Exclusion of settlor and the notional settlor (claws) or clauses** as the case may be

Today’s post looks at the rationale behind excluding settlors and notional settlors of trusts. 

Almost all trust deeds contain a clause excluding the settlor of a trust from being a beneficiary, in order to ensure the trust is not subject to adverse tax consequences as a ‘revocable’ or resulting trust under section 102 of the Tax Act. 

Some deeds, however, take the restriction further by prohibiting distributions to any ‘notional settlor’, in addition to the actual settlor. 

For example, a trust deed may include a provision along the following lines: 
1.1    ‘A person who has transferred property for other than full consideration in money or money’s worth to the Trustee to be held as an addition to the Trust Fund (herein called ‘the excluded persons’), or any corporation in which and the trustee of any settlement or trust in or under which any excluded person has an actual or contingent beneficial interest, so long as such interest continues, is excluded from the class of Beneficiaries.’ 

Where this type of a clause exists, a beneficiary will likely be excluded from receiving distributions, if they have: 

1. made interest-free loans to the trust;
2. sold an asset to the trust at less than market value; or
3. gifted cash or other assets to the trust.

As the main beneficiaries of a trust will have often contributed amounts to a trust in one or more of the ways mentioned above, the risk of invalid distributions being made, where such a clause exists in a deed, are significant and anecdotally we understand this issue is one the Tax Office reviews regularly. 

Generally the inclusion of provisions excluding a ‘notional settlor’ are seen as unnecessary given section 102 only applies to the creation of a trust, not contributions to an already existing trust. 

** for the trainspotters, the title today is riffed from the Elvis Costello song ‘Temptation’.  Listen hear (sic): 

Trust disclaimers – taking the (tax) position** for the trust

Recent posts have looked at some of the key issues to be aware of in relation to disclaimers by beneficiaries of a trust. 

One other critical issue to be aware of relates to the tax consequences of a disclaimer, particularly in relation to any intended income or capital distribution that is disclaimed. 

Where a disclaimer is made before the end of an income tax year, how the amount disclaimed will be taxed will depend on the factual matrix, and will likely result in one of the following outcomes, namely: 

1. If there is a valid default provision, then those default beneficiaries will be taxed (the key concepts in this regard are also explored in a previous post).
2. If the distribution resolution validly sets out a ‘safety net’ distribution if the initial intended distribution fails, then that safety net provision will apply.
3. If neither of the above scenarios apply, then the trustee is likely to be assessed on the disclaimed amount under section 99A of the Tax Act.

Critically, according to the decision in Nemesis Australia Pty Ltd v Commissioner of Taxation [2005] FCA 1273 (this case has also been explored in a previous post) the position in relation to disclaimers made after the end of an income tax year is more clear cut. 

In particular, in Nemesis it was held that as the interest of a default beneficiary only arises at the date of the disclaimer, then if the disclaimer arises after the end of the income year the trustee will be taxed under section 99A. This is despite the fact that the disclaimer itself has retrospective effect back to the date of the purported distribution (ie which will generally be before the end of the relevant income year). 

Where the trustee is taxed under section 99A, a flat rate of tax is imposed at the highest marginal rate. This means there is no splitting of income amongst beneficiaries, access to the stepped marginal tax rates nor the 50% general discount for capital gains on assets owned via trusts for more than 12 months. 

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

** for the trainspotters, the title today is riffed from the Pet Shop Boys song ‘Sad robot world’. Listen hear (sic): 

Sometimes** unit holders do have liability – another lesson from the leading case

Last week’s post featured a detailed look at the decision in JW Broomhead (Vic) Pty Ltd (in liq) v JW Broomhead Pty Ltd & Anor (1985) 3 ACLC 355 with reference to disclaimers. 

Previously the decision has also featured in posts in relation to the fact that a trustee of a unit trust will have a right of indemnity for the liabilities of the trust against both the trust assets and the unitholders, unless this is excluded by the trust deed. 

Where a trust deed is not crafted to exclude unitholder liability the question becomes the basis on which unitholders are liable. That is jointly, or severally. 

Broomhead addresses the question bluntly by confirming (unlike a partnership) the liability is several, capped at each unitholder’s percentage interest in the trust. 

In particular, the court confirmed that there is no justification for treating any one beneficiary as liable to pay the full amount of the trustee's indemnity. The beneficiaries are not jointly entitled to the whole trust fund. Each one is separately entitled to a separate part. 

Thus, the proportionate liability of a separate beneficiary (is) the same as (their) proportionate right to benefit. 

Further, each beneficiary bears the proportion of the trustee’s indemnity for liabilities incurred, correspond(ing) to the proportion of (their) beneficial interest when the liabilities were incurred. (Each unitholder’s) share of liability is limited to that proportion, even though other beneficiaries are not liable to indemnify or are unable through insolvency to meet their liability. 

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

** for the trainspotters, ‘Sometimes’ is a song by Yello. Listen hear (sic): 

How soon is now? ** – effective trust disclaimers

The decision in JW Broomhead (Vic) Pty Ltd (in liq) v JW Broomhead Pty Ltd & Anor (1985) 3 ACLC 355, is arguably most well known for the lesson that in relation to unit trusts, beneficiaries (or unit holders) can be personally liable for the debts of the trust. 

In particular the case confirms the general principle that unless specifically excluded by the trust deed, the trustee of a unit trust will have a right of indemnity for the liabilities of the trust against both the trust assets and the unitholders. 

One of our earlier posts explores this aspect of the decision. 

