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

What strategies are there available to protect at risk beneficiaries?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘What strategies are there available to protect at risk beneficiaries?’ at the following link - http://youtu.be/Joz2vYxhcDY

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

The obvious solution is to try to minimise the number of distributions that go to the at risk beneficiary. That’s obviously a lot easier said than done. Particularly from a tax perspective, there is a bias towards making sure that the income does flow out to an individual beneficiary, particularly if there's a capital gain to be distributed.

Leaving that to one side, there are other ways to manage it, the biggest one seen in practice is making sure that the recipient beneficiary is themselves not exposed.

The classic example would be using a corporate beneficiary or company as the recipient. In that scenario, it's important to remember that the ownership structure of the shares in that company is going to be vital.

You don’t want to create a situation where even though the beneficiary exposed doesn't directly have the asset or the income distributed to them, they're the shareholder of the company, which is the recipient beneficiary. The risk is that the wealth is effectively in just as exposed a position as it would have otherwise been.

Until next week.

What are the exceptions to the assets of a testamentary trust being protected?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘What are the exceptions to the assets of a testamentary trust being protected?’ at the following link - http://youtu.be/BzC3jFYyWp4



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

The main exception that comes up in a practical sense is primarily for tax reasons where distributions have gone down to an at risk beneficiary out of the trust and then those amounts remain unpaid, so they become an unpaid present entitlement or they become a credit loan on the balance sheet of that trust.

In that scenario, obviously, if the at risk beneficiary gets into strife and a trustee in bankruptcy is appointed, even though the asset is ultimately inside the trust, that trust has the obligation to repay the debt and the asset effectively comes out sideways in that scenario.

There are however a myriad of other reasons that trusts can be at risk. Some of the obvious ones include where the at risk beneficiary fulfils a really important role in the trust, whether that be an individual trustee, a director of a corporate trustee, a shareholder of a corporate trustee, or perhaps most relevantly, where the at risk beneficiary fulfils the role of an appointor.

Until next week.

DVD wills

While not as quickly as other areas of the community, the legal industry is starting to embrace technology changes.

One case that highlights the point is Mellino v Wnuk & Ors [2013] QSC336. As usual, a link to the full decision can be found here. [http://archive.sclqld.org.au/qjudgment/2013/QSC13-336.pdf#!]

In summary, the critical aspects of this case are as follows:

1. a deceased man, who had committed suicide, had made a DVD shortly before his death;
2. on the physical copy of DVD, the man had written 'my will';
3. the content on the DVD also, in a very informal way, explained the intention that the recording was to operate as a will on death;
4. the court decided that each of the main requirements from a succession law perspective had been satisfied and therefore the DVD could operate as the deceased’s last will;
5. the three main tests in this regard were as follows:
1. the DVD was considered to be a 'document';
2. the clear intention of the document was that it articulated the deceased's testamentary intentions; and
3. the DVD adequately dealt with all property owned by the deceased at the date of his death.

Until next week.

Accelerated superannuation contributions

There is nothing certain in life but death and taxes… and adjustments to the limits for superannuation contributions.

Again this week we have had an article featured in the Weekly Tax Bulletin. This time it is by fellow View Legal Director Tara Lucke and I and is extracted below for those who do not otherwise have easy access.

If is often said, there is nothing certain in life but death and taxes… and adjustments to the limits for superannuation contributions. In recent times, particularly given the ongoing adjustments to the limits for concessional superannuation contributions, the way in which to maximise contributions has been an area of focus.

Overview

As is well understood, concessional contributions to superannuation can generally be made by:

• an employer of a member;
• a member; and
• the spouse of the member.

The rules in relation to the quantum of permissible concessional contributions (historically referred to as deductible contributions) have been subject to regular change. The changes have primarily focused on the dollar limit for contributions made in each financial year.

Concessional contributions which currently count towards the annual concessional limit include:

• all employer contributions (eg super guarantee, salary sacrifice);
• member contributions which are claimed as a tax deduction; and
• in some situations, allocations from any fund reserves.

Concessional contribution limits

The maximum amount of concessional contributions that may be paid for the 2014-15 year of income without being subject to excess contributions tax were confirmed at 2014 WTB 9 [286] as follows:

• $30,000 per annum per person aged under 49 years on 30 June 2014;
• $35,000 per annum per person aged 49 years and over on 30 June 2014.

These limits have been increased, by way of "stepped" indexation, for the first time since the current contribution limit regime was introduced and are unlikely to be indexed again for at least 3 years.

Non-concessional contribution limits

Subject to potential variations by adopting one of the accelerated contribution approaches explained below, the maximum non concessional limits for the 2014-15 year of income (without being subject to excess contributions tax), have also been increased for indexation and are now as follows:

• $180,000 per annum per person (for contributions on or after 1 July 2014); and
• $540,000 per person averaged over three years (if a 3 year contribution was started before 1 July 2014, then the limit remains $450,000).

Accelerated contributions

Historically, when the per annum limit was capped at $150,000 (and the 3-year average at $450,000), the main strategies available in relation accelerating contributions have been best exemplified by the following table:

In relation to the above table (and the further table below), it is important to note the following assumptions:

1. contributions are made prior to member's 65th birthday; or
2. contributions are made after reaching age 65 and the member continues to satisfy the required gainful employment test.

With the changed superannuation thresholds commencing on 1 July 2014 (again as noted at 2014 WTB 9 [286]), it will be important to reference an updated version of the table, as set out below.

Critically, the updated table assumes that the first contribution is made after 1 July 2014.

As set out in the earlier article, if a combined contribution is commenced before 1 July 2014, the previous table continues to apply until the accelerated approach is completed.

As a comparison of the 2 tables clearly illustrates, in many client situations there will be a significant differential in delaying non concessional contributions until 1 July 2014 to take advantage of the increased thresholds.

Image credit: Tax Credits

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