Trusts, Tax and Estate Planning Update

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A detailed presentation on trust structuring (including asset protection strategies and updating trust deeds), Division 7A and Unpaid Present Entitlements, and effective estate planning strategies used to protect wealth.

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Trusts, Tax and Estate Planning Update

  1. 1. Trust structuring Matthew Burgess – Partner March 2012
  2. 2. Overview  The right structure  Asset protection  Read the deed!  Updating trust deeds 2 #16592097
  3. 3. The old world – discretionary trusts  Flexibility  Retained profits  CGT discount  Division 7A  One family  Partnerships of discretionary trusts 3 #16592097
  4. 4. The old world – companies  30% tax rate  No CGT discount  More than one family  Top up tax dividends  Larger business  Shares held by discretionary trusts 4 #16592097
  5. 5. What has changed  Bamford etc  Division 7A  TR2010/3 and PSLA 2010/4  The ‘interim’ legislation 5 #16592097
  6. 6. Problem areas  Problem area no. 1 - streaming  need an attribution clause  otherwise – proportionate approach  ATO attitude – Bamford DIS  is the ATO right? 6 #16592097
  7. 7. Problem areas  Problem area no. 2 – the interim rules July 2013 at the earliest – 3 years the process/steps unrealistic timeframes for distribution resolutions and minutes timing generally 7 #16592097
  8. 8. The six steps for trust distributions  Step 1 – application of Division 6 without modification  check definition of income for what is included  capital gains  franking credits 8 #16592097
  9. 9. The six steps for trust distributions  Step 2 – calculate adjusted Division 6 percentage  exclude amounts to which beneficiaries are specifically entitled  relevant for ‘unstreamed’ amounts  proportionate approach  blending of income, dividends and capital gains 9 #16592097
  10. 10. The six steps for trust distributions  Step 3 – apply Subdivision 115-C  is discount amount included in income?  capital gains  capital distribution if not (and if possible)  quantum approach 10 #16592097
  11. 11. The six steps for trust distributions  Step 4 – apply Subdivision 207-B  dividends  Step 5 – Division 6E recalculation  Step 6 – overall calculation 11 #16592097
  12. 12. Problems with the interim rules  Streaming power – read the deed  Specific entitlement  capital gains  dividends  associated expenses  ‘recorded in is character’ 12 #16592097
  13. 13. Problems with the interim rules  Chains of trusts  Allocation of expenses  resolution timing  deed provisions 13 #16592097
  14. 14. Are capital gains income?  Depends on the definition of income  Section 95 – yes – Discount capital gain is part of assessable income  Income on ordinary concepts – no: need capital distribution power 14 #16592097
  15. 15. Are capital gains income?  No definition – no  Trustee can determine – trustee decides  Discount amount 15 #16592097
  16. 16. Timing of resolutions  What does the deed say?  30 June and 31 August resolutions  Withdrawal of IT 328  Resolutions v minutes  What to do  Default or accumulation? 16 #16592097
  17. 17. What you cannot stream  Negatively geared shares  Capital gains – market value substitution rule  Deemed capital gains 17 #16592097
  18. 18. What you cannot stream  50% discount depending on the income definition  Where net financial benefit flows elsewhere 18 #16592097
  19. 19. Getting it wrong  Franking credits are not income  Mixture of normal income, franked dividends and capital gains  Capital gains end up in companies  Default beneficiaries 19 #16592097
  20. 20. Conclusions  Read the deed  Income definition in particular  does this include CGT discount  separate capital distribution (is there power in the deed)  Section 95  Trust law income  Different from tax law income  Preference – trustee has ability to determine 20 #16592097
  21. 21. Some possible solutions for structuring  Horses for courses  Separate trusts for shares/dividends  Beware of family trust elections  Beware negatively geared shares  Pooling of dividends  ‘Recycle’ bucket company dividends to overcome negative gearing 21 #16592097
