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A recent duties case in Victoria highlights the broad range of implications that can arise from estate planning decisions.
Many wills wisely create testamentary trusts to hold property of the deceased rather than, for instance, the property passing to the deceased's spouse (the assets are better held in risk-free trusts, since every person faces some degree of risk from legal action – whether privately, in relation to occupational activities, or both). There is a dilemma that arises, particularly where children are adults, about the form that testamentary trusts should take. Should there be multiple trusts created so that there is one for each child, who can consequently assume complete control of that share, or should there be a single trust with appropriate controls so that the children (together with their own respective families) share in the manner intended by their parents. Multiple trusts allow the children of the next generation to manage their own respective affairs but a single trust gives much better protection against divorce and relationship breakdowns for those children. Depending on the circumstances and dynamics in a particular family, there are also strategies to achieve the best of both worlds.
The deceased in the Victorian case created 5 testamentary trusts under his will. The deceased's property included 3 blocks of land and, following his death, a 1/5 interest in each block was transferred to the respective trustees of each of the 5 testamentary trusts. After more than 4 years, the decision was made to formalise the partnership between the 5 sets of trustees and each transferred their interest in each of the 3 blocks to a private company that was to act as agent for the partnership. The intention was that the respective interests in the land would not change and the agent company would merely hold the land beneficially for the 5 sets of trustees.
The Commissioner of State Revenue assessed duty on the transfers to the agent company and the Supreme Court of Victoria dismissed the agent company's appeals. The arguments were based largely on particular exemption provisions in the Duties Act 2000 (Vic), but a central conclusion in the case was the Court's decision that there had been a complete transfer of each block (rather than a mere legal transfer, with retention of equitable interests) and that the agent company's ownership was subject to a new trust for the respective trustees of the 5 testamentary trusts. With respect, the decision could hardly have been otherwise – it applied well settled trusts law in relation to those points.
Although the reasons for the deceased and his advisers choosing to create 5 testamentary trusts under his will are not known, the duty that applied in this case would have been avoided if the decision had instead been to create a single testamentary trust. The judge in his reasons also commented on the cumbersome structure that resulted from 5 testamentary trusts holding the 3 blocks of land. (White Rock Properties Pty Ltd v Comm of State Revenue (Vic) [2014] VSC 312)
The Commissioner earlier this month released his guidance about s100A of ITAA36, headed ‘Trust taxation – reimbursement agreement’. In very general terms, s100A applies where a trust beneficiary is presently entitled to a share of trust income and the present entitlement arose out of, or in connection with, a reimbursement agreement. In that case, the beneficiary is deemed not to be presently entitled and the trustee is consequently assessed under s99A at the highest marginal tax rate.
The essence of a reimbursement agreement is one providing for the payment of money (which is deemed to include a loan), transfer of property, or the provision of services or other benefits for a person other than the beneficiary. The section is deliberately quite broad, but at least one of the purposes must be a tax purpose and a reimbursement agreement does not include one ‘entered into in the course of ordinary family or commercial dealing’ – after all, s100A was introduced to counter trust stripping avoidance arrangements. And the section does not operate to the extent that income of a trust is distributed through another trust to beneficiaries, a strategy that was fairly common before amendments to Division 7A with effect from 1 July 2009.
The Commissioner's comments are very brief and simplistic. And it is fair to say that they favour the Revenue – the Commissioner should not attempt unduly to extend the ambit of the section beyond the range of circumstances for which it is intended.
It is plain that the Commissioner will generally not raise any issue where the funds representing a complying Division 7A loan from a corporate beneficiary, or UPE made subject to the so-called ‘sub-trust’ arrangements under PS LA 2010/4, are retained in the trust for working capital purposes. But if UPEs of non-corporate beneficiaries have funded loans to family members, then some annual repayments (not merely nominal amounts) will help reduce any risk (the Commissioner acknowledges that ordinary family dealings can include interest-free loans).
The Commissioner's guidance is fairly short and contains some examples to illustrate his views – below is a link to the relevant webpage.
In our previous Tax Facts of 2 July, I made the point ‘that tax applies to the legal position according to the application of the general law (both common law and statutory provisions)’. So intended tax outcomes of an arrangement can only be achieved if the arrangement has achieved its intended legal consequences to start with.
In a recent AAT case, 2 taxpayers failed in an attempt to effectively divert dividends to a limited partnership in which they were limited partners (a limited partnership generally being taxed as a company). The taxpayers had agreed to transfer the relevant private company shares to the limited partnership, but one of the agreements went on to provide that
The Partners shall not be required to transfer the property [the relevant shares] to the Partnership but shall provide the General Partner with a power of attorney to deal with the property and shall permit the property to be mortgaged or charged by the General Partner and shall apply income or proceeds of sale of property to the business of the Partnership.
Construing the agreements as a whole, the Tribunal held that the 2 taxpayers had not transferred the private company shares – they retained both legal and beneficial ownership. Consequently, they were properly assessed on dividends declared on those shares, even though they were bound then to apply the dividends for the benefit of the limited partnership.
