EPAs and gift and loan back arrangements

Two possible solutions.

Following the recent post about conflict of interest provisions under an enduring power of attorney (EPA) a question came up as to whether a gift and loan back arrangement would have provided another solution. 

A summary of the general way in which a gift and loan back arrangement would work is set out in recent posts (http://mwbmcr.blogspot.com/2014/04/how-gift-and-loan-back-arrangements-work.html).

The concept raised in the scenario touched on in the recent post was as follows:

1. The attorney could arrange for a cash gift equal to the value of the husband’s interest in the home to a discretionary trust that would ultimately pass to the control of the children of the marriage. 
2. That trust would then lend the amount back to the husband (via his wife as the attorney). 
3. The husband’s estate (following his death) would then be required to repay the debt to the trust effectively ensuring that only nominal assets would pass under the husband’s will and the main value of the estate would in turn be held via a more robust structure, being the previously established trust. 

Obviously the ability to implement this approach would depend entirely on whether the appropriate conflict of interest provision existed under the EPA and whether the attorney could satisfy themselves that they would not be breaching their fiduciary duties to the principal by undertaking the arrangement.

There would also be a range of commercial issues that would need to be considered, not least of which the fact that the trust involved would not be a testamentary trust and therefore would not enjoy the various advantages that testamentary trusts have as compared to standard discretionary trusts.

Until next week.

Image credit: Jens Wessling cc

Gift and loan back arrangements - some frequently asked questions

Recent posts have looked at various aspects of the 'gift and loan back' strategy (see http://mwbmcr.blogspot.com.ar/2014/03/leading-gift-and-loan-back-case.html and http://mwbmcr.blogspot.com/2014/04/subdivision-ea-giftloan-back.html) 

While there are a myriad of potential issues that always need to be considered, some of the key aspects include:

1. care should always be taken to ensure that the trust which will make the secured loan does not itself conduct risky activities (for example, run a business). 
2. while the arrangement can be entered into without registering a mortgage, if this step is not taken, the trust that has made the loan will simply be an unsecured creditor. 
3. the impact of the arrangement in relation to potentially accessing the small business tax concessions should always be carefully considered, because while a family home will generally be excluded from the $6 million test, a secured loan will generally be included if the trust is an affiliate or ‘connected entity’ under the Tax Act (which will typically be the case). 
4. to the extent that a third party financier already has a mortgage over the property, they will generally require a deed of priority securing their lendings (to whatever level they may be from time to time) as a first priority before the trust's second mortgage. 
5. As flagged in previous posts (http://mwbmcr.blogspot.com/2013/10/one-remedy-where-trust-distributions.html) if no real property is available for registering security over, personal property can be used via the Personal Property Security Register. 

Until next week.

Image credit: Alexander Henning Drachmann via Flickr

Subdivision EA & gift/loan back arrangements

Recent posts have touched on various aspects of the 'gift and loan back' arrangement.

Recently we had a situation where historically a gift and loan back arrangement had been entered into, however the provisions of the Tax Act under subdivision EA had been ignored.

While there has been some significant dilution of the circumstances where subdivision EA will apply given the Tax Office’s approach to unpaid present entitlements, in the situation we were looking at it remained potentially relevant.

In particular, the second 'tranche' of the gift and loan back arrangement involving a loan out of a trust was problematic because at the time the loan was made, there was an unpaid distribution to a corporate beneficiary.

We are working with the relevant adviser to determine the most appropriate approach moving forward, however the example was a timely reminder that in any structuring exercise, it is critical to consider all potential transaction costs and in particular those that are not immediately obvious.

Until next week. 

How gift and loan back arrangements work?

Previous posts have touched on various aspects of the gift and loan back strategy (see http://mwbmcr.blogspot.com.ar/2012/05/family-court-case-on-distinction.html and http://mwbmcr.blogspot.com.ar/2013/10/one-remedy-where-trust-distributions.html).  Recently, and as touched on last week regarding Atia’s case, one of the key aspects of the enforceability of this style of arrangement is that all documentation is drafted correctly and duly signed and processed. 

In this regard, the main critical steps that need to be followed are set out below with an example.

The ‘gift and loan back’ approach involves the owner of an asset gifting an amount equal to their equity in the property or shares in a company to a family trust (or low risk spouse).

The family trust then lends an amount of money to the owner and takes a secured mortgage over the property or registers a security interest on the Personal Property Securities Register over the shares.

Example

Using property as an example, assume that Anne holds 100% of an investment property and the current value of the home is $1,500,000. There is an existing mortgage of $500,000 owing to her financier.

Step 1: Anne gifts the amount of her equity in the property to a trust 

Step 2: The trust subsequently lends the amount back to Anne and takes security over property 

Until next week.

Leading gift and loan back case

Atia v Nusbaum: the leading case on gift and loan backs.

Other posts have dealt with various aspects of gift and loan back arrangements (see http://mwbmcr.blogspot.com.ar/2012/05/family-court-case-on-distinction.html and http://mwbmcr.blogspot.com.ar/2013/10/one-remedy-where-trust-distributions.html).

Arguably, the leading case in relation to gift and loan back arrangements is Atia v Nusbaum [2011] QSC044. As usual, a link to the full decision is as follows http://www.austlii.edu.au/cgi-bin/sinodisp/au/cases/qld/QSC/2011/44.html.

