Paper prepared for · Estate Planning vs. Doing it Over the Coffin “A vital focus of every...

Succession Planning in a Family Trust - is it possible? Paper prepared for CCH Learning 19 June 2019 1:00 PM - 2:00 PM AEST by Adjunct Professor, Dr Brett Davies CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD Legal Consolidated Barristers & Solicitors

Legal Consolidated wishes to thank Alison Wood from CCH Learning for her support.

Legal Consolidated licences CCH Learning and the agents of CCH Learning to quote from this paper as required.

Prof Davies, Legal Consolidated, Succession Planning in Family Trusts

Table of Contents

Paper

Succession Planning in a Family Trust - is it possible?

Prepared for CCH Learning

Author Adjunct Professor, Dr Brett Davies Legal Consolidated

Estate Planning vs. Doing it Over the Coffin

“A vital focus of every business owner is the exit strategy. Without an exit strategy, you

may have no business and no future. Without a business or future, why would Echo

Boomers want to stay? This is a fundamental truth for any business, professional or

otherwise.”

Dr Brett Davies, Legal Consolidated

“Arguably the most rewarding area for the Accountant is Business Succession Planning.

The best Project Manager for a Business Succession Plan is the Accountant.”

Dr Brett Davies, Legal Consolidated

"Over and over again courts have said that there is nothing sinister in so arranging one's

affairs as to keep taxes as low as possible. Nobody owes any public duty to pay more

than the law demands. Taxes are enforced extractions and not voluntary contributions.

To demand more in the name of morals is mere can’t."

Judge Learned Hand, 2nd Circuit Court, 1947, USA


Structuring your business for your children

Decisions made now affect your family later

As Benjamin Franklin said ‘in this world nothing can be said to be certain, except death

and taxes’.1 Even he could not have foreseen the amount of change that occurs in the tax

system each year. On top of that, business owners are concerned with the threat of

bankruptcy, being sued and asset protection. One mistake from a careless employee and

your business blows away like a pack of cards.

Before you start any business work out which business structure to conduct your

business out of.

My client purchased a real estate agency in his own name. He later got married and

wanted to share profit with his wife to reduce tax. Later he started to operate out of a

Family Trust and then took on business partners through a Unit Trust. He then transfer

his business into a company and listed it on the stock exchange.

Change the business structure and you change ownership. Each time you do the taxman

takes a cut on the increased value of the business. The acquisition cost or what you are

deemed to have acquired the asset is your cost base. You pay tax on the increase from

the cost base. This is Capital Gains Tax. It was the brainchild of then Treasurer Paul

Keating in 1985. On top of CGT the States inflict stamp duty as well.

If you started your business from scratch, then your “cost base” may well be nil. If you

later sell or transfer the business, to say, a Family Trust then you pay Capital Gains Tax

on 100% of the value of the business - often as calculated by the Tax Office. This can

have devastating results.

1 This is usually attributed to Benjamin Franklin, who wrote in a 1789 letter that “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.” However, The Yale Book of Quotations quotes “‘Tis impossible to be sure of any thing but Death and Taxes,” from Christopher Bullock, The Cobler of Preston (1716). The YBQ also quotes “Death and Taxes, they are certain,” from Edward Ward, The Dancing Devils (1724).


Therefore, decisions made now affect the future value and flexibility of the business. Let

us look at some of the options before you.

Tax Planning for the small or family business

Every Taxpayer is different. For one person, a Family Trust is best. For another, a

partnership may reduce more tax.

Checklist for business structure

1. Costs to maintain

2. Threat of legislative change

3. Estate Planning

4. Succession Planning get it into the next generation with minimal CGT and

stamp duty

5. Asset Protection

6. Income tax and flexibility in streaming income

7. Capital Gains tax issues

8. The degree of sophistication of the Taxpayer (appreciation of legal niceties

and understanding of the nature of the vehicle).

Possible Business Vehicles

1. Sole Proprietor

2. Partnership

3. Partnership of Family Trusts

4. Family Company (Pty Ltd)

5. Family Trust

6. "Loss" Company

7. Unit Trust

8. "Loss" Trust

9. Tax Haven vehicle

10. Cocktail of above


1. Family Trusts

The name of the game for a Family Trust is to:

1. Keep control within the family

2. Reduce Tax (hunt down beneficiaries on low marginal tax rates)

3. Reduce the chance of losing assets if you or the Family Trust go broke

After sole proprietorships and partnerships, Family Trusts are the most popular

business structure in Australia. Build your Family Trust Deed at

legalconsolidated.com.au. They are flexible. They provide your Advisor and

Accountant with scope in sharing the tax burden around your family.

