Bespoke Corporate Trustee Constitutions

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses some of the key issues in relation to ‘bespoke’ corporate trustee constitutions’ and trust splitting in a ‘vidcast’ at the following link - https://vimeo.com/145236253

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

One of the things that we're spending a lot more time working with is what we loosely call a ‘de facto corporatisation’ or indeed a de facto trust splitting exercise.

In other words, tailoring what would otherwise be a constitution for a shelf company, so as to provide all of the same outcomes that you might otherwise see under a trust split, and embedding those arrangements at least into the company’s constitution, but may be also into the trust instrument itself.

As part of segregating particular assets sitting underneath the trust structure, you can put in place a bespoke or a tailored company constitution, and regulate the way in which directors are appointed to that company, regulate the way in which the shareholders can operate, regulate the way decisions are made in relation to particular assets sitting down inside the trust.

If you actually contractually go and put that into the terms of the constitution, what you can effectively have is, for example, if you're talking about this in an estate planning context, kid 1 controlling part of the trustee company, and giving kid 1 complete autonomy over decisions in relation to assets that are related to that part of the trustee company.

You can then have kid 2 likewise in relation to another control part of the structure and so on.

Alternatively, many people will only look to regulate control in relation to the trustee company.

So they’ll say look, we'll put in place voting requirements, we'll say that one kid has a super vote, or we'll actually appoint an independent board to that company and regulate how those decisions might be made, and this will be an overall strategy for the trust at the trustee company level.

Challenging a Will due to Existence of Mutual Wills

A recent post listed the five main ways in which a will can be challenged – see 'Ways to contest a will'

One of the aspects listed was that wills are always subject to any contractual arrangements that a will maker may have entered into before their death.

One particular approach that is used from time to time is the concept of creating 'mutual wills'.

Essentially, a mutual will is a contract whereby two people agree to make their wills in a certain way and to then not change the document without the express consent of the other party to the agreement.

Traditionally, mutual wills are made between spouses, often where one or both of the spouses are in their second or subsequent life relationship. Alternatively, mutual wills can be implemented where there are particular assets in the estate that both spouses want to ensure are dealt with in a particular way, regardless of when they may each die.

The creation of a mutual will, if crafted correctly, can allow a party who would otherwise have received a benefit, but for a person entering into a new will in breach of the mutual will, to sue on the basis of a breach of contract.

While in theory, litigation for the breach of contract should be easier to succeed in, there have been a number of cases that have seen attempted mutual will arrangements fail.

Furthermore, the significant inflexibility created by mutual wills mean that most specialist advisers caution against their use.

New Financial Year; new small business roll-over in play

With the new financial year underway, the roll-over provisions under subdivision 328-G are now available to small business entities to restructure without adverse capital gain tax (CGT) consequences.

The rules significantly increase the flexibility to restructure businesses, particularly as part of an estate planning exercise.

This post considers the eligibility requirements for accessing the roll-over. A previous post has considered in detail a number of the main opportunities available under the provisions, see - 'Tantalising opportunities for trust restructures under new Subdiv 328-G'

Unlike other CGT roll-overs, the provisions allow direct roll-over of non-CGT assets such as trading stock, depreciating assets and revenue assets. The provisions do not however provide any relief in relation to related transaction costs such as GST or stamp duty.

Eligibility

The concessions are available to small business entities being individuals, companies or trusts whose annual turnover is less than $2M.

In order for the roll-over to apply, the following criteria must also be met:

1. the CGT asset must be an active asset; 
2. an election must be made; 
3. the transferor and transferee must be Australian residents; 
4. the transactions must not change the ‘ultimate economic ownership’; and 
5. the transferee cannot be an exempt entity (for example, a superannuation fund). 

The definition of active asset includes captures all assets used in a business except for company loans to shareholders and unpaid present entitlements which cannot be transferred under the provisions.

Ultimate Economic Ownership and Discretionary Trusts

The rules require that each relevant individual’s interest in the assets of the business remain in proportion after a restructure. Tracking economic ownership when using the provisions to transfer assets from an individual to a company, or from company to company is relatively easy.

Given the nature of a discretionary trust, where beneficiaries do not have a direct interest in the trust assets, the provisions set out how to determine whether ultimate economic ownership is maintained.

In particular, the rules create a ‘safety net’ test that allows access to roll-over relief if a trust has made (or makes) a family trust election. Where such an election is made, it effectively limits the range of potential beneficiaries who can receive a distribution without triggering a penal tax consequence (being the family trust distribution tax).

Integrity measures and the safe harbour rule

Given the very broad potential application of the provisions a discrete integrity measure has been included.

In particular, there is the requirement that any transaction is a 'genuine' restructure of an ongoing business.

