Estate planning and the 2017 super reforms – the six post death strategies you must be aware of

Last week’s post considered 11 of the key strategies that need to be taken into account from an estate planning perspective in light of the 2017 superannuation changes (see - Estate planning and the 2017 super reforms – the 11 things you must be aware of).

Each of the issues flagged were primarily focused on pre-death estate planning strategies.

There are however a number of post-death issues in light of the 2017 superannuation changes that should be considered from an estate planning perspective, namely:

1. Death benefit pensions can now be rolled over to a new fund (under the previous rules, this was very difficult). 
2. Reversionary beneficiaries will now have up to 12 months from the death of the member to determine whether or not they wish to cash a benefit before it is credited to their entitlements and if the amount will result in the beneficiary exceeding their $1.6 million transfer balance cap, the excess amount must be paid as a lump sum benefit. 
3. Where there is no reversionary pension, the pre-existing requirement that benefits be paid ‘as soon as practicable’ remains in place. Whether this phrase can be read in the context of the new amendments to mean (say) within 12 months remains open to debate. Next week’s post will consider in more detail the appropriate interpretation of this phrase. 
4. Where no specific strategies have been implemented and a member passes away, it may be possible to establish a post-death superannuation proceeds trust. Generally, a post-death superannuation proceeds trust can allow infant beneficiaries to gain access to adult tax rates on income received. 
5. This said, there are a number of technical requirements that must be met and the range of circumstances where the structure is available and appropriate is relatively narrow and should generally be seen as an alternative of last resort (previous posts have explained the various issues in this regard further, see - Why superannuation proceeds trusts should only be an avenue of last resort and Superannuation proceeds trusts: Tricks and traps). 
6. When dealing with an SMSF, control of the fund continues to be critical and prior to implementing any of the approaches above, steps should be taken to ensure the SMSF is compliant with the SIS Act and trust deed (in particular, by ensuring any required changes to the trustees or directors of the corporate trustee are processed within the required timeframes). 

The above post is based on the article we recently had published in the Weekly Tax Bulletin.

Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/

Image courtesy of Shutterstock

Estate planning and the 2017 super reforms – the 11 things you must be aware of

The 2017 superannuation reforms are widely acknowledged as being the most fundamental changes to the superannuation landscape in over a decade.

While the reforms will have a significant impact across a range of areas, the consequences from an estate planning perspective are at risk of being overlooked.

In no particular order, the fundamental issues that must now be considered when managing superannuation entitlements from an estate planning perspective are as follows:

1. Where an individual has a reversionary pension for an amount currently in excess of the $1.6 million balance transfer cap (which will be indexed for CPI), steps will need to be taken to manage how the amount which gets rolled back to their accumulation account is dealt with upon their death – for instance, via a binding death benefit nomination. 
2. While the exact factual matrix will always be critical, as a general comment, entitlements above the $1.6 million limit should be paid to tax death benefits dependants, ideally via a superannuation proceeds trust as part of a testamentary trust under a will (previous posts have explored various aspects of superannuation proceeds trusts, see Superannuation proceeds trusts, View Legal and superannuation proceeds trusts and Superannuation proceeds trusts: Tricks and traps. 
3. The utility of a superannuation proceeds trust is significantly undermined where there are no death benefit dependants for tax purposes. Where a person has superannuation entitlements and no tax dependants, the consequences of the ‘fast death tax’ remain critical to consider. The so-called ‘fast death tax’ arises where funds that could otherwise be withdrawn tax free by the member during their lifetime remain in the fund at the date of death of the member and are then subject to tax on the distribution from the fund. 
4. The ability to make anti-detriment payments ends on 30 June 2016. Anti-detriment payments were beneficial in many situations, although had limited applications for self-managed superannuation funds. 
5. Any estate planning strategy will continue to be ultimately dependent on the trust deed for the relevant fund and a detailed review of the deed should be undertaken before any succession strategies are implemented. 
6. The conservative approach is that all trust deeds should be reviewed in light of the 2017 changes, with particular focus on the client’s estate planning objectives. Our experience to date is that in most cases, a deed update will be appropriate. 
7. Regardless of whether a trust deed is updated, reviewing related estate planning documents to ensure that they align with the client’s objectives is critical. In particular, all death benefit nominations and reversionary pensions must be reviewed (for instance, in the context of the $1.6 million transfer balance cap mentioned above). To the extent that there are binding nominations in place, the structure of those nominations may need to be updated (again, previous posts have explored a number of relevant aspects in that regard, see Superannuation and binding death benefit nominations (BDBN), Death benefit nominations – read the deed and Double entrenching binding nominations). 
8. Similarly, the ability to make decisions, including potentially renewing or changing nominations in the event of a member’s incapacity, must be addressed by a comprehensive, superannuation compliant, enduring power of attorney. An appropriately crafted document in this regard will also provide a pathway to potentially avoid ‘fast death tax’ being triggered. 
9. The utility of reversionary pensions will be significantly undermined if the consequence of the reversionary pension is that the recipient exceeds their transfer balance cap. 
10. That said, in the right factual scenario, a child pension may provide planning opportunities as a child is entitled to access each of their parents transfer balance cap – in other words, if the two parents pass away, the children of the relationship can get access to up to $3.2 million. Unless a child has a permanent and significant disability however, any balance in a pension account on the child reaching the age of 25 must be commuted and paid to them as a lump sum. From an asset protection perspective, this has significant adverse consequences that need to be considered. 
11. A carefully crafted testamentary trust will, which can provide tax benefits that are broadly similar to those that could be obtained by a child allocated pension, may be preferable to ensure that access to capital only takes place at appropriate junctures and not automatically at the age of 25. 

Next week’s post will consider some of the specific post-death consequences of the new rules. The above post is based on the article we recently had published in the Weekly Tax Bulletin.

Image courtesy of Shutterstock

When exactly is a related party debt statute barred?

For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

The case of Re Breakwell and FCT [2015] AATA 628 (25 August 2015, reported at 2015 WTB 37 [1393]) highlighted a common trap in relation to the circumstances where a related party debt will be statute barred. The decision, which was upheld on appeal in Breakwell v FCT [2015] FCA 1471 (22 December 2015, reported at 2016 WTB 1 [27]) remains a timely reminder of the critical interplay between various legislative provisions that practitioners must be constantly aware of.

