The most important tax tip for family law matters you will learn this week

As set out in earlier posts, and with thanks to the Television Education Network, today’s post considers the above mentioned topic in a ‘vidcast’ at the following link - https://youtu.be/XZx3PozjtTg

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

If you go back many years to the introduction of the Division 7A regime in the late 1990s, early 2000s, one of the anti-avoidance provisions that they brought in was ultimately set out in subdivision EA of the Tax Act.

These rules said regardless of any other provisions, if a distribution was made out of a trust and it was left as an unpaid present entitlement (UPE) to a company and there was then a debit loan made by the trust, that debit loan has to comply with the Division 7A rules.

In this type of situation, some advisers try to argue that if the funds are lent out for income generating purposes and the interest on the debt is deductible, then the loan is not caught by Division 7A. The reality however is that the loan is a significant tax problem.

In this particular case study scenario, there were two key problems. Firstly, there was an EA problem because the trust had made debit loans when there were UPEs to a corporate beneficiary. In addition to the EA loans, there had been purported distributions by the trust to the wife over many years.

However, the wife was not a beneficiary.

So not only was there the big EA problem, there also had been a whole raft of distributions over many years that were completely invalid on the face of the trust instrument.

Ultimately, the parties entered into a settlement where the husband took over control of the trust, the wife got paid out all of her loan accounts, and was entitled to keep all of the historical distributions.

Now the interesting aspect is that the wife and her family lawyers asked for a tax indemnity in relation to both the failure to comply over the years in relation to EA and the inability to read the deed and thus the invalid distributions to the wife.

Then, three months after the wife had been paid out, the husband by chance gets a tax audit. The wife didn’t have to worry about the outcome of the tax audit because she was fully indemnified.

How long can deceased estates run?

A recent post looked at the requirement that following the death of a member, an SMSF must ensure that it pays a member’s death ‘as soon as practical’ (see - How soon is now ** (or ‘as soon as practicable’)?)

Following last week’s post in relation to the liability of executor’s for a deceased’s tax debts, one related issue is worth considering – namely - how long can a deceased estate remain in ‘administration mode', following someone’s death?

Assuming there are no complications with the deceased estate due to, for example, a challenge against a will, it is generally the case that the Tax Office accepts a maximum period of three years for an estate to be administered.

The administration of the estate, from the Tax Office’s perspective involves the ultimate distribution of assets to beneficiaries if there is no formal testamentary trust under a will, or the distribution of assets to a testamentary trust if the deceased has incorporated that into their will.

This effectively means that for the purposes of the excepted trust income rules (these are the rules that allow children to be treated as adults for tax purposes), all wills contain a form of testamentary trust.

Where the will provides for the assets to pass directly to beneficiaries, the length of time the ‘testamentary trust’ lasts for tax purposes will be equal to the maximum period of time it takes to administer the estate. In contrast, where a traditional testamentary trust is established, the standard vesting date rules for trusts apply (broadly up to 80 years from the date of death).

It is important to note that while the Tax Office allows a maximum of three years, often they will in fact expect that the deceased estate is administered within 12 months from the date of death, and therefore may deny access to the excepted trust income provisions despite the fact that the estate has not been fully administered.

The Tax Office has confirmed its broad position in this regard via taxation ruling IT2622. As usual, if you would like a copy of the ruling please contact me.

The above post is based on an article originally published in the Weekly Tax Bulletin.

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At last some tax clarity for legal personal representatives of deceased estates(?)

Practical Compliance Guideline 2017/D12 (PCG 2017/D12) contains guidance from the ATO in relation to the liability of an executor or legal personal representative (LPR) of a deceased estate for the deceased’s tax debts.


Background

Historically, the leading decision in this area has been seen as the case of Barkworth Olives Management Ltd v DFCT [2010] QCA 80 (Barkworth).

Broadly Barkworth acknowledged that, subject to some limitations (such as the application of s 99A ITAA 1936), the trustee of a trust has a right of indemnity for trust tax debts and under s 254 ITAA 1936 is generally not personally liable for those debts.

In the context of a deceased estate, this means the LPR will generally not be personally liable for the deceased’s tax debts.

Personal liability will however arise (to a maximum of the original assets in the estate) where the assets of the estate have been fully distributed, or distributed to an extent that means there are still unsatisfied tax debts outstanding.

In contrast, if a tax debt arises during the course of the administration of the deceased estate, the LPR can automatically be personally liable, regardless of the assets in the estate.

Importantly, beneficiaries of deceased estates can never be liable for the tax debts of the deceased, unless there has been fraud or evasion.