The taxpayers also argued that the dividends were not ‘paid’ to them for the purposes of s44 of ITAA36, since they had been credited to the limited partnership in the books of the company declaring the dividend. However, the Tribunal held that that amounted to a payment by direction of the shareholders (‘paid’ being defined in s6(1) as including credited or distributed) and that s44 should be interpreted as applying to a payment by direction. (Yazbeck v C of T [2014] AATA 423)
The No’s 2 & 3 Tax and Superannuation Laws Amendment (2014 Measures) Acts both became law on 30 June. The sole purpose of the No 3 Act is to limit immediate deductions for expenditure on mining, quarrying or prospecting rights and information.
The No 2 Act increases the Medicare levy low-income threshold in some respects and introduces an integrity rule to counteract the tax benefits from so-called ‘dividend washing’. Importantly, it also introduces a one-off protection rule for taxpayers who have self-assessed in reliance on measures announced but not enacted by the previous Government and which were then abandoned by the current Government on 14 December 2013. The Commissioner's power to amend relevant assessments in respect of those measures will be restricted if it would lead to a less favourable result for a taxpayer. This is a welcome relief to alleviate what could otherwise be very unfair outcomes arising from the failure to enact tax announcements within a reasonable time.
The taxpayer's appeal in Howard v FC of T has been unanimously dismissed by the High Court. Despite the complex facts, the tax point involved was a short one about who the correct taxpayer was. It was whether the taxpayer should be assessed on his share of damages awarded for breach of a joint venture or, on the basis that he owed fiduciary duties to a related company in connection with the joint venture and could not benefit personally, he held the damages as constructive trustee for the company and that the company should consequently be assessed. The Court held that there was no relevant breach of fiduciary duties and that the taxpayer was liable to be assessed. It also rejected a subsidiary argument that the taxpayer had effectively assigned his rights to receive the damages – any assignment was of future income so crystallised only upon receipt and, thus, after derivation by the taxpayer.
The main interest of the case is what was said in the judgments relating to fiduciary duties, a very complex area of the law. In other factual situations, the taxpayer's argument might succeed. The point is that tax applies to the legal position according to the application of the general law (both common law and statutory provisions) – one firstly has to analyse the true legal position and that is not always what it seems on its face to be. (Howard v FC of T [2014] HCA 21)
The temporary budget repair ‘levy’ has become law, increasing the individual marginal tax rate by 2% for the part of taxable income in excess of $180,000. The increase is to apply only for the 2015, 2016 & 2017 years of income. A number of other rates aligned with the maximum individual rate are similarly increased by 2% – examples are trustees taxed under s99A and non-arm's length income of super funds. And the FBT rate also increases by 2%, although that change only commences on 1 April 2015 so as to avoid the extra administration that a change part way through the FBT year would create.
On a positive note, the concessional super contributions cap has increased to $30,000 or, for those aged 49 years or more on the last day of the previous financial year, $35,000. The non-concessional contributions cap is now $180,000 or $540,000 under the 3 year ‘bring forward rule’.
Tax planning arrangements can fail for a number of reasons. One of those reasons has little to do with technical tax rules. With a real-life example, this episode of Tax Solutions illustrates how tax planning can go wrong because of a fatal legal flaw in the underlying transactions or circumstances on which the tax plan is based. With the result that the practitioner involved is highly exposed.
The small business CGT concessions provide very substantial benefits in situations where they apply. And given the policy intent to direct the concessions to business assets, one of the central conditions that must normally be satisfied is the ‘active asset test’.
This episode of Tax Solutions emphasises a class of CGT assets that achieve a special status for the purposes of the small business CGT concessions. Those assets continue as active assets indefinitely – retaining that status even long after they have ceased being used in any business controlled by the owners!
Widely drafted beneficiary classes in discretionary trusts can create headaches in dealing with various State taxes. A recent example is Victoria’s new 3% additional duty on foreign buyers of residential property – where a trustee is the buyer and a family beneficiary lives overseas. A starker example that applies in all States and Territories is payroll tax grouping of businesses controlled by family relatives, where at least one of the businesses is operated by a discretionary trust.
Having extraordinarily wide beneficiary classes is an outdated practice that creates problems, rather than serving any useful purpose. There is really no point in including a whole range of relatives who are never intended to benefit. A narrow class of beneficiaries is required, with a simple and practical mechanism to add others to whom it is desired to distribute.
Frustrations with ATO views about UPEs of corporate beneficiaries have led to companies more frequently being used to acquire and operate small and medium sized businesses. But the problem is not discretionary trusts owning businesses, it is Division 7A. And there will usually be ways to deal with Division 7A anyway.
Some advisers believe that a business owner can still access the small business CGT concessions on a future business sale, by selling shares in the company that owns the business. But how realistic is it to hope that that is the way things will turn out. This edition of Tax Solutions emphasises 2 reasons why clients with a business owned by a company may not actually benefit from the CGT concessions.
One of the best things you will ever do for some of your small business clients is to deliberately trigger a CGT event and capture the small business CGT concessions. In the right client circumstances, this strategy can produce several very substantial benefits. That will particularly be so if 100% CGT exemptions can be achieved without duty applying to the transaction.
A restructure for this purpose should always be kept in mind, particularly for clients who may grow to the point where they can no longer satisfy either the $2M turnover test or $6M net asset value test. But it warrants greater consideration at the moment, given the apparent increased political risk of changes to CGT concessions.
