as an arm’s length investment and would effectively maintain that interest until the other owner had sufficient funds to acquire the interest, or alternatively, the entire property was sold to a third party.
3. The above approach is predicated on the assumption that the super fund of the exiting principal otherwise has sufficient assets to pay the death benefit.
4. A second alternative is for each principal to self-own insurance to pay out any debt referable to ‘their’ interest in the underlying property, noting that practically any such insurance must be held outside the superannuation funds. This is because if it is owned via the super fund, the insurance proceeds are simply added on receipt to the exiting member’s entitlements that must be paid as a lump sum or pension (and can therefore not be used to help reduce debt).
5. If this approach is adopted, the succession arrangements can proceed essentially along the same lines as set out above, or the estate of the deceased principal can acquire an interest in the property using the insurance proceeds (and triggering the potential tax and stamp duty consequences on the sale).
6. Finally, each principal can obtain sufficient insurance to clear the entire debt. The buy-sell arrangement would require that 50% of the proceeds are paid to each principal (or their estate). The underlying property can then be dealt with as set out above, or alternatively, steps can also be taken to ensure that the relevant share of the property is transferred to the surviving principal’s benefit.
7. This last pathway is often used in business succession arrangements and is referred to as the ‘hybrid’ approach (see previous View posts explaining the model). This said, the involvement of superannuation funds does create additional, potentially significant, complications.

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 Regurgitator song ‘Modern Life’.

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How many calls must be made?** - Insurance funded buy sell arrangement: 5 key questions

Previous posts have explored various aspects of insurance funded buy sell arrangements

Based on adviser feedback, 5 of the most often asked questions during the planning process for implementing an insurance funded buy sell arrangement – with View’s short form answer – are set out below.

In no particular order, View generally asks for access to the following information before providing recommendations on the optimal way to structure the buy sell legal documentation:

1. the insurance policies for each principal – why: to ensure the agreements align with the ownership structure of the insurance;
2. copies of the most recent financial statements for each business entity (including any notes to the statements) – why: there is a material risk that loan accounts are not properly considered as part of the business succession arrangements. Certainly at a minimum, we would recommend that the legal documents specifically regulate how loans are to be treated on the various triggering events;
3. copies of the trust deeds for each of the trusts involved in the structure – why: many trusts do not permit the entering of buy sell arrangements (due to the rules against fettering of trustee discretion – concept explored in previous View posts);
4. the most recent ASIC statement (showing all shareholders and directors) for each business entity – why: to ensure the documentation is binding there should be an audit of the structure of shareholdings and directorships as against the records of the statutory authority; and
5. any existing legal agreements – why: if the existing documents are appropriate our preference is to leave them as is, as opposed to amending simply to ensure they align with View’s approach.

View’s initial review of the material provided is at no cost or obligation and is so that we can ensure we have a proper understanding of the circumstances before suggesting the best way to progress.

All information provided is only retained with authority and is otherwise treated in strict confidence.

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 Spandau Ballet song 'Only when you leave’.

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Buy-sell deeds: pricing to pay** the premium?

One issue that comes up regularly in the context of insurance funded buy-sell arrangements is who should be responsible for the payment of insurance policy premiums.

Depending on the policy ownership approach adopted and the underlying business structures, there are a range of alternatives, including:

1. Each principal pays a premium on their own policy.
2. All principals contribute a proportion of the total premiums for all policies, equal to their respective equity interests in the business.
3. Each principal pays an exactly equal proportion of the total premiums based on the number of principals (regardless of their underlying equity interest).
4. If there are only two principals, sometimes the approach will be that each principal pays premium for the other.

As previous posts have touched on, there are a myriad of tax consequences that can arise from each of the various alternatives.

Assuming that these tax consequences can be managed, generally the pragmatic approach is to apportion the total premiums payable for all policies in accordance with the equity interest of each principal.

While this will not necessarily be seen as fair by each principal in all scenarios, it does keep things relatively simple and also helps the principal's focus on what should be the overriding objective of any insurance funded buy-sell arrangement. That being, to facilitate a smooth transition of a business in a factual scenario where the prospects of a smooth transition otherwise occurring are unlikely.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** for the trainspotters, the title today is riffed from the Janes Addiction song ‘Price I Pay’.