Breakwell

In Breakwell, the taxpayer argued that a $1.1 million debt owed by him to a family trust should not be included in the calculation of the trust's net assets under the maximum net asset value test for the small business CGT concessions under Div 152 of the ITAA 1997. The basis of the argument was that the debt had arisen prior to 1998 and was therefore outside the 6-year period provided for under the Limitation of Actions Act 1936 (SA).

In this regard, as noted by White J in the Federal Court decision, the relevant section in South Australia is not a bar to proceedings, rather, it creates a defence which bars the granting of a remedy. Similar legislation applies in every State and Territory except in New South Wales, where a creditor's right to the debt is effectively extinguished after the expiry of the limitation period.

Specifically, the taxpayer claimed that because no repayments had been made and he had not acknowledged the existence of the debt in writing, the debt had become statute barred meaning the family trust could no longer enforce repayment of the debt.

In finding against the taxpayer, the Administrative Appeals Tribunal noted that the taxpayer had signed the balance sheets for the family trust for the 2003 to 2008 income tax years (in his capacity as trustee). It was held that the signature on the balance sheets was sufficient to constitute an acknowledgement by him (as the borrower) of the existence of the debt.

This meant the debt was not statute barred and was required to be included in the calculation of the trust's maximum net asset value.

The taxpayer was unsuccessful in appealing the decision to the Federal Court, as previously reported by Jack Stuk and Danielle Gorman (see 2016 WTB 7 [181]). In brief, White J also raised a number of alternative methods by which the loan could effectively be recovered, including:

• the taxpayer as trustee of the family trust would face a duty-interest conflict in raising the limitation of actions defence; 
• the South Australian legislation (which differs from other States in this respect) allows for an extension of the limitation period; and 
• through an action by the trustee to recover trust property, which was again due to differences in the South Australian legislation as it has no limitation period in this regard. 

Why are the statute barred rules so important?

Determining whether a debt has become statute barred can be relevant in a number of areas, for example:

• From a commercial perspective, ensuring the lender has the ability to demand the repayment of the debt. 
• As highlighted in Breakwell, for determining whether or not a debt should be included in the maximum net asset value test under Div 152 of the ITAA 1997. 
• Under Div 7A of the ITAA 1936, which treats a debt that has become statute barred as being forgiven (and therefore potentially gives rise to a deemed dividend). 
• For determining whether a bad debt deduction can be claimed (see for instance TR 92/18). 
• Estate planning, particularly (for example) where there are debts owed by a trust to a will maker and certain beneficiaries are intended to control the trust, with others to benefit under the will. 
• Asset protection, particularly if the "gift and loan back" strategy has been implemented (see for example our article reported at 2013 WTB [1821]). 

The key issue – the start date

In this context, it is obviously important to determine the date on which a loan is deemed to begin.

Historically, there has been some support for the argument that the start date for limitation period purposes was the date that a demand was made for repayment of the debt or the last date a formal acknowledgement (including by way of part payment) was made.

This position was at least partially due to the fact that under the relevant limitation legislation, an acknowledgement must generally be made in writing by the debtor to the creditor, and be signed by the debtor.

The "acknowledgment" debate
Although the relevant legislation is slightly different in each State and Territory across Australia, the general test to determine if a debt has become statute barred is whether, within the relevant period (typically 6 years for unsecured debts and 12 years for secured debts) there has been either:

• a partial repayment by the borrower; or 
• a written acknowledgement of the existence of the debt signed by the borrower and addressed to the lender. 

Although these tests would seem fairly straight forward, there is some debate as to whether the written acknowledgement must be intended by the borrower to be an acknowledgement to the lender of the existence of the debt.

In VL Finance Pty Ltd v Legudi [2003] VSC 57 (13 March 2003) (in the context of the Victorian legislation), Justice Nettle (then sitting on the Victorian Supreme Court) held that any acknowledgement must be intended by the borrower to be an acknowledgement to the lender of the existence of the debt.

Therefore, the mere signing of financial statements by the borrower in their capacity as a trustee or director will not be sufficient to "refresh" the debt. Importantly, it was also held that the limitation period (at least for the purposes of Div 7A of the ITAA 1936) begins to run immediately on the date that an at-call loan is made; not from the time when the first call for repayment is made.

By contrast, Lonsdale Sand & Metal v FCT [1998] FCA 155 (5 March 1998) (in relation to the South Australian legislation) and now Breakwell have both concluded that the mere signing of the financial statements by the borrower will be sufficient to "restart the clock" on the recovery period.

Conclusion

The differences between the outcomes in relation to acknowledgments in VL Finance on one hand and Lonsdale and Breakwell on the other are hard to reconcile.

While it could be argued that VL Finance provided a far more robust analysis of the issue and reached a more reasoned conclusion, practitioners should be cautious relying on the decision given the conflicting judgments.

Nonetheless, some common themes can be identified from all 3 cases, including:

• An oral acknowledgement by the borrower by itself will be insufficient to "refresh" a debt, unless accompanied by some written acknowledgement. 
• The inclusion of a debt on the borrower's signed financial statements should be insufficient to "refresh" the debt, unless it can be shown that those financial statements were subsequently provided to the lender with the intention of acknowledging the existence of the debt. 
• Where the debts are owed between entities with common directors, the signing of the lender's financial statements by a director who is also a director of the borrower will likely be seen by the ATO to be sufficient to "refresh" the debt. 

Ultimately, practitioners should be wary of advising clients that debts have been statute barred where the debts are between related parties.

This issue is generally most relevant if a client wishes to rely on PS LA 2006/2 (GA), which provides administrative relief from Div 7A where loans which arose prior to the introduction of those provisions in 1997 become statute barred. In this factual situation, it is critical to review the financial statements for each relevant financial year. The analysis must focus on whether it could be argued that the debt has at any time been "refreshed" by virtue of the borrower signing the financial statements in their capacity as a trustee or director.