While ‘genuine’ is not itself defined, a transaction will be deemed to fall within a safe harbour under the rules if for three years after the relevant restructure:

1. there is no change in the ultimate economic ownership of significant assets; 
2. the significant assets transferred continue to be active assets; and 
3. the significant assets transferred are not used for personal purposes. 

Conclusion

The 328-G concessions are arguably the most comprehensive CGT roll-over provisions introduced since the commencement of CGT. The new rules will provide small business entities with a myriad of restructuring opportunities.

View Legal will be live streaming a webinar on 21 July 2016 covering everything you need to know about the new small business roll-over rules.

For more information about the webinar and your opportunity to register, see the link below - https://viewlegal.com.au/product/webinar-small-business-rollover-rules/

The webinar will explore all technical aspects of the provisions and use numerous case studies, including:

1. what constitutes a ‘genuine restructure’; 
2. using trust cloning and trust splitting as a restructuring method;
3. restructuring heritage trusts with proximate vesting dates or limited variation powers; 
4. how to restructure from a sole-trader to a company owned by a family trust; and 
5. other planning opportunities.

Image courtesy of Shutterstock

The firm of the future is in fact the firm of now

For those that do not otherwise have access to the ALPMA post feed, a recent article by View is extracted below.

The evidence has been collected.

The submissions have been heard.

Judgment has been handed down - the incumbent law firm business model is broken.

The great lawyer bubble

One of the first people to starkly address the fundamental problems at the heart of the legal profession was Stephen Harper and his book 'The Lawyer Bubble'.

The book details why the legal profession, similar to most other professions, will struggle in the short term to reinvent core aspects of their business model, particularly in relation to time billing, in the short term.

While a myriad of reasons are provided, perhaps the most compelling is the fact that universities across the western world have become factories for producing professional service firm graduates, who specialise in the areas rewarded by time billing such as:

• long hours;
• rote learning;
• technology adverse; and
• engrained arrogance, particularly in relation to solutions that undermine the traditional personalised bespoke service offering (such as alternative business models, offshoring, outsourcing and automation).

Catalysts for change
Harper argues that any change to the 'BigLaw' business model from within the profession will require the university system to start rewarding students who are able to demonstrate more innovative attributes than those outlined above.

Just as importantly, the owners of the incumbent firms must themselves create a demand for this style of graduate.

Another leading thinker, Clayton Christensen (in The Innovator's Dilemma), predicts that the prospect of the incumbent firms having the vision to truly cannibalise their existing business model is at best remote.

Maister still matters
While much of Harper’s work was ground-breaking at the time, the framework for many of the answers to what law firms should be doing right now to re-engineer their businesses was provided a generation ago by another US consultant, David Maister.

Maister categorised the delivery of all professional services, including the law, into four broad categories, each of which has the prospect of being highly profitable.

The price is right
The price sensitivity goes from least to most through the following four components:

• unique services (or as Maister describes them ‘brain surgery’);
• experiential services (or as Maister describes them ‘physiotherapy’);
• brand name services (or as Maister describes them ‘nursing’);
• commodity services (or as Maister describes them ‘chemist’).

Arguably, due to the internet, there are two further categories further down the value chain:
wholesale; and
online, with product produced only on demand.

Ultimately, the internet has increased the rate at which all technology disruption has historically taken place.

What the winners do

Winning firms understand that success ultimately depends on being:

• differentiated or unique;
• of demonstrable value; and
• delivered in a way that is difficult to replicate.

Sustaining innovation is ultimately just as important as any disruptive one; the challenge is that both types require different visions, metrics and practices.

The disruptive business model requires funding, resource allocation and working environments that are significantly different from those of the traditional firm.

History doesn’t repeat; although it does rhyme
History shows the vast majority of traditional firms are unable to allocate resources away from the primary revenue source, because of their focus on short-term profitability and the need to avoid any perception that there is a 'cannibalising' of the core business model.

The key to a sustainable and successful business model is being self aware enough to know that unless they cannibalise their existing lines of revenue, competitors certainly will. Further, those competitors will have complete disregard for the ongoing profitability of the incumbent firms.

Primarily due to the embedded restraints of being a start up, innovative firms find ways to:

• monetise ideas quickly;
• minimise upfront cash expenses;
• understand that a product in market is always better than a delay to launch in order to ensure the quality is better - in other words, if you are not embarrassed by version 1 of the solution, you have launched too late;
• recycle and reuse what they have immediate access to; and
• understand that everything can look like a failure during the 'middle part'.

What will the changes look like?
To give some insight to what we believe a ‘firm of the future now' looks like, 10 examples from our business are listed below – five that we have abandoned and five that we have embraced.

Five things abandoned

• Timesheets – with timesheets, all we ever focused on was what was chargeable – without timesheets, we now focus on what is valuable.
• No leave policies – leave policies are a hangover from the industrial age – it is time to move on.