  22. 22. Some possible solutions  Business Licence  Corporate beneficiary owns business assets  Business held by a company and shares held by a trust  Separate trust for capital assets, to deal with capital gains 22 #16592097
  23. 23. Some possible solutions  Still be wary to distribute the discount amount  Read the deed  Trust ordinary income with corporate beneficiary  Using a company for investments 23 #16592097
  24. 24. New structures versus restructures  Easier for new structures  Revenue costs of restructure  Stamp duty, properties not shares  Capital gains tax 24 #16592097
  25. 25. Key issues  We have started doing some things differently  Asset protection from relationship breakdowns  Estate planning  Other recent cases  Audit process  Deed updates 25 #16592097
  26. 26. Div 7A & UPEs Matthew Burgess – Partner March 2012
  27. 27. Summary  UPE refresher  ATO view – TR 2010/3 and PS LA 2010/4  Solutions - the subtrust approach  The impact of not adopting the subtrust approach 27 #16592097
  28. 28. Summary  Alternatives to the PS LA options  Restructuring business entities to prevent UPEs arising in the future  WHAT should have HAPPENED BY 30 JUNE 2011  Questions 28 #16592097
  29. 29. Section 2 loans Unpaid present entitlement can be a Div 7A loan if:  explicit agreement between the company and trustee  implied agreement by crediting a loan account with authorisation by the company (express or acquiescence with knowledge)  note assumed family knowledge 29 #16592097
  30. 30. Section 2 loans  the terms of the trust as set out in the Deed permit the trustee unilaterally to apply the UPE by way of a loan to the trust Investigate further if  UPE described as a loan in accounts  UPEs added to or set off against other loan accounts Take action by 31 December 2011 30 #16592097
  31. 31. Section 3 loans  ATO view - Unpaid present entitlement can be a Div 7A loan if......  provision of ‘financial accommodation’  company acquiesces (i.e. by company not calling for UPE funds)  with knowledge of the use of the funds for trust purposes 31 #16592097
  32. 32. ‘Knowledge’  Where trust and corporate beneficiary part of same family group  in absence of sufficient evidence to the contrary  ATO view is company has requisite knowledge of the use of the UPE for trust purposes 32 #16592097
  33. 33. UPE Solutions - manage  Broadly, two ways to prevent Division 7A  First - ensure funds are held on sub-trust for the sole benefit of the private company  PS LA 2010/4 sanctioned arrangements – – – – 33 #16592097 option 1 – a 7 year ‘interest’ only ‘loan’ option 2 – a 10 year ‘interest’ only ‘loan’ option 3 – specific investment in main trust ‘Return on investment’ arrangement (option 4)
  34. 34. UPE Solutions - restructure  Second - ensure no UPE arises  Asset licenses  Rollover of assets  Pay UPE and acquire depreciating assets in company  Other planning strategies 34 #16592097
  35. 35. Why we care now  Unlike a number of other controversial ATO views the ATO has not withdrawn from its position  many will have received an ATO letter identifying the clients that have company’s that have received trust distributions  Fundamentally action in respect of the 30 June 2010 distributions by trusts to companies needed to occur by 30 June 2011 35 #16592097
  36. 36. Sub trust overview General guidelines - ATO accepts sub trust if  sub-trust invests in main trust on commercial terms  all benefits flow to sub-trust and company  all benefits actually paid by lodgement day of ITR of main trust for year of benefit 36 #16592097
  37. 37. Sub trust options  Apply above or adopt specific options from PS LA 2010/4  option 1 – a 7 year ‘interest’ only ‘loan’  option 2 – a 10 year ‘interest’ only ‘loan’  option 3 – an investment by the main trust in an income producing asset  option 4 - ? 37 #16592097