Image courtesy of Shutterstock

Changing trustees of trusts – Simple in theory … not so simple in practice

For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

The decision in Balcaskie Investments Pty Limited v Chief Comr of State Revenue [2017] NSWCATAD 19 ("Balcaskie") was reported at 2017 WTB 4 [120].

The case is a timely reminder of the critical issues that can arise from a revenue perspective in relation to the superficially simple area of changing the trustee of a trust.

The starting point for any change of trusteeship is always the terms of the trust deed. In this regard, the 'read the deed' mantra has been regularly highlighted by us.

Assuming the trust deed creates the relevant power and the change of trustee documentation follows the procedure mandated by the trust instrument, there are 2 key revenue issues to be aware of, namely

1. Capital gains tax ("CGT");
2. Stamp duty provisions in the relevant jurisdiction (in the case of Balcaskie – NSW). 

Each of these issues is considered in turn below.

CGT consequences

Arguably the most commonly triggered CGT event is the disposal of a CGT asset (being CGT event A1).

A question that regularly arises, particularly in estate planning and asset protection exercises, is whether a change of trustee triggers CGT event A1.

Relevantly, s 104-10 of the ITAA 1997 provides as follows:

1. CGT event A1 happens if you dispose of a CGT asset; and 
2. you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur: 

1. if you stop being the legal owner of the asset but continue to be its beneficiary owner; 
2. merely because of a change of trustee. 

Therefore, it is generally accepted that CGT event A1 does not occur as a result of a change in the trustee and the ATO acknowledges this position in Tax Determination TD 2001/26.

Similarly, there are numerous private binding rulings ("PBRs") that confirm the same outcome, such as PBR 1011623239706.

Stamp duty consequences

Unfortunately, while there are generally no stamp duty consequences for changing a trustee, the rules to gain access to the relevant exemption are different in each state.

Generally however, an exemption should be able to be accessed to mirror the revenue neutral CGT position, with the requirements likely to include at least the following:

1. the dutiable transaction was undertaken for the sole purpose of giving effect to a change of trustee; 
2. the transaction is not part of an arrangement: 

1. involving a change in the rights or interests of the beneficiary of the trust; 
2. terminating the trust; and 

3. transfer duty has been paid on all trust acquisitions for which transfer duty is imposed for the trust before the transaction. 

It is important to note that each state adopts its own approach in this area, and (for example) in New South Wales, additional requirements must be met including that the new trustee cannot be a beneficiary of the relevant trust.

Section 54(3) of the Duties Act 1997 (NSW) limits the nominal duty exemption for a change of trustee to trust deeds that contain provisions ensuring that:

1. none of the continuing trustees remaining after the appointment of a new trustee are or can become a beneficiary under the trust; 
2. none of the trustees of the trust after the appointment of a new trustee are or can become a beneficiary under the trust; and 
3. the transfer is not part of a scheme for conferring an interest, in relation to the trust property, on a new trustee or any other person, whether as a beneficiary or otherwise, to the detriment of the beneficial interest or potential beneficial interest of any person. 

This prohibition is relevant for trusts established in NSW obviously. It is however also relevant in other jurisdictions as well because many trust deed providers are based in NSW, or rely on precedents originally sourced from NSW.

In addition, the NSW requirements will need to be satisfied where a trust which has been established in another jurisdiction owns dutiable property in NSW.

As noted in Balcaskie, prior to the case, there had not been a reported decision interpreting the way in which the stamp duty exemption on changing a trustee under the NSW rules operates.

The trust deed in Balcaskie had a specific clause (inserted by a deed of variation some years after the deed was originally settled) that required any change of trustee to comply with the NSW stamp duty rules to ensure access to duty relief.

In particular, the relevant clause stated –

"The Original Trustee and the New Trustee and any future and past trustees are absolutely prohibited from being a beneficiary under the Trust Deed or from otherwise directly or indirectly benefiting under the Trust Deed and this clause will not be capable of amendment or revocation."
The separate power of variation clause in the trust deed was very widely crafted, and on the reading adopted by the NSW Office of State Revenue ("OSR"), created the power for the trustee to amend (and potentially remove) the above mentioned prohibition.

This apparent power of variation meant (in the view of the OSR) that the duty exemption on changing the trustee was not available.

The NSW Civil and Administrative Tribunal decided the conflict solely on the basis of a fundamental rule of construction.

That rule being that a specific provision must be read as prevailing over a provision of general import.

In this case, the rule meant that the specific prohibition had priority over the general power of variation. In turn, the OSR was therefore required to grant the duty exemption on the change of trusteeship.

The case may also impact on the OSR's interpretation of the law in other areas – for instance, the NSW OSR has historically adopted the view that a trust will not qualify as a 'fixed trust' for land tax purposes if there is a power for the trustee to amend the trust deed in a manner which alters the fixed entitlement. The Balcaskie decision arguably means the OSR should be considering the terms of the fixed trust deed as they exist at a particular point in time, regardless of any power the trustee may have to subsequently amend those terms.

Conclusion – always start by reading the deed

As explained regularly in this Bulletin, given the range of significantly adverse consequences that can result where a purported change to a trust is subsequently found to be invalid, advisers should proactively invest in processes and systems to minimise the risk of such an outcome.

Invariably, best practice dictates that the starting point must be to read the trust deed.

There must then be a methodical analysis of all potential revenue consequences.

Image courtesy of Shutterstock

Tantalising opportunities for trust restructures under new Subdiv 328-G

For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

Introduction

The new Subdiv 328-G rollovers (the provisions) commencing 1 July 2016 provide significant opportunities for Small Business Entities (SBE) to restructure into a more appropriate entity, assuming the “genuine restructure” provisions can be satisfied.

This article considers a number of opportunities to restructure discretionary trusts. In particular:

1. trust cloning with or without a Family Trust Election (FTE);
2. trust splitting and effectively limiting the range of potential beneficiaries without causing a resettlement; and 
3. restructuring out of trusts with heritage issues. 

The new rollovers were introduced via the Tax Laws Amendment (Small Business Restructure Roll-Over) Bill 2016 which passed all stages without amendment and received Royal Assent on 8 March 2016.