View hear (sic):

 

Fettering of a trustee's discretion – when will it be ignored? **

Discretionary trusts are regularly used in commercial transactions, and of course tax issues are always present. But, there is a more fundamental issue that deserves attention – fettering of a trustee's discretion.

Take for example an insurance funded buy-sell arrangement that uses options under the contractual arrangement to help facilitate any ultimate buyout. This is a widely used, and generally very sensible, approach to take. A significant difficulty can arise however where the parties to the buy-sell agreement include trustees of discretionary trusts.

There are cases (admittedly dating back many years) which provide that unless a trust deed for a discretionary trust specifically allows the granting or an acquiring of an option, then the arrangement will not be enforceable as the trustee has effectively fettered its discretion.

In order for a discretionary trust to remain an ongoing valid structure, it is necessary for the trustee to always retain its discretion and therefore not enter into arrangements which will remove this flexibility in the future.

Traditionally, entering into option arrangements has been seen as clearly limiting future decision making ability and therefore prohibited - unless specifically allowed under the trust instrument.

Despite the longstanding rules in this area, many otherwise ‘modern’ trust deeds do not have the required powers to in fact allow a trustee to grant options.

Leading case

As mentioned in last week’s post, the principle in relation to the prohibition on a trustee fettering its discretion is arguably best captured in the decision of Fitzwood Pty Ltd v Unique Goal Pty Ltd (in liquidation) [2001] FCA 1628.

In this case, the key concepts concerning fettering were summarised as follows –

"… a trustee is not entitled to fetter the exercise of a discretionary power (for example a power to sale) in advance: Thacker v Key (1869) LR 8 Eq 408; In re Vestey's Settlement [1951] Ch D 209.

If the trustee makes a resolution to that effect, it will be unenforceable, and if the trustee enters into an agreement to that effect, the agreement will not be enforced (Moore v Clench (1875) 1 Ch D 447), though the trustee may be liable in damages for breach of contract …".

Arrangement in breach of fettering trustee's discretion enforced

Arguably the leading case explaining when the prohibition on fettering of discretion will essentially be ignored is Dagenmont Pty Ltd v Lugton [2007] QSC 272.

The background in this case was as follows:

• a family discretionary trust was established to be the owner of a start up business; 
• a company was nominated as trustee of the trust, with the shares in the company owned by the husband and wife and the husband as the sole director; 
• the wife’s brother was listed as the sole appointor, with the right to remove the trustee in his sole discretion; 
• the wife’s brother had no involvement in the business at any stage, and the husband and his wife claimed they had never understood why the brother was nominated as appointor, nor indeed the extent of his ultimate power; 
• as part of a succession and estate planning exercise, the wife’s brother agreed to relinquish his rights as appointor; 
• in particular, an agreement was entered into by the wife’s brother as the original appointor of the discretionary trust and the husband, wife and one of their sons, whereby the wife’s brother would resign as appointor of the trust, in return for guaranteed distributions from the trust for as long as he lived; 
• the distributions were set at an amount of $150,000 each year, indexed for inflation, in priority to any other distributions from the trust, and regardless of the level of profitability of the business owned by the trust; 
• the agreement by the trustee to make these future distributions was therefore effectively a fetter on its future discretion; 
• each party received independent legal advice at the time of the agreement, however some years later the trustee attempted to cease the distributions due to the, argued, invalid fettering of its discretion and in turn the apparent inequality of the original bargain struck – the wife’s brother had never had any involvement in any aspect of the business and indeed had never exercised his power as appointor. 

The Supreme Court specifically acknowledged the general prohibition on a trustee fettering its discretion (based on the case law stretching back over hundreds of years), confirming that:

"trustees cannot fetter the future exercise of powers vested in trustees … any fetter is of no effect. Trustees need to be properly informed of all relevant matters at the time they come to exercise their relevant power."

While therefore agreeing that the agreement was at face value void and should be set aside, the court went on to in fact ignore the fettering and uphold the validity of the agreement.