  38. 38. Option 1  Better than a Div 7A loan – interest only  Option 1 – UPE funds repaid within 7 years interest at Div 7A benchmark interest rate (7.40%) or  Payable by ITR due date 38 #16592097
  39. 39. Option 2  UPE funds repaid within 10 years RBA small business variable overdraft rate for prior May (10.65%)  ATO: terms of investment must be documented and need to be legally binding  could be as part of ITR working papers 39 #16592097
  40. 40. Options 1 and 2 - risks  how is ‘legally binding’ possible?  documentation issues ‘investment agreement’  if merely allocation of main trust income (as draft allowed) – not legally binding  if actual loan - parties are main trust and subtrust?  can this loan in itself cause Div 7A issues? – interposed entity rules 40 #16592097
  41. 41. Options 1 and 2 - risks  potentially best solution for 2011 year  implement ‘investment agreement’  ‘investment agreement’ needs to be drafted correctly to preserve the position and satisfy the ATO requirements  arguably still a UPE if documented correctly  cash flow ‘interest’ due by lodgment date for 2012 ITR  although ‘interest’ must accrue from 1 July 2011 41 #16592097
  42. 42. Options 1 and 2 - outcome  ‘interest’ is ultimately assessable to company beneficiary of the subtrust  if applied to income producing assets then ATO position that ‘interest’ is deductible to main trust that retains use of the funds  given that the ‘interest’ is potentially funded out of the trust income it can give rise to a neutral outcome  no separate tax return 42 #16592097
  43. 43. Option 3  Specific investment by trust in income producing (or capital appreciating) asset  Separate accounts and ITR (not required for options 1 and 2)  Arm’s length return  Payments must be made to company each year by ITR due date 43 #16592097
  44. 44. Option 4  Not specifically recognised in final practice statement  UPE in favour of company, placed on sub-trust  Sub-trust invests funds back into main trust  Main trust pays ‘rate of return to sub-trust’  Contemplated in draft PS LA 3362  Contemplated in TR 2010/3 at example 8 (an ‘investment on terms’ as opposed to legally binding loan) 44 #16592097
  45. 45. Option 4 - outcomes  Possible to argue not a ‘loan’ but an ‘investment agreement’  Repayments linked to performance of trust business/investment  Lower or nil if losses in trust 45 #16592097
  46. 46. Rollover business into company     Restructure using trust-to-company rollover (122-A) Sell business into company and operate in company at 30% tax rate Could use small business concessions, if possible, rather than 122-A to uplift cost base Potential stamp duty issues Assets Trust 100% shares Company 46 #16592097
  47. 47. Asset licence – depreciating assets    Commence or transfer business to operate in the company, retain capital assets in trust (can also use 122-A rollover) Business assets licence (‘goodwill licence’) Stamp duty issues if transferring assets Trust Licence to use assets Company 47 #16592097
  48. 48. Asset licence – business operated by Trust    Continue to carry on business in Trust Pay the UPE to the Company The company uses the funds to buy depreciating assets for the business and license back to the Trust Trust Licence to use assets Company 48 #16592097
  49. 49. Business licence  Trust ‘licences’ business assets and operations to a company  under written licence agreement  supply all assets, rights, customers lists etc  Licence fee arm’s length e.g. % of company turnover  Licence agreement terminates with say 1 month’s notice and all assets revert to trust 49 #16592097
  50. 50. Business licence (cont)  If licence agreement structured correctly then  no CGT etc  limited stamp duty costs  company taxed at 30% on operating profit less licence fee  future CGT issues for business sale should remain with trust  NOT a goodwill licence (Murry) 50 #16592097
  51. 51. Special purpose company  Instead of option 3 – establish SPC  Trust distributes AND pays the entitlement to the company which acquires the depreciating assets  lease or licence for a fee to operating trust  appropriate fee for depreciation deduction claim  Division 7A payment rules  109CA extended ‘payment’ definition  109CA(5) – ‘otherwise deductible’ rule 51 #16592097