Historically, where an LPR was concerned that there may be taxes that they might ultimately be personally liable for, best practice was to obtain clearance from the ATO that there were no outstanding tax liabilities. However, the ATO no longer issues letters of clearance.

Therefore, if there are genuine concerns that the ATO may audit the estate, then the conservative approach is generally for the LPR to retain sufficient assets to cover any possible tax liability for either two or four years (depending the nature of assets in the estate and therefore the potential audit period) following the lodgement of the final tax return for the deceased.

Practically, in this type of situation it therefore means that the estate can only be fully administered and final lodgements made to the ATO after the two or four year period has lapsed. This is because until the final notice of assessment has been received by the LPR (listing no outstanding amounts owing by the estate), they are not relieved of personal liability.

This conclusion also relies on the assumption that there is no fraud or evasion involved, as if there is, the ATO is not restricted by time limits on the ability to issue amended assessments.


PCG 2017/D12 – Overview

PCG 2017/D12 is broadly consistent with the approach outlined above, although (as is often the case with this style of release from the ATO) there some important caveats.

In particular, the guidelines outline the circumstances where the LPR will be treated as having notice of a claim or potential claim by the ATO, which could result in personal liability should the assets of the estate be distributed without leaving sufficient funds to discharge the ATO claim.

The ATO adopts the view that the LPR will have a notice of the claim (or potential claim) where:

• the deceased had amounts owing to the ATO at the date of their death (including any additions to those amounts such as interest); 
• the deceased had an outstanding assessment from an income tax return which had been lodged but not yet assessed by the ATO; 
• the ATO notifies the LPR within 6 months of the lodgement of the deceased’s last return that it intends to review the deceased person’s tax affairs; or 
• further assets come into the hands of the LPR after what was thought to be completion of the estate’s administration (the ATO takes the view that the identification of further assets might suggest the deceased’s income was understated previously). 

In each of the above circumstances, the LPR should take a conservative approach and delay the distribution of some or all of the estate assets, until the estate’s potential tax exposure can be quantified.

‘Smaller and less complex estates’

Arguably the most significant caveat with PCG 2017/D12 is that it is expressly stated to only apply to ‘smaller and less complex estates’.

Assuming an estate satisfies the concept of being ‘smaller and less complex’, PCG 2017/D12 confirms the basis on which a wind up can proceed without concern that the LPR’s personal assets may be exposed to a claim by the ATO.

In particular, the following elements must all be present:

• in the 4 years before their death the deceased did not carry on a business or receive distributions from a trust; 
• the estate assets consist solely of shares or interests in widely held entities (such as public companies), superannuation death benefits, Australian real property, cash and personal assets; 
• the total market value of the estate assets was less than $5 million; 
• none of the circumstances outlined earlier in this article where the LPR is deemed to have notice of the claim (or potential claim) arise; 
• the LPR acted reasonably in lodging the deceased person’s outstanding returns; and 
• the ATO has not given the LPR notice that it intends to examine the deceased person’s tax affairs within 6 months from the date of lodgement of the last outstanding return. 

Conclusion

As a result of PCG 2017/D12 (and assuming the draft guidelines are issued in final form on broadly similar terms), it should be possible for smaller and simpler estates to be wound up in a shorter period of time, without the LPR creating personal exposure in relation to tax debts.

While the guidelines are a welcome initiative in a fast growing area for many adviser practices, they also highlight that where clarity is most needed – that is larger and more complex estates – significant risks remain for LPRs.

Any person currently an LPR, or considering accepting an LPR role, in situations outside the scope of PCG 2017/D12 should continue to proceed with caution in relation to tax debts.

The above post is based on an article originally published in the Weekly Tax Bulletin.

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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 see - http://viewlegal.com.au/product/the-seven-foundations-of-business-succession/

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Converting water into wine (or family trusts into fixed trusts)

Recent posts have considered various aspects of fixed trusts, see - Unit trusts and fixed trusts.

For a myriad of structuring issues, one issue that appears to be raised more regularly is whether it is possible to convert a family discretionary trust into a fixed trust.

This issue was considered by the Tax Office in Private Ruling Authorisation Number: 1012991136582. As usual, if you would like a copy of the ruling please let me know.