In rejecting the trustee's attempt to avoid the agreement and in turn the obligation to continue to make the trust distributions of $150,000 a year for the rest of the wife’s brother’s life the court confirmed:

• a provision in a document authorising a trustee to release powers which they would otherwise have a duty to exercise is valid; 
• here, the document confirming the agreement between the parties was in essence a release by the trustee of the power conferred on it to exercise an unfettered discretion to distribute amongst all potential beneficiaries; 
• alternatively, the agreement effectively amounted to a variation of the terms of the original trust deed; 
• this meant that what would otherwise have been an unfettered trustee discretion became reduced in scope, simultaneously with an obligation being imposed on the trustee (created by the agreement with the wife’s brother as original appointor) to distribute the annual amount of $150,000 (indexed); 
• arguably, particularly where parties receive independent advice at the time, the court should always uphold bargains where it can, rather than destroy them – even where there is longstanding case law suggesting the opposite conclusion. 

Conclusion

As explored regularly in this blog, while reading the trust deed of a discretionary trust (including all valid variations) is necessary, it will not be sufficient by itself. This is because there are a myriad of related issues that need to be considered that may impact on any intended distribution, aside from whatever powers are set out in the trust instrument.

While not necessarily an obvious example, the rules in relation to trustee fettering are longstanding and go to the heart of a trustee’s duties. A failure to understand the impact of the regime can have significant detrimental impacts both from a trust law perspective and the related tax consequences – regardless of whether any purported fettering is ultimately held to be valid or invalid.

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 recently had published in the Weekly Tax Bulletin.

** for the trainspotters, ‘it will be ignored’ is a line from the Black Rebel Motorcycle Club song ‘At my Door’, listen hear (sic) - https://www.youtube.com/watch?v=SFTZot0hPkA

Image courtesy of Shutterstock

Leading case about fettering of a trustee’s discretion

Last week’s post considered the issues of a trustee fettering its discretion in the context of an insurance funded buy sell arrangement, see – Fettering (and flies) of a trustee’s discretion **

The principle in relation to the prohibition on a trustee fettering its discretion is arguably best captured in the decision of Fitzwood Pty Ltd v Unique Goal Pty Ltd (in liquidation) [2001] FCA 1628. As usual, if you would like a copy of the decision please contact me.

In this case the key concepts concerning fettering were summarised as follows –

‘… a trustee is not entitled to fetter the exercise of a discretionary power (for example a power to sale) in advance: Thacker v Key (1869) LR 8 Eq 408; In re Vestey’s Settlement [1951] Ch D 209.

If the trustee makes a resolution to that effect, it will be unenforceable, and if the trustee enters into an agreement to that effect, the agreement will not be enforced (Moore v Clench (1875) 1 Ch D 447), though the trustee may be liable in damages for breach of contract …’

Next week's post will consider one of the leading cases where an arrangement that would have been a breach of the fettering of the trustee’s discretion was in fact enforced.

Image courtesy of Shutterstock

Fettering (and flies) of a trustee’s discretion **

Last week, an adviser contacted us in relation to an insurance funded buy-sell arrangement that used options under the contractual arrangement to help facilitate any ultimate buyout.

As many would be aware, this is a widely used, and generally very sensible, approach to take.

The difficulty here was that the parties to the buy-sell agreement included trustees of discretionary trusts.

There are cases (admittedly dating back many years) which provide that unless a trust deed for a discretionary trust specifically allows the granting or an acquiring of an option, then the arrangement will not be enforceable as the trustee has effectively fettered its discretion.

In order for a discretionary trust to remain an ongoing valid structure, it is necessary for the trustee to always retain its discretion and therefore not enter into arrangements which will remove this flexibility in the future.

Traditionally, entering into option arrangements has been seen as clearly limiting future decision making ability and therefore prohibited - unless specifically allowed under the trust instrument.