• No individual budgets – while we certainly have team goals, these are never broken down into individual monetary targets. Our targets are aligned around our performance in the eyes of customers. If we get those right, everything else flows (including money).
• No performance reviews – again, a very poor hangover from the industrial age.
• No diversity goals – seeking to mandate minimum percentages of certain genders, cultures, religious beliefs or sexuality disguise much bigger problems with the underlying business model.

Five features embraced

• Guaranteed fixed pricing – the definition of a competent service provider is someone who can devise a scope of work and provide an upfront fixed price that they are willing to refund in full if the customer is not satisfied with the performance.
• ROWE – if you do not know what this is, Google it or see - https://en.wikipedia.org/wiki/ROWE and join the movement.
• Solution choreographed teams – we work with whomever and on whatever terms are best to achieve the client’s objectives.
• AAR – again, if you do not know what it is, Google it or see - https://en.wikipedia.org/wiki/After-action_review and embed it into your business today.
• Diversity of thought – when two people in business are constantly of the same opinion, one or more is irrelevant. Raise diversity in every sense of the word and arbitrary politically correct percentages become irrelevant.

As mentioned in previous posts, we began the journey to address many of the challenges of redefining the professional services firm business model over 10 years ago.

For many, the journey has started more recently and we believe it important to share our learnings.

In this regard, there is still time to register for our upcoming Roadshow that will be a full day example of our contribution in this space.

Download the brochure.

Watch the promo video below.

Later in the year, we are excited to be presenting at the 2016 ALPMA Summit, A Blue Print for Change, 7-9 September in Melbourne – see -http://www.alpma.com.au/Summit

Your free access to our white paper on PSF innovation

It is exciting to confirm the release of our professional service firm innovation white paper.

Titled – ‘How I learned to stop building faster horse carriages and love disruption’, the release is with the support of LexisNexis.

To access a free copy of the 3,000 word white paper click here - http://lexisnexis.com.au/media-centre/blog-articles/2016-June-17-How-I-learned-to-stop-building-faster-horse-carriages-and-love-disruption

As mentioned in previous posts, we began the journey to address many of the challenges of redefining the professional services firm business model over 10 years ago.

For many, the journey has started more recently and we believe it important to share our learnings.

In this regard, we are excited to be presenting at the 2016 ALPMA Summit, A Blue Print for Change, 7-9 September in Melbourne – see http://www.alpma.com.au/Summit

Before then, there is still time to register for our upcoming Roadshow that will be a full day example of our contribution in this space.

Download the brochure.

Watch the promo video below.

Vesting Dates and Trust Distributions: measure twice; cut once – read the deed … and then some

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

As previously reported by us in the Weekly Tax Bulletin, there are a range of issues often overlooked in relation to trust distributions (see 2014 WTB 43 [1426]) and extensions to vesting dates (see 2014 WTB 44 [1446]). Rarely, however, do these issues arise together in the same factual scenario.

In the lead up to another 30 June, the decision in Domazet v Jure Investments Pty Limited [2016] ACTSC 33 (7 March 2016) is a timely example of the problems that can arise when a deed is not carefully reviewed before trust distributions are made.

The decision

In summary, a Family Trust was settled in the ACT on 1 April 1980. The Family Trust deed gave the trustee the power to nominate additional beneficiaries, including trusts, so long as the vesting date of the other trust was not longer than that of the Family Trust.

In 2009, a new trust (referred to as the "Finance Trust"), which was part of the same family group was purportedly appointed as a general beneficiary of the Family Trust.

The Family Trust had a cascading optional perpetuity period, which the parties wrongly interpreted as allowing the vesting date to be 80 years from the date of settlement. In fact, the Family Trust vesting date was 21 years after the death of King George VI's living issue as at 1 April 1980.

The Finance Trust, established in 2005, was set to vest either upon the election of the Trustee or a maximum of 80 years from settlement, making it prima facie ineligible. In an attempt to ensure the Finance Trust was an eligible beneficiary of the Family Trust, the vesting date was then amended to be one day before 80 years from 1 April 1980 (ie 31 March 2060).

Practically speaking, this meant that in order for the Finance Trust to be an eligible beneficiary of the Family Trust, it needed to be absolutely certain that at least one of King George VI's living issue in 1980 would still be living on 31 March 2039 (that is, 21 years before 2060), which the Court thought was possible, but not absolutely certain. This meant the appointment of the Finance Trust as a general beneficiary was invalid.

It appears from the decision that a number of capital distributions were purported to be made after the Finance Trust was invalidly appointed as an additional beneficiary. The invalid appointment meant that the distributions made to the Finance Trust would have been done in breach of trust. Furthermore, the invalid distributions would have also caused adverse tax consequences for the parties. This seems to have been a potential issue because the ATO had made submissions as part of the proceedings.