Ultimate Economic Ownership (UEO) and cloning

Section 328-430(1)(c) requires the UEO of assets being transferred remain the same, or in the same proportion after the restructure. While this is relatively simple for companies or sole-traders, it presents difficulties for trusts, where beneficiaries do not have a direct and absolute interest in the assets of the trust (merely a right to due administration).

Trust cloning of discretionary trusts is again available following its abolition on 31 October 2008 through the provisions without causing any CGT consequences. Where a trust makes (or has previously made) an FTE pursuant to Sch 2F of the ITAA 1936, the provisions ensure (under s 328-440) access to the roll-over if the cloned trust has made the same FTE.

Historically, the Tax Office had set out its view of how to implement a valid trust clone for tax purposes in the (now withdrawn) Taxation Ruling TR 2006/4.

Although not free from controversy, the Tax Office was of the view that in order to implement a valid trust clone, it was necessary for the "beneficiaries and terms of both trusts (to be) the same".

In this context, the position of the Tax Office was that any FTE made by the original trust would need to be made by the cloned trust in order to gain access to the tax concessions.

Under the UEO rules, in situations where there is either no FTE made by the original trust or a desire for the cloned trust to not make a FTE, the provisions still allow cloning to take place so long as there is "no material change" between the original trust and the cloned trust.

It is assumed, pending more detailed comments from the Tax Office, that withdrawn TR 2006/4 will provide at least a framework for how to interpret the concept of "no material change". Given that there is a discrete roll-over available under the provisions for trusts that have identical FTEs, it is reasonable to conclude that the no material change requirement will be satisfied regardless of the approach taken by either trust in relation to a FTE.

Anecdotally, prior to 31 October 2008, there was some debate as to whether "reverse clones" could be implemented without tax consequence. In other words, consolidating assets across 2 or more trusts into one trust. Again, under the provisions, it seems clear that reverse cloning will be available, so long as each trust has made the same FTE, or alternatively, the "no material change" test can be satisfied.

Trust splitting

With the Tax Office providing some clarity in relation to trust splitting through Private Binding Ruling Authorisation Number 1012921290075 (Ruling) (see - http://blog.viewlegal.com.au/2016/03/trust-splitting-some-clarity-at-last.html) the provisions appear to provide further opportunities to structure a comprehensive split.

In the Ruling, the Tax Office confirmed its view that narrowing the class of potential beneficiaries of each split trust to a separate family unit would cause a resettlement. Relying on the FTE safety net, it should be possible to limit the range of potential beneficiaries to individuals or classes of individuals falling within the specific family group.

Similarly, all other substantive aspects of a trust split, including limiting the right of indemnity for each trustee to only the assets of the split trust, will fall within the ambit of at least the "identical FTE" aspect of the provisions.

Whether a traditional trust split can also be used, for example, to extract certain assets out of the reach of a pre-existing FTE, for example, by relying on the "no material change" provisions, is more debatable. In particular, from a stamp duty perspective, access to duty concessions in most states for trust splitting relies on any split trust still forming part of the original trust, in which case, any FTE made would need to continue to apply for tax purposes.

Heritage trusts

Where a trust deed has heritage problems, such as limited variation powers or a proximate vesting date, the provisions can be used to transfer the assets to a "clean skin" trust deed, avoiding the difficulties and costs associated with making an application to Court to vary the deed.

While there have been a number of Court decisions in recent years allowing the extension of a vesting date to avoid adverse impending revenue consequences, it should be noted there are similarly a number of cases where the Court has denied such an application (see Re Arthur Brady Family Trust; Re Trekmore Trading Trust [2014] QSC 244; Re Plator Nominees Pty Ltd [2012] VSC 284; Stein v Sybmore Holdings Pty Ltd [2006] NSWSC 1004 and Paloto Pty Limited v Herro [2015] NSWSC 445).

In any event, the costs of a Court application itself would appear to be able to be avoided if the provisions can be accessed.

In theory, the new rules will also provide a potential pathway in other problematic areas of an existing trust such as narrow beneficiary classes, mandated (but now inappropriate) appointor or principal roles and, potentially, lost trust instruments.

Future focus While the provisions appear to meet many of the tax-related issues facing SBEs wishing to restructure, other potential transaction costs, particularly stamp duty, will need to be carefully considered before implementing a rearrangement. With New South Wales, following the lead of Victoria and South Australia, set to abolish stamp duty on business transfers from 1 July 2016, it is hoped that all states fall into line in the near future.

Image credit: Markus Spiske cc

Trust Splitting – some clarity at last

For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

The recent Tax Office Private Binding Ruling Authorisation number 1012921290075 (Ruling), considers a number of key issues relating to the concept of trust splitting.

While trust cloning is generally seen as preferable to trust splitting, there are a range of reasons cloning may be commercially inappropriate including –

• an inability to access any of the small business CGT rollovers;
• assets that do not lend themselves to complete separation;
• no stamp duty relief (which is the case in most Australian states).

The Ruling is a timely reminder of the need to ensure care is taken with any intended rearrangement of an existing trust.

Overview of questions answered

The Ruling confirms the following key conclusions -

• the insertion of powers into a trust instrument to provide a trustee the ability to create a split trust will not be a resettlement if the power of variation is sufficiently wide;
• a change of trusteeship in relation to certain trust assets will not cause any tax consequences, again subject to the trust deed providing the requisite powers;
• a change to the person nominated as principal or appointor of a split trust will not cause any tax consequences, again subject to the trust deed providing the requisite powers; 
• varying a trust deed to limit each trustee’s right of indemnity such that each trustee is only permitted to be identified from the assets of the split trust they act as trustee for will not cause a resettlement; 
• narrowing by deed amendment the class of beneficiaries of each split trust to focus around the family unit intended to control that trust will cause a resettlement. 

Arguably, since the decision in FCT v Clark [2011] FCAFC 5 (Clark) and the ATO’s response in Tax Determination 2012/21, none of the above conclusions are controversial, other than in relation to the narrowing of beneficiaries causing a resettlement. It is important to note however that the ability to limit the right of indemnity does change the previously adopted ATO position.