** for the trainspotters, ‘fetters and flies’ is a line from Massive Attack’s song ‘Flat of the Blade’, listen hear (sic) - https://www.youtube.com/watch?v=vAIOQMJAzxE

Image courtesy of Shutterstock

Trust-owned business succession insurance arrangements: Some clarity at long last

For those that do not otherwise have access to the Weekly Tax Bulletin, the article from earlier this month by fellow View Legal Director Patrick Ellwood and me is extracted below.

Largely due to the level of intergenerational wealth transfer, there has in recent years been an increasing emphasis on all forms of succession planning and, in particular, business succession planning.

In broad terms, a buy-sell agreement is a contractual arrangement between the ultimate owners (or ‘principals’) of a business. The agreement is structured so that if certain events occur, such as the death or incapacity of a principal, the continuing principals are given the option to purchase the interest of the departing principal.

Most commonly, insurance is obtained to help fund buy-sell arrangements.

Since the withdrawal of the ATO's draft Buy Sell Discussion Paper in 2010 there has been some uncertainty about many aspects of insurance funded buy-sell arrangements, particularly those that utilise insurance trusts.

Recent changes introduced as part of the Tax and Superannuation Laws Amendment (2014 Measures No 7) Bill 2014 (now awaiting Royal Assent after having been passed by Parliament without amendment) appear to have clarified the position (the 2015 Changes).

Trust ownership

The trust ownership approach generally involves the establishment of a special purpose entity, often with an independent trustee appointed, to acquire the insurance policies and then distribute proceeds, on the exit of a principal, in accordance with the terms of the trust instrument.

If the trading entity is itself a trust or owned via a trust (for example, a discretionary trust owning shares in a trading company), then it may not be necessary to establish a separate structure.

The core benefit of an insurance trust is its ability to centralise the ownership of all insurance policies and facilitate the efficient transition of an ownership interest following a triggering event.

Historically, from a tax perspective, the level of uncertainty regarding the tax treatment of the insurance proceeds (compared with that of other ownership models such as self-owned insurance) often undermined the commercial attractiveness of the trust ownership approach.

Certainly an insurance policy taken out by a trustee (who was also the beneficiary of the policy) over one or more principals, was likely to see the proceeds paid directly to the trustee and be exempt from CGT pursuant to s 118-300 of the ITAA 1997.

However, due to a lack of guidance from the ATO, many advisers believed there was a risk CGT was triggered where a new principal joined the business and there was any change to the trustee or insurance policy or on the subsequent distribution of the insurance proceeds to the beneficiary. 

The concerns were largely driven by the ongoing uncertainty around the concept of ’absolute entitlement’, discussed later in this article.

2010 ATO ruling

The ATO released Product Ruling PR 2010/18 in relation to the CGT consequences for the beneficiary of what is generally seen as a ’standard’ insurance trust deed.

In many respects, the ruling reflects what most specialists in this area have advised for many years, namely, that a properly crafted insurance trust deed should provide appropriate protection for the principals of a business without any significant tax detriment, notwithstanding there might be other commercial issues to consider regarding the structure.

Unfortunately, the positive aspects of the ruling were largely undermined by the fact that the outcomes are based on the stated assumption that the insurance trust deed will in fact create ’absolute entitlement’ for each beneficiary in the relevant insurance policy.

As has been widely documented, the expressed views of the ATO concerning absolute entitlement are somewhat contentious and the ATO continues to refer to a draft ruling that has never been finalised – despite being issued in 2004 (ie Draft TR 2004/D25).

In this regard, a significant concern was that the Product Ruling confirmed that, in order to ensure absolute entitlement, the relevant beneficiary must be able to call for the asset at any time.  This largely undermined one of the main commercial reasons why advisers historically recommended insurance trusts, being that the trustee will be able to control the payment of any insurance proceeds received.

A further practical issue, given the way in which many providers traditionally structured trust arrangements, was that the Product Ruling only related to insurance trust deeds where the company acting as trustee was an entity owned and controlled by the principals involved in the business entity and the relevant insurer was not a party to the arrangements.

ATO minutes

Minutes released from a National Tax Liaison Group meeting in December 2010 (item 9) provided further insight into the apparent ATO views in relation to insurance trust deeds.

