One way or another** way to convert water into wine - trust to company rollovers

The vast majority of rollovers available under the Tax Act relate to transactions between companies.

There is however a series of transactions that effectively allows one form of structure to be converted into another.

Following last week’s post, I was reminded of one of the very few rollovers that allows the iteration from one legal structure to another. In particular, the tax rollover available for a discretionary trust that allows a trust to transfer all of its assets into a company, so long as the shares in the company are owned by that same discretionary trust. This form of rollover is available under Subdivision 122A of the 1997 Tax Act.

Obviously, there are stamp duty considerations in many states still that often need to be taken into account, however the rollover can be a very useful one in a wide range of circumstances to ensure no tax is triggered.

We have particularly seen it used proactively as part of a succession plan – it is often seen as easier to facilitate the transfer of shares in a company, as opposed to managing the control of a discretionary trust.

For those interested, our book ‘The Seven Foundations of Business Succession’ explores each of the key company and trust rollover concessions used in estate and succession planning.

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

** For the trainspotters, the title of today's post is riffed from the Blondie song ‘One way or another’.

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Thinking you will let the tax tail wag the dog; plan to play a slow hand**

Last week's post explored the case of Wheatley v Lakshmanan [2022] NSWSC 583, with a focus on the (possible) exception to the rule that a willmaker can only regulate the transfer of assets they personally own under a will.

Another key aspect of the decision related to the tax consequences of the various proposals considered by the court. The potential tax liability was said to be in the region of $1M.

Relying on advice of a specialist tax adviser the court made the following observations (in the context of the implications of a company owned by the willmaker distributing one of its assets to a beneficiary under the will):

1. the estate, for tax purposes, would be deemed to be a trust under section 6(1) of the Tax Act;
2. any payment of any amount by the company to the executor of the estate would be a dividend assessable under section 44 or under Division 7A of the Tax Act - and, if the moneys were paid to the executor who then used them to pay the purported gift under the will, the recipient of the gift would be subject to income tax on a flow through basis;
3. if instead the company distributed to the estate and no particular beneficiary was eligible to receive those moneys, then the trustee would be taxed (at the highest marginal rate) under section 99A of the Tax Act;
4. an argument that the payment by the company to the beneficiary as a form of notional estate order would not constitute a deemed dividend had been rejected by the Tax Office in a private ruling issued before the trial - the Tax Office instead determining that the payment would in fact be treated as a deemed dividend under Division 7A;
5. although not expressly stated in the decision, it seems likely that the relevant private binding ruling in this regard is Authorisation Number 1051799201069. This ruling references Taxation ruling TR 2014/5 (Income Tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate)) in concluding that the reasoning from a family law perspective also applies in the succession law setting, and as such, the requirement in section 109J(b) of the Tax Act to access an exemption from the deemed dividend regime is not satisfied;
6. the use of the word in the gift provision of the will 'unencumbered' was held to be intended to be in its common parlance - that is referring to mortgages or charges secured on the property – not the embedded tax liability. Thus, any income tax liability should be largely ignored by the court in determining the appropriate provision to be made for the aggrieved beneficiary. This conclusion was reinforced by the fact that the tax liability only arose subsequent to the sale of the property, on the distribution of the proceeds of sale - and furthermore the purported gift was held to be invalid in any event.

The court also observed that it seemed likely that tax issues 'overtook' common sense during the litigation and contributed to the high level of legal and accounting costs, which the court stated it was inclined to place a significant cap on in terms of what the estate would be liable to pay for.

The exact cap in this regard was confirmed in Wheatley v Lakshmanan (No 2) [2022] NSWSC 851. In this subsequent decision, the court held that in relation to costs that were over $620,000 for the plaintiff and more than $450,000 for the estate, the estate was ultimately effectively required to pay its own costs and a net amount of $160,000 of the plaintiff's costs.

This outcome was after a careful analysis by the court balancing between depriving the plaintiff of a substantial portion of the legacy ordered in her favour and the estate being further burdened by costs. Given the plaintiff received an award of $820,000 as further provision under the initial judgment, her final net position was likely in the region of $350,000.

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

** For the trainspotters, the title of today's post is riffed from the Pointer Sisters song ‘Slow hand’.

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