It might be recalled that in Clark, a majority of the Full Federal Court held that changes to a trust (primarily a change in the ownership of units of beneficial entitlement to the trust property and changes to the trust property itself) did not result in a break in continuity of the trust. As a result, capital losses incurred by the trustee before those changes occurred could be offset in calculating net capital gains arising after the changes occurred.

Each of these issues are explored in more detail below.

Narrowing of right of indemnity

One of the fundamental concerns with trust splitting, as compared with trust cloning, was the asset protection issues with trust splitting, if the trustee of each split trust remained able to be indemnified from assets held by other trustees of assets in a different split trust.

Prior to this Ruling, ATO guidance has historically indicated that limiting a trustee’s right of indemnity as part of a trust splitting arrangement could cause CGT event E1 to happen.

In particular, in ATO Interpretative Decision 2009/86, it was decided that a trust split did trigger CGT event E1 on the basis that there was a 'fundamental change to the rights and obligations attaching to the trust assets’. A key aspect raised by the ATO was that the trustee's rights of the ‘original’ trust had been altered by excluding the transferred assets from its right of indemnity.

In the Ruling, a desire to limit the right of indemnity was based on achieving the asset protection objectives and to align with the estate plans of the shareholders and directors of the trustee of the orignal trust.

However the ATO confirms in the Ruling that, following Clark, this type of change does not result in the trust estate as originally constituted coming to an end.

Furthermore the altering of the indemnity does not cause any of the assets of a trust to be subject to a new charter of rights or obligations separate to those on which the property was originally settled.

Rather, the restriction of the respective trustee’s rights to be indemnified is in fact consistent with the appointment of separate trustees over different assets of a trust. Ultimately then the changes, without more, did not alter the rights of the beneficiaries to be able to benefit from all of the assets of the trust.

Narrowing the class of beneficiaries

Again due to the objectives under the estate plans of the shareholders and directors of the trustee of the orignal trust, there was a desire to narrow the class of potential beneficiaries.

In the Ruling the ATO states that any such change will amount to a situation where assets are commenced to be held on trusts different to the original trust. In other words, that CGT event E1 would happen by reason of the changes.

In reaching this conclusion the ATO relies heavily on the decision in Commissioner of State Revenue v. Lam & Kym Pty Ltd (2004) 58 ATR 60 (Lam & Kym).

Whether the position adopted by the ATO on this point is correct would need to be considered in light of the following –

• Lam & Kym involved an express declaration of trust over specific assets, which does not appear to be the case in the factual scenario considered in the Ruling.
• In any event, Lam & Kym was a Victorian Supreme Court case which has been largely superseded by the High Court in Clark.
• Clark confirmed, as acknowledged in TD 2012/21, that a variation of a trust by the trustee in accordance with an express power in the trust instrument will generally not result in the establishment of a new trust. 
• The narrowing of a beneficiary class is analogous to Clark and TD 2012/21, which confirm that no resettlement arises from a variation of beneficiaries where the variation is permitted by the trust deed and there is continuity of the trust estate. 

Conclusion

The Ruling provides useful clarity around the scope of changes that can be implemented as part of a trust splitting arrangement. While the ATO’s position in relation to narrowing beneficiary classes is disappointing, there remains significant scope for helping trustees achieve succession planning objectives via trust splitting.

Image credit: OuadiO cc

At last some clarity with the streaming of franking credits? But trust law re-write still urgently needed

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

For ease of reference, an earlier post addressing a previous decision in this matter is at the following link - http://blog.viewlegal.com.au/2010/11/streaming-decision-released.html

The recent case of Thomas v FCT [2015] FCA 968, reported in this Bulletin, considers a number of key issues relating to the distribution of franking credits by the trustee of a discretionary trust, including the ability to stream franking credits as a separate class of income.

It follows the well-publicised decision of the Queensland Supreme Court in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417 (reported at 2010 WTB 49 [1884]), which relevantly held that franking credits could form part of the income of a trust estate for trust law purposes and be streamed to particular beneficiaries.  The Commissioner was not a party to that earlier decision.

The Thomas case explores the interaction between s 95 and s 97 of the ITAA 1936 dealing with trust income and Div 207 of the ITAA 1997 dealing with the imputation system.

The decision is a timely reminder of the need to ensure that trust distributions are made in compliance with the trust deed, the ITAA 1936 and the ITAA 1997, and of the complexities that can arise when streaming different classes of income.

Facts

A more detailed summary of the facts of the case are set out separately in this Bulletin, however in brief, the trustee of Thomas Investment Trust purported to distribute the trust's income in several consecutive financial years as follows:

• Around 90% of the franking credits and foreign income and 1% of the remaining net income to an individual beneficiary.
• The balance of the net income to a corporate beneficiary.

The Commissioner challenged the effect of the distributions and in essence, argued that the franking credits could not be distributed to a beneficiary independently of the franked dividend to which those franking credits related.

The taxpayer contended that the franking credits were in fact a class of income capable of being streamed to particular beneficiaries in accordance with the trust instrument.

A number of other matters relating to the trust instrument and distribution resolutions were considered by the Court, which are beyond the scope of this article.

Outcome

The judgment, which the Commissioner at least is likely to believe is a thorough and well-crafted decision, rejects the earlier conclusion in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417 and provides significant guidance in relation to the streaming of franked dividends and franking credits.

It is widely understood that Div 207-55(3) of the ITAA 1997 provides that a beneficiary's share of a franked distribution is equal to the amount included when determining the beneficiary's share of the trust's income under s 95 of the ITAA 1936.

Div 207 also recognises and permits a trustee to stream some or all of a franked dividend to one or more beneficiaries to the exclusion of others, subject to the requisite powers under the trust deed.

Provided the relevant trust instrument expressly permits streaming of franked dividends as a separate class of income, a trustee can choose to make one or more beneficiaries specifically entitled to franked dividends, while distributing other classes of income to different beneficiaries.

Any beneficiary who is made specifically entitled to franked dividends is then entitled to the benefit of the franking credits attaching to those dividends.