  52. 52. Special purpose company  Division 43 improvements – funded / acquired by SPC on trust’s land  Division 7A payment rules  otherwise deductible for use  issue if land owned by trust is sold – payment that is not otherwise deductible  agreement for market value compensation  Capital appreciating assets 52 #16592097
  53. 53. UPE – complying loan  Strictly it is a UPE that is a ‘financial accommodation loan’  BUT needs to satisfy 109N requirements  Risk - cannot do so without in substance becoming a loan at law 53 #16592097
  54. 54. End option 1 or 2 ‘loan’  ATO position PSLA 2010/4 – para 74 & 86  needs to be repaid  Alternative rely on para 120 & 121  end of loan period becomes a section 3 loan  turn into a complying loan 54 #16592097
  55. 55. Accounting issues – Option 1 & 2  ATO guidance no separate accounting or tax returns  ‘Interest’ return journalised – then paid  Separate line item/s in accounts? 55 #16592097
  56. 56. Timing – 2010 UPE 30 June 2010 UPE arises from 2010 trust distribution 30 June 2011 2011 ITR due date 30 June 2012 2012 ITR due date Record 2012 accrued interest PS LA subtrust options if no subtrust loan arises 56 #16592097 109N loan agreement P&I repayment Pay 2012 accrued interest
  57. 57. Timing – 2011 UPE 30 June 2011 UPE arises from 2011 trust distribution 2011 ITR due date PS LA subtrust options 30 June 2012 2012 ITR due date Record accrued interest (2012 part year) 30 June 2013 Pay 2012 accrued interest Record 2013 accrued interest 109N loan agreement P&I repayment if no subtrust loan arises 57 #16592097
  58. 58. Other strategies ?  Secured loans (including converting 7 year loans)  Capitalisation and on lending  Rollover of investment agreements  Dividend recycling  Absolutely entitled trusts  Limited and corporate partnerships 58 #16592097
  59. 59. Estate planning update Matthew Burgess – Partner March 2012
  60. 60. Estate planning overview  Different strategies  More than a will !  Protecting wealth  creditors (bankruptcy)  matrimonial breakdown (divorce)  family provision application (challenge against estate)  ‘spendthrift’ beneficiaries 60 #16592097
  61. 61. Case study 100% (4) 61 #16592097 Liz Shane (9) (12)
  62. 62. Option 1 – ‘traditional’ approach Assets Estate Debts Liz (4) 62 #16592097 (9) (12)
  63. 63. Option 1 - ramifications   Bankruptcy Simplicity Divorce Cost Estate challenge Spendthrift Tax on income 63 #16592097
  64. 64. Option 2 - testamentary trust  Trusts established pursuant to a will  Takes effect upon death of the willmaker  Concessional tax treatment:  distributions to minors from inter vivos trust  $416 tax free  balance taxed at up to 66%  distributions to minors from testamentary trust  $16,000 tax free (applying LITO)  balance taxed at marginal rates 64 #16592097
  65. 65. Option 2 - example Trustee Liz Testamentary Trust Estate Trust Beneficiaries Liz (4) 65 #16592097 (9) (12)
  66. 66. Option 2 - ramifications  Estate challenge  Bankruptcy Divorce* Spendthrift Tax on income 66 #16592097
  67. 67. Bankruptcy provisions  May 2004 draft legislation – very significant  Withdrawn July 2004 – but did not go away  Bankruptcy requires  debt  failure to meet that debt  creditor seeks to appoint trustee in bankruptcy 67 #16592097
  68. 68. Clawbacks  Bankruptcy Act voidable transactions  undervalue transactions – 4 to 5 years  transactions to defeat creditors – no time limit  preference payments – 6 months  Corporations Act voidable transactions  uncommercial transactions – 2 years  involving related entities – 4 years  for the purpose of defeating creditors – 10 years  Start the clock running 68 #16592097
  69. 69. Richstar  Corporations Act v Bankruptcy Act  At least a contingent interest  Trustee the alter ego of the beneficiary or otherwise subject to effective control – as good as certain they will benefit  Something akin to proprietary interest  Combination of beneficiary, trustee, appointor and control 69 #16592097