In summary the minutes stated:

• the status of the taxation ruling on absolute entitlement (Draft TR 2004/D25) is unclear;


• the ATO considers the finalisation of Draft TR 2004/D25 as intricately linked to how it will deal with bare trusts, which again remains an unresolved issue;


• the ATO believes that the Product Ruling released in relation to one provider's insurance trust arrangement is based entirely on the assumption that absolute entitlement was created.  This assumption might be an unwise one to make, given the ATO's apparent attitude in this area; and


• while the ATO flags that it will further consider providing appropriate guidance, it specifically confirmed that the ATO Buy Sell Discussion Paper is not current.

Ultimately, given the complexities in this area and the uncertainty created by the ATO Buy Sell Discussion Paper, Draft TR 2004/D25, the Product Ruling and the above minutes, many advisers defaulted to recommending the obtaining of a private ruling on any proposed trust arrangement documenting an insurance funded buy-sell agreement from the ATO before implementing the approach. 

Needing to seek a private ruling on what was otherwise a relatively benign arrangement was for many business owners sufficient reason to either use a different ownership approach or, more commonly, simply decide against implementing a business succession plan.

The 2015 changes

Amongst other amendments, the 2015 changes have adjusted the way insurance payments are taxed in certain circumstances.

In particular, the 2015 changes amend the ITAA 1997 to:

1.  remove the requirement that, in order to access the exemption under s 118-300, the insurance proceeds are received by the original ’beneficial’ owner of the life insurance policy.  The amendment removes the reference to ’beneficial’ to clarify that a trustee is eligible for the exemption, where they hold the beneficial interest in the policy for a beneficiary;


2. extend the exemption for compensation for injury/illness (ie total and permanent disablement and trauma insurance proceeds) in s 118-37 to apply where the proceeds are received by the trustee of a trust or superannuation fund (subject to certain policy ownership prohibitions for superannuation funds), if the injured/ill person is a beneficiary of the trust; and


3. insert a CGT exemption where a trustee makes a payment to a beneficiary (or their legal personal representative) in respect of life, TPD or trauma insurance proceeds.  This change also ensures that where the relevant trust is a unit trust, CGT event E4 does not apply.

The 2015 changes make it likely that trust and superannuation fund ownership of life, total and permanent disablement or trauma insurance policies will be more attractive, given the new clarity regarding the tax treatment of the insurance proceeds.

Importantly, the changes also operate to reflect the intended administrative position of the ATO in this area, and therefore apply from 1 July 2005 and taxpayers adversely impacted who would otherwise be out of time are granted an extension to amend their returns.

Until next week.


Image credit: GotCredit cc

Latest View Legal Apple and Android app launched

Following the successful launch earlier this year of the View Legal Directors Duties and Estate Planning apps, we have now developed and launched another Apple and Android app.

The new app is in relation to Business Succession and can be downloaded via the following links –

1. iPhone – https://itunes.apple.com/au/app/business-succession/id927283653?mt=8
2. Android – https://play.google.com/store/apps/details?id=business.succession

Business succession is the important process of ensuring a plan is in place for a person’s business assets so they are dealt with, after death, as intended, while minimising the impact of challenges against the arrangements and costs such as stamp duty, tax and administration expenses.

The business succession area is however heavily regulated and it is vital that business owners and their advisers have a deep understanding across all relevant areas.

The business succession app is designed to allow the user to narrow down some of the broad areas that might be relevant in relation to a business succession plan.

Depending on the answers provided, the app generates a free white paper containing general information in relation to some of the issues that are often relevant.

Until next week.

Digital assets on death

The virtually limitless ability to create digital content has seen an increasing amount of media attention focused on ownership of content, particularly in the event of death.

In most jurisdictions, government legislation does not separately deal with digital assets, and therefore, the same rules that apply to physical assets will generally apply.

Unfortunately, many of the rules in this area lack this sophistication required to deal with digital platforms that are normally either hosted outside Australia, or alternatively, perhaps outside any discrete jurisdiction on the basis that they are cloud based.