In Thomas, the trustee purported to stream franking credits as a separate class of income from the dividends themselves.  This approach, permitted under the trust deed, saw one beneficiary receive the benefit of the tax offset under the imputation system at their marginal tax rate, while another beneficiary paid income tax on the dividend at the corporate tax rate.

The Court held that, although franking credits will generally have a clear commercial value to a beneficiary (as a result of the beneficiary's ability to claim a tax offset from the credit), a franking credit is not "income" for trust law purposes.

Specifically, although franking credits constitute statutory income for the purposes of the gross-up provisions, they are a notional, statutory creation in this regard and do not constitute "ordinary income" under trust law principles.

As a result, the operation of Div 207 makes it clear that franking credits can only "attach" to the franked dividend and cannot be streamed as a separate class of income, notwithstanding any other provision that may indicate to the contrary within the trust instrument.

The outcome of the case can perhaps be best summarised by the following quote from the judgment:

"What cannot occur if the tax offset is to be preserved…is an allocation of the s 95 net income amongst beneficiaries on a particular basis and a distribution of the franking credits otherwise attached or stapled to the franked dividends on an entirely unrelated basis, amongst the same beneficiaries." [Court's emphasis]

Lessons

A number of lessons can be taken from the case, including:

• As regularly highlighted in this Bulletin, it is critical to "read the deed" before purporting to exercise trust powers, particularly in relation to trust distributions.

• While reading the trust deed (including all valid variations) is necessary, it will not be sufficient by itself.  There are a myriad of related issues that need to be considered that may impact on the intended distribution, aside from whatever powers are set out in the trust instrument.  Examples include renunciations and disclaimers by beneficiaries, purported changes that are not permitted under the relevant trust instrument (see for example the article at 2015 WTB 37 [1373] in relation to amending trust deeds) and the effective narrowing (for tax purposes) of permissible beneficiaries due to the impact of family trust and interposed entity elections.

• The wording of the distribution minute or resolution will be critical for determining the consequences of the distribution.  Terms like "income" and "net income" will be defined differently depending on the trust instrument (even deeds that have been sourced from the same provider) and failing to understand those distinctions can result in inadvertent adverse outcomes for the trustee and beneficiaries.

• Distribution resolutions must also be crafted with reference to the trust instrument, trust law principles, the ITAA 1936 and the ITAA 1997.  For example, with increasing regularity, we are seeing trust deeds that require distributions take place before they are otherwise needed under the ITAA.

• Trustees should act with significant care when dealing with "notional" amounts such as franking credits, to ensure the intended tax and commercial objectives are achieved.

• Trustees have a duty to ensure they are aware of their rights and responsibilities under the trust deed and the limitations under the ITAA 1936 and the ITAA 1997.  A failure to discharge this duty can mean a trustee is personally liable.

Ultimately however the latest installment in this series of cases (so far) also highlights the need for the Government to prioritise the long awaited re-write of the legislation governing the taxation of trusts in order to simplify what continues to be an unnecessarily complex area of the taxation law.

Image credit: Dwayne Bent cc

Trust distributions – 3 reminders for 30 June 2014

Getting ready for 30 June.

For the fourth time in recent weeks we have been fortunate to have an article featured in the Weekly Tax Bulletin. This time it is by fellow View Legal Director Patrick Ellwood and I and is extracted below for those who do not otherwise have easy access.

As regularly addressed in the Weekly Tax Bulletin, a methodical approach is needed when preparing trust distribution resolutions to ensure the intended outcomes are achieved.

With another 30 June fast approaching, it is timely to consider 3 key issues often overlooked, namely:

1. ensuring that the intended recipient of a distribution is in fact a valid beneficiary of the trust;
2. avoiding distributions to beneficiaries who appear to be validly appointed under a trust deed, however are in a practical sense excluded; and
3. complying with any timing requirements under a trust deed, regardless of what the position at law may otherwise be.

Further comments on each of these issues are set out in turn below.

Is the intended recipient a beneficiary?

A beneficiary is a person or entity who has an equitable interest in the trust fund. A beneficiary has enforceable rights against a trustee who fails to comply with their duties, regardless of whether they have ever received distributions of income or capital from the trust. 

The range of eligible beneficiaries will generally be defined in the trust deed and the first step in any proposed distribution should be to ensure that the intended recipient falls within that defined range.

Once the range of eligible beneficiaries has been determined, the next step is to identify classes of specifically excluded beneficiaries.

These exclusions will usually override the provisions in a trust deed which create the class of potential beneficiaries and some common examples include:

• persons who have either renounced their beneficial interest or have been removed as a beneficiary of the trust fund;
• the settlor and other members of the settlor's family;
• any "notional settler"; and
• the trustee.

A comprehensive review of a trust deed must include an analysis of every variation or resolution of a trustee or other person (such as an appointor) that may impact on the interpretation of the document.

The range of documents that could impact on the potential beneficiaries of a trust at any particular point in time is almost limitless. Some examples include:

• resolutions of the trustee to add or remove beneficiaries pursuant to a power in the trust deed;
• nominations or decisions of persons nominated in roles such as a principal, appointor or nominator; and
• consequential changes triggered by the way in which the trust deed is drafted (eg beneficiaries who are only potential beneficiaries while other named persons are living).

Does the intended recipient appear to be a beneficiary, yet practically is excluded?

It is important to remember that the unilateral actions of a potential beneficiary may impact on whether they can validly receive a distribution. For example, a named beneficiary may disclaim their entitlement to a distribution in any particular year, or may in fact renounce all interests under the trust.

There are also a number of potential issues that can arise in relation to beneficiaries that appear to have been nominated as beneficiaries, as to whether the nomination is effective. These issues can include:

• whether the appointment needs to be made in writing;
• whether the appointor has been validly appointed to their role;
• at what point the nomination needs to take place in the context of the timeframe within which a distribution must be made; and
• are there any consequential ramifications of the nomination, eg stamp duty, resettlement for tax purposes or asset protection.

Family trust election

In addition to the traditional trust law related restrictions on the potential beneficiaries of a trust, it is important to keep in mind the consequences of a trustee making a family trust election or interposed entity election.