  70. 70. Richstar - effect  Freezing order only  Single judge decision  French J  Subsequent cases  Public Trustee v Smith 70 #16592097
  71. 71. Matrimonial breakdown  Asset or resource?  Kennon v Spry  Harris v Harris  Inter vivos trust v testamentary trust  Gift and loan back 71 #16592097
  72. 72. Spry – reheated  Kennon v Spry – 2008 High Court decision  Court ordered payment of discretionary trust funds to satisfy an order under a property settlement  Dr Spry appealed  Facts  Dr Spry not a beneficiary  Dr Spry was trustee  transferred trust property to other trusts – transactions set aside  irrational behaviour 72 #16592097
  73. 73. Spry - the decision  The trust property was the property of the parties to the marriage  The order of the family court to ‘do all things’ included making a trust distribution  Only extension of law is the definition of ‘property’  Family Law Act supports argument that ‘property’ includes assets that a party to the marriage may be ultimately entitled to 73 #16592097
  74. 74. Spry – Practical implications  Other decisions after Spry  Less is more  The ‘Part IVA’ of family law world  50% x 5% x 5%  Another checkpoint for ‘Richstar compliant’ checklist 74 #16592097
  75. 75. Keech  Trust established by father of husband  Acquisition of home lived in by husband and wife  Specific evidence that father intended to protect assets to the 'bloodline’  No evidence of a ‘fraud' Trust 75 #16592097
  76. 76. Harris  Assets at most a resource  History of wider family involvement  Pattern of distribution still relevant  Must have clear evidence if puppet argument to succeed  Wrongful distributions (read the deed)  Contribution issues still a relevant factor, even if a resource 76 #16592097
  77. 77. Option 3 – lifetime disposal Appointor/trustee Shane, or after Shane’s death, Liz Shane transfer 77 #16592097 Family Trust
  78. 78. Option 3 - ramifications   Tax Bankruptcy Duty Divorce * Transaction costs Estate challenge Spendthrift 78 #16592097
  79. 79. Family provision applications  Eligibility:  spouse  children  dependents  Estate assets v non-estate assets  joint tenancies  superannuation nominations  related entities 79 #16592097
  80. 80. Family provision applications  Tax/duty  Lifetime disposals  Use of contractual rights (options)  NSW rules – ‘notional estate’  Beware loans/unpaid present entitlements 80 #16592097
  81. 81. Option 4 – corporate model Will/letter of wishes  - shareholdings Tailored constitution: - appointor powers - loan accounts Trustee Pty Ltd - general directions - eligible shareholders - share rights - director representation Trust - independent directors - voting rights Trust deed: - beneficiaries - distribution entitlements - control mechanisms (e.g. appointors) 81 #16592097
  82. 82. Option 4 - ramifications   Complexity Bankruptcy Estate challenge* Divorce * Spendthrift 82 #16592097
  83. 83. Atia v Nusbaum  Gift and loan back strategy  parties mum & son  if legal documents done – binding  fallout  query family trust use, not mum 83 #16592097
  84. 84. Amending trust deeds  Resettlement issues  income and capital entitlements  default beneficiaries  vesting date  Creation of a new trust  Statement of principles  Stamp duty and CGT  Clark decision 84 #16592097
  85. 85. Trust deed reviews  Rule 1 – read the deed  Checklists and training  Risk management – get all aspects right  Actively implement 1 of 3 models 85 #16592097
  86. 86. Clark  Commercial Nominees confirmed  Significant variations available at law  Always read the deed  Stamp duty (other states & trustee duty)  Private rulings  Splitting & cloning 86 #16592097
  87. 87. Super strategies  Special purpose trust  Embed into will or do post death  ATO attitude  'Quick death' tax 87 #16592097
  88. 88. Contact details Presenter: Matthew Burgess Position: Partner Direct line: 07 3233 8918 Email: mburgess@mccullough.com.au 88 #16592097

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