While most digital platforms do offer deactivation mechanisms or automatic closure due to inactivity (similar to the much publicised approach taken by Google), these features do not necessarily of themselves assist in relation to ownership of the data.

Ultimately therefore, digital assets should be treated in the same way as any other asset, and to the extent that they are of significant emotive or financial value, dealt with in the last will of the owner.

Alternatively, digital assets (including passwords) should at least be communicated via documents such as letter of wishes or memorandum of directions (click here for a template memorandum of directions on the View Legal site - via the 'learn' and then 'resources' tabs).

Some of the specific information that should be documented includes a listing of every digital platform utilised, account, user name and passwords for each platform, security question answers, and even directions as to post death activity and ultimate closure of the various accounts.

Until next week.

Image Credit: TheRealMichaelMoore via Flickr

Buy sell deeds, family trusts and the deemed market value substitution rule

Click here for an overview of buy-sell arrangements

With thanks to co View Legal director Tara Lucke, today’s post considers an issue that has been raised with us by an adviser recently.

It is generally accepted that where a business succession plan is structured with self owned insurance policies and a buy sell deed using put and call options, the deemed market value substitution rules apply for taxation purposes.  This outcome occurs notwithstanding that the transfer has been funded (either wholly or partly) by insurance.

Given the recent changes to the rules relating to the taxation of trusts, some uncertainty has arisen in relation to the ability to effectively manage the taxation consequences of a deemed capital gain arising from a transfer under a buy sell deed.

Under the ‘interim’ taxation rules relating to trusts, there can be particular problems relating to distributions of capital gains arising under the deemed market value substitution rule.  In particular, it is generally not possible to create specific entitlement to a deemed capital gain, notwithstanding that there may be a streaming power in the trust deed. 

However, where $1 of consideration has been received (which is how we generally recommend buy sell deeds be crafted), provided a beneficiary is made specifically entitled to the $1 of consideration, the deemed gain should be distributed to that same trust beneficiary.

It will therefore be important in each case to consider the specific terms of the trust deed and the other income of the trust, and to craft the distribution minute correctly to ensure the gain can ultimately be distributed to individuals who can access the general 50% capital gains tax discount. 

Until next week.

How should a partnership of discretionary trusts be structured?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘How should a partnership of discretionary trusts be structured?’ by way of audio podcast (not video) at the following link - http://youtu.be/qPJJ_1NRwcw

As usual, a transcript of the presentation for those that cannot (or choose not) to listen to the presentation is below –

There's a number of aspects relevant here. 

The biggest one, if we pick up on that idea of it being a little bit of a messy structure, is that ideally there should be some sort of corporate entity that’s the face to the outside world.  We see that being used very regularly. 

Now whether that's a standalone nominee or agent company that’s appointed to act on behalf of all the trusts or whether in fact you just have one company acting as trustee for all of the trusts is probably a mute point. 

The outcome that’s delivered to the outside world is that they're not having to deal with numerous separate trusts; as far as the clients know, all they see is that standalone Pty Ltd company.  That would probably be the biggest thing. 

The other types of things that need to be thought about I guess are looking at the constitution of that company and making sure that you've got an appropriate balance between directorship powers and shareholder powers. 

You'd also obviously, particularly if you're going to use the same company as trustee for a number of trusts, need to have a fairly good understanding of how an appointor or principal or nominee type power under the trust documents work, to give everyone the comfort of knowing that they do have ultimate say over ‘their’ particular trust. 

Probably, the final point would be, and we've got recurring themes coming through here, (this harks back to this concept of asset protection) and that is, if you're serious about maintaining protection against issues that might go wrong in the practice, it would really be quite important in our view that the trust that is involved as a partner in the partnership of trusts do nothing else but be a partner in that partnership. 

So in other words, you don’t buy the investment property in that trust and you don't have a listed share portfolio in that trust, because otherwise you're potentially exposing all those passive assets to the risks of the business.

Until next week.

How do business, or goodwill, licences work?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘How do business, or goodwill, licences work?’. If you would like a link to the video please let me know.