In summary the circumstances of this case were as follows:

1. Dr Atia (a cosmetic surgeon) entered into a gift and loan back style arrangement with his mother; 
2. when Dr Atia's mother subsequently called in the debt, Dr Atia argued that the loan and mortgage were not intended to be actually binding and were only a pretence to protect against situations where Dr Atia was sued professionally; 
3. in particular, Dr Atia argued that his mother was only calling in the debt secured by the mortgage because he had married his girlfriend against his mother's express wishes; 
4. the court found that all aspects of the legal documentation, including a deed of gift, loan agreement and registered mortgage, had been validly signed; and 
5. the court confirmed that the legal effect of the documentation signed was exactly as the parties intended it to be and there was no mistake or sham involved. This meant that Dr Atia's mother was allowed to enforce recoverability of the debt, and if necessary, exercise her rights under the registered mortgage. 

Until next week.

One remedy where trust distributions prove problematic

For those that do not otherwise have access to the Weekly Tax Bulletin, the article from last week is extracted below.

A recent article in this Bulletin focused on the critical need to "read the deed" whenever making trust distributions (see 2013 WTB 38 [1642]).

Even where distributions are made validly to a potential beneficiary, they can prove extremely problematic from an asset protection perspective.

One scenario that seems to arise regularly in this regard is the distribution by a trust to a corporate beneficiary, the shares in which are owned personally by an at-risk individual.

Often, the difficulties with this ownership structure are not identified until after many years of distributions have been made to the bucket company, and anecdotally, the issue is often first identified at a point which is too late, for example, just before litigation proceedings are to commence against the relevant shareholder.

Where this ownership structure is identified and assessed to be inappropriate, the first critical step is to ensure that any future distributions to a corporate beneficiary are directed to a newly established company, the shares in which are owned by a non-risk entity (e.g. a passive family trust).

However, resolving the historical distributions is generally not as simple.

Depending on the circumstances, some form of dividend access share or discretionary dividend share may provide a pathway to remedy the historic distributions, although it will be important to consider the ATO's recent guidance in Draft Taxation Determination TD 2013/D5 (see 2013 WTB 24 [1092]) and Taxpayer Alert TA 2012/4 (see 2012 WTB 30 [1194]) which warned taxpayers of arrangements where accumulated profits of a private company are distributed substantially tax-free to an entity associated with the ordinary shareholders of the private company.

Similarly, since the introduction of the Personal Property Securities Act 2009 (PPSA), steps can often be taken to grant a security interest over the at-risk shares to a low risk related entity.

Broadly, this solution can be achieved by a "gift and loan back" style arrangement, whereby:

1. the at-risk individual gifts a cash amount equal to the gross value of the shares to a protected environment (e.g. a passive family trust);
2. the family trust subsequently lends the gifted amount back to the at-risk individual; and
3. the family trust simultaneously registers a security interest over the shares on the PPS register to secure repayment of the loan. Subject to certain conditions (such as the family trust establishing "control" over the shares) the family trust's interest in the shares should be protected under the PPSA.

The advantages of utilising a gift and loan back, compared to a straight transfer of the shares in the corporate beneficiary can include:

1. the arrangement achieves broadly equivalent protection for the asset compared with a straight transfer; and
2. as there is no change in the legal ownership of the shares, transfer duty (where applicable) and capital gains tax will generally not apply. The only transaction cost should be the PPSR registration fee.

The disadvantages of utilising a gift and loan back approach, compared to a straight transfer of the shares can include:

1. the arrangement is more complex than a simple transfer, and involves the preparation of additional documentation (including a deed of gift, loan agreement and security documentation);
2. it only protects the amount of net equity in the asset at the time of the gifting, however as mentioned above, there should not be any further distributions made to the inappropriately structured corporate beneficiary; and
3. the arrangement is subject to the bankruptcy clawback rules and specialist advice should be obtained in relation to the operation of these provisions.

Until next week.

When do ‘gift and loan’ arrangements need to be refreshed?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘When do ‘gift and loan’ arrangements need to be refreshed?’ at the following link - http://www.youtube.com/watch?v=QuRRvCIx9e8&feature=relmfu

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

There's two real reasons that the top up arrangement can come into effect. 

The first one, and hopefully for most people, even in a post GFC environment, is that the actual underlying asset has gone up in value. 

So in other words, you end up with a gap between the amount that was originally forwarded and the underlying asset value.  So in that instance, there is obviously a desire to ‘catch up’ that gap or to remove that gap and that can be done by effectively recycling or regenerating a debt back to the trust and then making sure that the mortgage arrangements are updated to catch that additional amount. 

The other reason that it might take place, and this particularly can arise in relation to master trusts, is where there's a feeling amongst the family unit that all arrangements are to be on a commercial basis.

In that instance, it's quite often the case that there are interest and principal repayments.  So in that scenario, you'll start to get a gap between the level of security that the trust might have over the particular asset and the debt that’s actually outstanding. 

The critical point in relation to either of those scenarios, so in other words the asset going up in value or the debt being reduced, or for that matter, both things happening at once, is that whenever that gap is removed, you will generally find that there is wealth being moved away from an at-risk individual into a protected environment being the trust.  Obviously in that scenario, in each and every instance that it takes place, you've potentially got to be aware of and advise the client, in relation to the application of the bankruptcy clawback provisions.

Until next week.