Perpetuity rules

It is critically important to not just read the deed, but also specifically consider which perpetuity rules apply. The difficulties arose in this case because amendments to the rule against perpetuities were progressively rolled out throughout Australia. The advisers which prepared the documents had wrongly assumed the ACT rules, which came into effect on 18 December 1985 (after the Family Trust was settled), were implemented at the same time as the Queensland rules were introduced (1 April 1973).

In this respect, the earliest change to the rule against perpetuities occurred in Victoria in 1968, whereas Tasmania only introduced new rules in 1992. When reviewing trusts which span between these dates, it is therefore critically important to firstly determine the trust's governing jurisdiction, but also consider which perpetuities rules apply.

Some possible workarounds

With the aid of hindsight, there were a number of alternatives that could have avoided the outcome that the parties ultimately faced: a substantive trust to trust distribution being invalid. In summary, the other alternatives that could have been adopted include:

1. The vesting date of the recipient trust could have been amended to provide that - notwithstanding any other provision of either trust instrument, it would automatically vest on or before the date of the distributing trust.
2. The requirement in the distributing trust that the recipient trust needed to vest before it could have simply been deleted. While it still would have been necessary for the recipient trust to have ultimately vested by the date of the distributing trust, it would have been possible to rely on the 'wait and see' rule rather than the distribution being void immediately on the date that it was made.
3. Depending on the factual matrix, the distributing trust could have made a distribution directly to the ultimate intended beneficiaries, even if that may have required a variation to the trust instrument (and thereby avoid the need to distribute to an interposed trust).

In any of the above cases, again with the aid of hindsight, a private ruling could have been sought from the ATO, or indeed a declaration from the Court could have been obtained. While both of these approaches obviously create significant time delays and cost exposure where (as here) there are significant funds at risk, these additional costs can be an appropriate investment.

In regards to the "wait and see" rule, the approach to be taken was summarised in the case of Nemesis Australia Pty Ltd v FCT [2005] FCA 1273 (14 September 2005) (reported at 2005 WTB 40 [1638]). The case confirmed that the "wait and see rule" in each jurisdiction can be relied on in a situation where a trust distributes to another trust with a later perpetuity date.

The "wait and see" rule means the initial distribution will not be void when made, and will not become void until such time as there is a failure to distribute out of the recipient trust before the vesting date of the original distributing trust.

Rectification

The final main alternative to the issues faced in this case, which was the one ultimately adopted, was to seek rectification of the documentation from the Court.

The case provides a very detailed analysis of the way in which the rectification rules work, including heavily quoting Dr Spry, who has been featured prominently in trust related areas, both for his academic writing and his legal challenges in a personal family law dispute (see Kennon v Spry (2008) 238 CLR 366 (reported at 2008 WTB 51 [2303]).

Ultimately, although with some reservation, the Court did rectify the relevant documents to essentially adopt the approach outlined at paragraph (a) above. While it cannot be certain, it is likely that the rectification order settles a number of the potential taxation consequences resulting from what would have otherwise been invalid distributions.

Pace of change an issue for incumbent professional service providers

Previous posts have looked at various aspects of the radical change sweeping through the professions.

Generally, the four main areas where disruptors, innovators and incubators tend to focus their attention are:

1. unchallenged orthodoxies - the parts of a business model that have remained unchanged and are assumed by industry players to be non-negotiable


2. unappreciated trends - things that are happening in other unrelated industries that have not been embraced more widely


3. unleveraged competencies - a focus on what the business knows as opposed to what it does can create new value propositions


4. unarticulated needs – a focus on the '5 Whys' and 'What job is to be done?'.

As Jack Welch has explained, firms are at significant and potentially irretrievable risk when the rate of internal change is slower than the pace of external change.

True incubators understand that plans for the future must simply be plans for learning. In other words, plan to be wrong - and then learn how to be right as fast as possible.

A new solution must always be simple, reliable and convenient. It will always be delivered at lower margins - the profits will follow as market share is secured.

As the solution is generally only valued by the least profitable customers, a firm that chooses simply to listen to its best customers to identify new products essentially ignores all forms of disruptive innovation and, in turn, essentially ensures that it will fail the innovator's dilemma test.

This means there is a very strong first mover advantage as the incumbents effectively ignore the disruptive model until it is too late.

As mentioned previously, we began the journey to address many of the challenges of redefining the professional services firm business model over 10 years ago.

For many, the journey has started more recently and we believe it important to share our learnings.

In this regard, we are excited to be presenting at the 2016 ALPMA Summit, A Blue Print for Change, 7-9 September in Melbourne – see -http://www.alpma.com.au/Summit

Before then, our upcoming Roadshow will also be a full day example of our contribution in this space.

Download the brochure.

Watch the promo video below.

Image courtesy of Shutterstock