Broadly the factual matrix was as follows -

1. a 'standard' family trust held an asset; 
2. the trust had a widely crafted power of variation; 
3. the trustee resolved to make a capital distribution of the balance in the unrealised capital profits account to certain beneficiaries, with this amount left unpaid (ie meaning it was a debt owed by the trust to the beneficiaries); 
4. by agreement there was then a conversion of the debts (and some other outstanding loans) to equity such that each of the relevant beneficiaries had a certain percentage of ‘equity’ in the trust; 
5. relying on the power to vary, the trustee then amended the terms of the trust deed to convert it into a fixed unit trust. 

After analysing the provisions of its Tax Determination in relation to resettlements (namely TD2012/21, see our previous post that explores this - ATO releases draft determination on trust resettlements) the Tax Office confirms that so long as the amendments are within the powers of the trust deed, the continuity of the trust will be maintained for trust law purposes.

This is because the ultimate beneficiaries of the trust after the proposed amendments would be the individuals who were the objects of the trust before the variation. The fact that the extent of the interests of the beneficiaries in the trust change as a result of the variation was seen as irrelevant.

Therefore, the amendments to the terms of the trust did not trigger capital gains tax (CGT) event E1 or CGT event E2, being the 'resettlement' CGT events.

CGT event E1 happens if a trust is created over a CGT asset by declaration or settlement.

CGT event E2 happens if a CGT asset is transferred to an existing trust.

The Tax Office further confirmed that CGT event E5 was not triggered by the conversion of a family trust to a fixed trust.

CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee despite any legal disability of the beneficiary.

CGT event E5 does not however happen if the trust is a unit trust and thus this exemption was held to apply here.

The Tax Office also confirmed that there are no other CGT events that happened when the family trust was converted into a unit trust. This is because the amendments were within the trustee's powers contained in the trust instrument. This means that the continuity of the trust was maintained for trust law purposes.

The above post is based on an article originally published in the Weekly Tax Bulletin.

Turning comments into wine and books



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All those who interact with the post this week with any comments or likes on LinkedIn will go into the draw to win a bottle of View wine (which we are excited to confirm is now drinkable) or a paperback copy of our workbook ‘40 Forms of Trusts’.

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Fixed trusts – what exactly are they?

A recent post explored some threshold issues around the distinctions between unit trusts and fixed trusts (see - Unit trusts and fixed trusts).

Whether a unit trust is in fact a fixed trust is an area that has been the subject of significant uncertainty.

In 2016, the Tax Office did release Practice Compliance Guidelines on its view of what is a fixed trust. Unfortunately, the release by the Tax Office is problematic for at least three reasons, namely:

1. it only considered the meaning of ‘fixed trust’ for the purpose of the trust loss provisions under the Tax Act; 
2. the drafting approach of the Tax Office is non-definitive; in other words the Tax Office confirms it will retain the discretion to deem a trust not to be fixed despite what it sets out in the guidelines; 
3. furthermore, the guidelines are not themselves binding on the Tax Office. 

Subject to the above comments, broadly it seems to be accepted that the following factors will be relevant to supporting that a trust is a fixed trust: 

1.  the trustee cannot create different rights or different classes of units; 
2. all units on issue must have the same rights to receive income and capital of the trust; 
3. units must be allotted for market value; 
4. all income and capital of the trust must be distributed in proportion to the unitholdings, i.e. there is no discretion held by the trustee; 
5. partly paid units cannot be issued; 
6. the trust deed requires all unitholders to agree on the redemption of units and any redemption must be at market value; 
7. all valuations of the trust fund, and in turn the determination of unit values, must be conducted by a valuer in accordance with ‘applicable Australian accounting principles’; 
8. the trustee cannot make gifts;
9. the unanimous consent of all unitholders is required to vary the trust deed and the variation power should prohibit amendments to any of the above provisions.

The above post is based on an article originally published in the Weekly Tax Bulletin.

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Tyre pumping, timesheets and The Force

Last week’s shout out to #oldlaw (or #BigLaw as the case may be) and #burningtimesheets caused a significant amount of discussion.

Some will recall our long held view (no pun intended) that if you are not part of the solution, you are part of the problem* – particularly in relation to sustainable business models for professional service firms.

Creating a #timeless solution was a key foundation for the launch of View 3 years ago this week.

The #starwars inspired 90 second video we created to explain our vision can be viewed (again no pun intended) here – https://youtu.be/g965Sz8n9uc

Best wishes for the new financial year ahead, particularly if you have suddenly been asked to be somewhere between 5% and 23.6% (depending on your firms definition of current CPI rates**) more valuable to your customers …

* For trainspotters this is the Eldridge Cleaver (of Black Panther Party fame) quote

** For trainspotters the actual CPI in Australia over the last year is somewhere around 1%-2%