As usual, a transcript of the presentation for those that cannot (or choose not) to listen to the presentation is below –

The key idea, and it’s probably not dissimilar to some sort of service trust arrangement, is having the two arms of the business being conducted by different entities.

An example, particularly for those that are currently in a partnership of individuals is that if the right to run the business was able to be utilised by someone else or by another entity, for example a partnership of trusts, then there's arguably the ability to create a licence arrangement that would say that the partnership of trusts has the ability to do everything to conduct the business and to enjoy the fruits of conducting the business, the income that’s generated for the payment of invariably a relatively nominal fee back to the actual original owners of the business.

Now the idea of that arrangement obviously, particularly from an asset protection perspective is that, if you can get the risks associated from running the business away from the individuals, that’s obviously a very attractive thing.

It also gives the partners the ability to think a little bit strategically about how they would want that income derived. So in other words, rather than earning the income in their own name, they have the ability to earn it through a company or trust environment.

Until next week.

Company owned insurance policies for business succession

We recently had an adviser seeking more detailed comments about company owned business succession insurance policies.

In particular, feedback was requested about the specific reservations with insurance policies for business succession being owned by a company. In summary, and with thanks to co View Legal director Tara Lucke, we provided the following reasons:

1   while capital gains tax (CGT) should not be payable on receipt of life insurance proceeds, it will be payable on any total and permanent disablement or trauma proceeds that are paid to a company. In contrast, no CGT should be payable on receipt of the insurance proceeds where the policies are self owned;

2   there can also be significant practical difficulties in extracting insurance proceeds from a company to the appropriate recipient. This is particularly important when the main purpose of the policy is for an equity payment, as opposed to debt cover. Again, where the policy is self owned, the exiting principal or their estate will receive the proceeds directly and none of these practical issues will arise, as long as an appropriate agreement is implemented;

3   where insurance proceeds need to be accessed by the exiting principal (or their estate) this is generally only achievable via a share buy-back or dividend. A dividend will likely be tax inefficient and generally a buy back will also have an inefficient tax outcome for the following reasons:

(a) the consideration will be split between an assessable capital gain and a dividend, which restricts access to the full benefit of the CGT 50% discount and small business CGT concessions;

(b) while a company may be able to pay the proceeds to the exiting shareholder/s as a partially or fully franked dividend, this will use franking credits that would otherwise have been available for distributing profits; and

(c) the surviving owner/s will own 100% of a company after a share buy-back, however their cost base in the shares will not have increased;

4   insurance proceeds will be under the control of the remaining director/s of a company, in contrast with a self owned or superannuation owned policy where the estate directly receives the benefit of the proceeds; and

5   finally, the legal documentation required for company ownership is comparatively complex to all other policy ownership approaches.

Until next week.

Penalising the under insured

With thanks to co View Legal director Patrick Ellwood, this week’s post looks at a situation we had recently under an insurance funded buy sell arrangement where the parties were wanting to craft the agreement in order to penalise a business owner if they were under insured.

In particular there was a desire to ensure that the agreement discounted the purchase price that was otherwise payable under the agreement if the insurance payout was less than the market value of the interest in the business at the relevant date.

For a number of reasons we recommended against this approach, including:

1.   The overall aim of any business succession agreement is to achieve as smooth a transition of the business as possible.  If a party to the transaction believes that they are not getting fair value then the prospects of a smooth transmission are significantly decreased.

2.   The exiting owner (or their estate) will still be required to pay tax on the transfer of the interest at full market value (even though the price under the agreement would be less than market value) due to the way in which the market value substitution rules under the Tax Act operate.

3.   Practically, if the exiting party had sold their interest the day before the triggering event, they would have received market value.  It is arguably inequitable for an owner to be disadvantaged because of a sudden involuntary exit event, as opposed to a planned voluntary exit.

4.   Generally most agreements (ours included) cater for any shortfall in insurance funding by ensuring that the remaining owners are still required to pay the difference but have an extended period of time (for example, three years) to repay the difference.

Until next week.

Insurance premiums & FBT

As many regular readers would be aware, one particular innovation in recent times in relation to insurance funded business succession arrangements is the so-called 'debt reduction' strategy.