The decision however is also important due to its comments in relation to arguably one of the most critical aspects of disclaimers (following on from recent posts), namely whether they are made ‘within time’. 

Relevantly the case confirms that the test to apply is ‘whether in the circumstances (a beneficiary) has accepted by words or other conduct or has remained silent for so long that the proper inference is that (they have) determined to accept the interest’. 

The other ways in which the court explained this concept included the following statements: 

1. Acceptance may be presumed unless the donee disclaims the gift.
2. Knowing of the gift, the donee, unless he disclaims it, is ordinarily treated as tacitly accepting it.
3. During the period that the donee remains entitled to disclaim, the gift is treated as vested in the donee subject to repudiation.
4. What is a reasonable time for (a disclaimer) depends on the nature of the property with respect to which it is given and all the circumstances.
5. By remaining silent beyond the time when he would be expected to decline the gift if not accepting it, the donee has tacitly accepted.
6. While there is no limit to the acts which may constitute a disclaimer, an effective disclaimer must be intentional and show unequivocally that the beneficiary rejects the beneficial interest.
7. A disclaimer is to be established by the party alleging it.
8. The consequence of (a) disclaimer … is that in law (the donee) is treated as retrospectively disentitled to the interest declared for (their) benefit in the trust deed (and thus) … freed from all burdens which would have gone with acceptance of the interest.
9. (The donee’s interest is) described as a right "defeasible by the beneficiary's own act of disclaimer”.

While ultimately the test is obviously subjective, it also is clearly based on other disclaimer cases that unless a properly crafted disclaimer is signed within weeks of a beneficiary being made aware of their entitlement it will likely be held to have been made out of time. 

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

** for the trainspotters, ‘How soon is now?’ is a song by The Smiths. View a more recent version by Morrissey hear (sic): 

Sometimes you get kicked** Trust disclaimers … some further lessons

As mentioned in last week’s post, a previous post has explored arguably the leading case in relation to trust disclaimers, being the decision in FCT vs. Ramsden [2005] FCAFC 39. 

The decision in Smeaton Grange Holdings Pty Ltd vs. Chief Commissioner of State Revenue [2016] NSWSC 1594 provides further clarity around the key issues in this regard. 

While the case is primarily focused on payroll tax grouping issues, it does provide an analysis of the key principles in relation to trust disclaimers that are also important for income tax purposes. 

In summary, the case confirms: 

1. No person can be compelled to accept a gift against their wishes. This principle is derived from the leading English case Re Gulbenkian’s Settlements (No.2) [1970] CH408. Again, if you would like a copy of this case, please let me know.
2. A beneficiary of a discretionary trust can therefore disclaim their interests unilaterally by way of deed poll, which means that no consideration needs to be paid.
3. A disclaimer cannot be made however if a person has full knowledge of all aspects of their entitlements and then fails to take steps to make the disclaimer.
4. A person can disclaim their interest in specific entitlements to income or capital of a trust without disclaiming their interest in the entire trust. In this situation, the disclaimer only applies in relation to the specific interest defined in the disclaimer.
5. Alternatively, a beneficiary can disclaim their interest in the entire trust.
6. Disclaimers, once made, operate retrospectively, thereby meaning that the entitlement disclaimed is effectively deemed to have never arisen. Contrast this with a renunciation, which is effective prospectively.
7. A disclaimer or renunciation can be made from time to time in relation to distributions of income and capital in any income year, however if the person is a default beneficiary the disclaimer or renunciation must be in relation to their entire interest.
8. To be effective a disclaimer must be made within a reasonable time period of the beneficiary becoming aware of the distribution. The importance of this aspect can not be understated and will be explored in more detail next week.

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

** for the trainspotters, the title today is riffed from the INXS song ‘Kick’. View hear (sic): 

When amended assessments and trust disclaimers don’t mix**

Last week’s post explored the Yazbek decision. 

One of the critical aspects of the core principle from that decision is the potentially significant adverse consequences that can arise in relation to the Tax Office issuing amended assessments to a taxpayer. 

In particular, any person that is merely a potential beneficiary of a discretionary trust can automatically be subject to a four-year amendment period. 

This is despite the case that they may not even have been aware that they were a potential beneficiary of, for example, a distant relative’s trust. 

This said, where a potential beneficiary is unaware of their beneficiary status, if an amended assessment is issued more than two years (which is the general time limit), but less than four years, the relevant beneficiary may be able to challenge the assessment if they immediately disclaim their interest in the relevant trust. 

A previous post has considered the manner in which an effective disclaimer can be made. 

Next week’s post will further explore some of the key issues in relation to trust disclaimers. 

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

** for the trainspotters, the title today is riffed from the ACDC song ‘Dogs of war’. Listen hear (sic): 

Sometimes** you need to ask: Who are beneficiaries under a trust deed?

Today’s post considers the meaning of ‘beneficiary’, from a tax perspective as confirmed by the Federal Court in the case of Yazbek. 

The decision confirms that a ‘beneficiary’ is not simply a person who, as a matter of fact, has obtained some tangible benefit from the trust, rather a beneficiary is someone who is entitled to enforce the trustee’s obligation to administer the trust according to its terms. 

In other words, anyone named as a potential beneficiary, or a member of a class of beneficiaries (even if not specifically named) will be a beneficiary. 

A comprehensive review of a trust deed should always include an analysis of every variation or resolution of a trustee or other person that may impact on the interpretation of the range of potential beneficiaries. 

Some examples of documents that may impact and the class of potential beneficiaries include: 

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

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

** for the trainspotters, ‘Sometimes’ is a song by Depeche Mode. Listen hear (sic):