Where such an election has been made, despite what might otherwise be provided for in the trust instrument, the election will effectively limit the range of potential beneficiaries who can receive a distribution without triggering a penal tax consequence (being the family trust distribution tax).

A family trust election will generally be made by a trustee for one or more of the following reasons:

• access to franking credits;
• ability to utilise prior year losses and bad debt deductions;
• simplifying the continuity of ownership test; and
• eliminating the need to comply with the trustee beneficiary reporting rules.

While a full analysis of the impact of family trust elections and interposed entity elections is outside the scope of this article, it is critical to consider the potential implications of any such election on what might otherwise appear to be a permissible distribution in accordance with the trust deed.

Complying with any timing requirements under the trust deed

Historically, the Commissioner permitted resolutions to be made after 30 June each year via longstanding ITs 328 and 329, however as practitioners will recall, these were withdrawn in 2011.

The current law does allow resolutions in relation to capital gains to be made no later than 2 months after the end of the relevant income year. Any other distributions, including in particular franked distributions, must be made by 30 June in the relevant income year.

Notwithstanding the general position above, the ATO has regularly confirmed its view that regardless of any timing concessions available under the tax legislation or ATO practice, these concessions are subject always to the provisions of the relevant trust instrument.

In recent times, we have reviewed a number of trust deeds by different providers that require all resolutions to be made by a date earlier than 30 June, eg no later than 12pm on 28 June in the relevant financial year. Unfortunately, in every situation we have seen, all distributions for previous income years were dated 30 June, meaning each resolution was in fact invalid under the deed, regardless of the fact that the resolution otherwise complied with the law.

In these situations, arguably the only practical solution is to proceed with lodgment of amended returns, relying on the default provisions under the trust deed – assuming there are adequate default provisions.

Until next week.

Image credit: Steve Corey cc via Flickr

Taxation consequences of testamentary trust distributions - Part II

Again for those that do not otherwise have easy access to the Weekly Tax Bulletin, Part II of the article by fellow View Legal Director Patrick Ellwood and I is extracted below.

Part I of this article (at 2014 WTB 19 [658]) considered a number of specific aspects of the transfer of assets under a deceased estate testamentary trust. Part II of the article now considers:

• distributions from testamentary trusts to beneficiaries;
• the proposed changes to CGT event K3; and
• the proposed changes where an intended beneficiary dies.

Distributions from testamentary trusts

In 2003, the ATO released PS LA 2003/12, which states that its purpose is to inform ATO staff that the Commissioner will not depart from the long-standing administrative practice of treating the trustee of a testamentary trust in the same way as a legal personal representative (LPR) is treated for the purposes of Div 128 of the ITAA 1997.

In the 2011-12 and 2012-13 Federal Budgets, it was proposed that the current ATO practice set out in PS LA 2003/12 of allowing a testamentary trust to distribute an asset of a deceased person without a capital gains tax (CGT) taxing point occurring would be codified.

While draft legislation to effect the change was prepared, the Federal Government announced that it was reviewing the progress of a large number of unenacted legislative announcements and ultimately confirmed on 14 December 2013 that the amendments would not be implemented - see 2013 WTB 53 [2270] and also 2014 WTB 12 [399].

As set out at 2014 WTB 16 [561], the ATO recently republished PS LA 2003/12 confirming that it intends to continue to consider itself bound by it. Despite the ATO apparently acknowledging that the Government will not proceed with any legislative changes, some amount of confusion has been caused by the ATO stating in updates on its website that it will "accept tax returns as lodged during the period up until the proposed law change is passed by Parliament". Those comments are contained in the ATO update entitled "Refinements to the income tax law in relation to deceased estates" (dated 22 April 2014). It is assumed these comments are simply an oversight by the ATO and that PS LA 2003/12 (as amended) will continue to be applied indefinitely into the future.

The position therefore appears to remain that there is exemption roll-over from CGT covering the "transfer" of assets from the LPR to the trustee of the testamentary trust in the first instance and the subsequent transfer by the trustee to an eventual beneficiary of the testamentary trust. The subsequent transfer may either involve a capital distribution being made by the trustee of the trust to a beneficiary during the lifetime of the trust, or a payment of capital upon vesting of the trust.

The result of PS LA 2003/12 is that, on the subsequent disposal of a CGT asset from a testamentary trust trustee to a beneficiary of the testamentary trust:

• any capital gain or loss that the testamentary trust trustee makes is disregarded under s 128-15(3); and
• the beneficiary will be taken to have acquired the CGT assets of the deceased at the date of the deceased's death (rather than on the date they were distributed by the LPR) and the first element of the cost base and reduced cost base for the beneficiary will be:
• for pre-CGT assets in the hands of the deceased - the market value of the asset on the day the deceased died; and
• for post-CGT assets in the hands of the deceased - the deceased's cost base (or reduced cost base) at the date of their death.

Ultimately under PS LA 2003/12, Div 128 (in particular ss 128(2), (3) and (4)) effectively applies twice:

• initially, when the LPR is the "LPR" for the purposes of Div 128 and the testamentary trust trustee is the "beneficiary"; and
• subsequently, when the testamentary trust trustee is treated as an "LPR" for the purposes of Div 128 and the beneficiaries of the testamentary trust are treated as the "beneficiaries".

CGT event K3

The ATO has indicated that the position in PS LA 2003/12 is subject to CGT event K3, which covers assets passing to tax-advantaged entities.

CGT event K3 operates to ensure that, where assets pass to concessionally taxed entities from a deceased estate, a capital gain or loss is recognised in the deceased's final tax return. This prevents assets with embedded capital gains from avoiding capital gains when they are later disposed of by the concessionally taxed entity. CGT event K3 has, in the past, been avoided by ensuring an asset does not pass to a concessionally taxed entity until after the deceased's standard amendment period (generally 4 years after the assessment) has expired.

As part of the 2011-12 Budget measures, it was announced that amendments would be made to ensure that where CGT event K3 happened outside of the deceased's standard amendment period, a CGT liability still arose in the deceased's tax return. It was proposed this could be achieved by excluding CGT event K3 from the standard amendment period.