One aspect of the arrangement that is often raised concerns the fringe benefits tax (FBT) implications of the premium payments.

Broadly, there are a number of reasons as to why FBT will normally not apply to the payment of insurance policy premiums.

Generally the accountant for the business will always be best placed to give the guidance, however some of the reasons FBT will not apply can include –

1.    the arrangements not having anything to do with employment;

2.    in some instances, the otherwise deductible rule; or

3.    while for administrative ease the premiums might be paid by the business, the actual tax position is that the amount is included as part of other payments made (for example, a dividend).

It is important to remember that aside from FBT, there are a number of other tax issues that may also be relevant (for example division 7A or capital gains tax) so it is also best to ensure the exact circumstances are considered by the accountant for the particular client.

Until next week.

What roles do ‘quasi-ownership’ arrangements play in succession planning

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘What roles do ‘quasi-ownership’ arrangements play in succession planning ?’ at the following link - http://youtu.be/oUcuYyRXZ_U



As usual, a transcript of the presentation for those that cannot (or choose not) to view the presentation is below –

This is probably a really developing area in terms of what we've seen in recent times, because out of the GFC, the changes to trust law that many of us have experienced first hand in terms of the impact of relationship breakdowns and/or the intergenerational transfer that goes wrong; you find in many family scenarios they are effectively wanting to, if not fully rule from the grave, at least do a very good impersonation of it.

In that scenario, as much as we've spoken earlier today about secured loan arrangements and actually transferring assets down and securing those under a loan arrangement; a more ‘bespoke’ version of that is never having the asset leave the master trust in the first place and using tools such as letters of wishes or the way in which the trustee company constitution is crafted to allow the underlying beneficiaries to have indirect access to the assets, whether they be business assets or investment assets.

Beneficiaries will probably still have to meet KPIs in relation to their performance and running of those assets, but they never actually get the physical ownership or the legal control of them.

It may be overtime that beneficiaries do ultimately receive legal ownership or legal control, but for an interim period, which may last for many years, what this final form of structure does is effectively keep the assets within the initial master trust structure and really only have a synthetic or notional allocation of assets made, at a trustee level, for the underlying beneficiaries.

Until next week.

Insurance funding via superannuation

Earlier posts have mentioned the ‘debt reduction’ and ‘hybrid’ buy sell arrangements and I can forward information in this regard for those interested.

One particular issue raised with me recently in this area was the ability to use superannuation owned policies for insurance arrangements supporting a debt reduction (or asset protection) solution.

Generally the position is that the asset protection (debt reduction) component of any insurance policy should be self owned, rather than superannuation owned.

This is because a superannuation fund trustee is unlikely to be able to make the required payment directly to the other principals, as the fund can only pay a benefit to a member (in the case of disablement), or to the dependants or estate (in the case of death).

Furthermore, a superannuation fund could not be a party to the agreement as this would raise issues about compliance with the sole purpose test, and also might be construed as an assignment of a benefit, which super fund trustees are prohibited from recognising.

Given these technical limitations, there could be no certainty that insurance proceeds held in superannuation would find their way to the correct parties to enable them to pay down the external debt.

This said, it is often possible to have two policies for each principal under a hybrid buy sell deed, one being a self owned policy for asset protection (debt reduction) purposes and the other policy being owned through superannuation for equity transfer (that is, traditional ownership or buy sell) purposes.

Until next week.

ATO Discussion Paper on buy-sell agreements

Following last week’s post, we had a number of people contact us in relation to the, withdrawn, ATO Discussion Paper on business succession arrangements (i.e. buy-sell agreements).

As mentioned in last week’s post, the ATO has unequivocally stated its belief that the Discussion Paper is not current and that advisers in this area should be deterred from relying on it.

This said, the Discussion Paper remains (even 11 years after its initial circulation) the only comprehensive attempt by the ATO to articulate its view of the various business succession models.

For those interested in the issues addressed by the Discussion Paper, please email me. 

Please note the copy of the paper I have access to is shown in 'marked up' format as this was the final version released by the ATO before it was withdrawn from circulation.

Until next week.