In particular, the CGT event would have been deemed to happen to the relevant entity that passed the asset to the concessionally taxed entity (rather than with the beneficiary), avoiding the need to amend the deceased's tax return. This change would have allowed the entity to which CGT event K3 applied to be able to utilise its realised capital losses against CGT event K3, instead of the deceased utilising their capital losses against their capital gain from CGT event K3.

The change would have been consistent with how Div 128 operates under PS LA 2003/12 where an LPR or testamentary trust trustee sells an asset to a third party, rather than passing the asset to the intended beneficiary of the estate.

However, as with other proposed changes mentioned below, the announced changes to CGT event K3 were abandoned in late 2013.

Where an intended beneficiary dies before administration is completed

The Federal Government released a proposal paper "Minor amendments to the capital gains tax law" in June 2012 which specifically addressed the circumstance where an intended beneficiary dies before administration of an estate is completed. Generally, in that situation, s 128-15 provides a CGT roll-over provided that the asset passes from the first deceased's LPR to the beneficiary's LPR.

However, no CGT roll-over exists where the asset passes (ultimately) from the first deceased's LPR via the second deceased's LPR to the trustee of a testamentary trust or a beneficiary of the intended beneficiary's (ie the second deceased) estate because the asset was not one which the intended beneficiary owned when they died.

The former Labor Federal Government proposed to introduce measures to allow the intended beneficiary's LPR to access the roll-over where the intended beneficiary died before an asset that the first deceased owned passed to them, regardless of whether it passed first to a testamentary trust trustee. Again, however, the Coalition Government confirmed the amendments would not be implemented.

Arguably, PS LA 2003/12 can be relied on to provide relief in this type of situation.

Image credit: Alan Cleaver cc

Taxation consequences of testamentary trust distributions - Part I

There has been a refocus on what is likely to be the approach of the ATO in this area.

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

In December 2013, the Federal Government announced its decision to abandon a number of proposed legislative changes in relation to various aspects of the taxation of testamentary trusts - see 2013 WTB 53 [2270] and also 2014 WTB 12 [399]. As a result, there has been a refocus on what is likely to be the approach of the ATO in this area.

Part I of this 2-part article considers the taxation aspects of:

• the transfer of assets under a deceased estate;
• distributions from a will maker to a legal personal representative (LPR);
• distributions from a LPR to a testamentary trust.

Part II of this article will focus on distributions from testamentary trusts to beneficiaries and the abandonment of the previously announced legislative changes.

Transfer of assets

On the death of a will maker, each asset of the estate will potentially be transferred 3 times:

• from the will maker to the LPR;
• from the LPR to the beneficiary of the estate, which may be the trustee of a testamentary trust; and
• where the recipient was the trustee of a testamentary trust, from that trustee to a beneficiary either as a capital distribution during the lifetime of the trust or as a distribution of corpus upon vesting.

The CGT consequences of each of the abovementioned transfers must be separately considered.

Distributions from will maker to LPR

The first roll-over to examine is the initial transfer of a deceased's assets from the deceased person to their LPR for distribution under the terms of the deceased's will.

As a starting point, the general position is that, when a taxpayer dies, any capital gain or loss from any event relating to a CGT asset owned by the deceased is disregarded under s 128-10 of the ITAA 1997. This means that the distribution from the deceased to their LPR does not result in a CGT liability for the deceased.

As to the consequences for the LPR, the CGT assets are taken, under s 128-15 to have been acquired by the LPR on the date the deceased died. The cost base of each CGT asset (other than for a property which was a main residence for the deceased immediately before they died) for the LPR is modified under s 128-15(4) so that:

• for pre-CGT assets in the hands of the deceased - the first element of the LPR's cost base (and reduced cost base) is the market value of the asset on the day the deceased died (meaning that pre-CGT assets in the hands of the deceased become post-CGT assets in the hands of the LPR); and
• for post-CGT assets in the hands of the deceased - the first element of the LPR's cost base (and reduced cost base) is the deceased's cost base (or reduced cost base) at the date of their death (i.e. the deceased effectively passes their cost base and reduced cost base to the LPR).

Distributions from LPR to testamentary trust

From a CGT perspective, a testamentary trust is treated much the same as other trusts. However, it should be noted that CGT event E1 does not apply to the creation of a testamentary trust since that event only applies to the creation of a trust "by declaration or settlement".

In the testamentary trust scenario, there is no such declaration of trust and there is no initial settlement sum.

The CGT rules which apply to the distribution from the deceased to the LPR apply in the same manner to subsequent distributions from the LPR to a "beneficiary" of the estate.

It would appear that "beneficiary" for the purposes of the ITAA 1997 includes the trustee of a testamentary trust (however, as will be explained in Part II of this article, for the purpose of Div 128, the trustee of a testamentary trust is also treated the same as an LPR by the ATO), meaning that distributions from an LPR to the trustee of a testamentary trust are treated in the same manner as distributions from an LPR to an individual beneficiary.

A CGT asset is taken to have passed to a beneficiary of a deceased's estate if the beneficiary (or in this case, the trustee of the testamentary trust) becomes the owner of the asset whether under the terms of:

• the deceased's will;
• under the intestacy laws; or
• under a deed of arrangement.

Section 128-15(3) provides that on a subsequent distribution from the LPR to a beneficiary (including the trustee of a testamentary trust), any capital gain or loss that the LPR makes is disregarded.

Again, the trustee of the testamentary trust is taken to have acquired the CGT assets of the deceased at the date of the deceased's death (rather than on the date they were distributed by the LPR) and the first element of the cost base (and reduced cost base) for the testamentary trust trustee will be:

• for pre-CGT assets in the hands of the deceased - the market value of the asset on the day the deceased died; and
• for post-CGT assets in the hands of the deceased - the deceased's costs base (or reduced cost base) at the date of their death.

The testamentary trust trustee is also able include in its cost base any expenditure the LPR has incurred, up to the time of the disposal by the LPR, that the LPR would have been entitled to include in its cost base had it retained the asset.

Until next week.

Image credit: Barbara Agnew cc