Here is a story about my clients Charles and Mei Lin…

Charles and Mei Lin control (through a Family Trust) a corner deli. They give themselves

annual wages of $110,000 each. At the end of the year, their Accountant tells them the

good news that (after their “wages”) they have made $90,000. What would happen if

Charles and Mei Lin took this additional income? They would pay almost half of it in tax -

not much fun for all that hard work.

Because they are in a Family Trust, they can easily distribute the ‘extra’ $90,000 to their

18-year-old son who is still at high school. The son pays tax at adult tax rates. Obviously,

the boy gets none of the money. He merely signs a Deed of Debt Forgiveness at the end of

the year. (Build a Deed of Debt Forgiveness at legalconsolidated.com.)

Their 16-year-old daughter is still a minor. Sadly, she pays tax at penalty minor tax rates.

After $416 she is taxed at 66%. Therefore, apart from the $416 she is distributed nothing

from the Family Trust.

The distributions to the children are designed for only one purpose: to reduce tax.

Who are the players in the Family Trust?

1. The puppet: Trustee – all trust assets are in the trustee’s name. But, the

trustee is only the legal owner; an owner in name only. The trustee is not the

“beneficial” owner. If the Family Trust goes broke then often the Trustee goes

down with the sinking ship. Therefore, your Trustee is a company. Only one

parent is the director.

2. The god: Appointor (Guardian) – hires and fires the Trustee. Therefore,

people often call the Appointor ‘god’. The Trustee is often called a ‘puppet’.


The power to appoint and dismiss the trustee is given to the Appointor. Mum

and Dad are often the Appointor. Upon their death then their children are the

Appointors. I would want to be Appointor if it was my trust.

In Legal Consolidated’s Family Trust Deeds we also have a Guardian. The

Appointor hires and fires the Trustee. The Guardian tells the Trustee who gets

what capital and income each year. Usually the Appointor and Guardian are

the same people.

3. Trust Fund – these are the assets that you keep in your Family Trust. These

can be business or other assets such as property or shares. The most common

assets, with the lowest risk first:

a. Shares

b. Real estate

c. Safe business assets – commercial property leased to your business,

Trademark and business names leased to your business, database of

clients, secret information


d. Business activities – business name, giving advice, selling things,

employing staff

Business actives are high risk. You shouldn’t mix high risk assets with lower

risk assets such as shares, real estate, and safe business assets.

Michael Jackson sings ‘one bad apple spoils the whole darn bunch’.2 One bad

asset losing money or insolvent – means all the other assets in the same

Family Trust are lost as well. Don’t keep all your eggs in one basket.

4. General Beneficiary - the group of people who can benefit from the trust’s

income and capital. Often 100,000s of people that you have never met or who

haven’t been born yet. If you own a share in BHP Billiton then all the

shareholders of that company are also beneficiaries of your Family Trust. It

doesn’t make any difference. Beneficiaries have no right to ask for any assets

out of the trust.

The more beneficiaries you have the better, because you have more flexitility.

A client asked me to staple the White Pages to one of our Family Trust Deeds

so that everyone would be beneficiaries. Sadly the ATO thought the class of

beneficiaries was not certain enough.

5. Specific Beneficiary - or sometimes-called “takers in default”, “Primary

Beneficiary” and “Specified Beneficiary”. They are a special class of

beneficiaries. If you forget to distribute all income by the end of the financial

year, then instead of the trust paying the highest marginal rate, the Specific

Beneficiaries are deemed to receive the income, at their own marginal tax

rates.

Similarly, if you forget to distribute the capital of the trust after 80 years, (the

usual life of the trust) then the Specific Beneficiaries get the capital.

However, this is just a legal fiction. In reality, Specified Beneficiaries are rarely

used.

6. Settlor – generally a stranger (such as your accountant or adviser) settles

(gives) $10 on the trust. This just ‘starts’ the trust. This is because of English

law introduced by King Henry VIII; you need to prime the trust with some value.

The Settlor is about the only person that can never be a beneficiary under the

trust. Therefore, don’t pick your friends or family for this job. The ‘head of the

family’ or a doting uncle should never ‘settle’ the trust. The Settlor can be your

2 The lyrics written by George Henry Jackson was actually ‘One bad apple don't spoil The whole bunch’


accountant who builds the trust at the law firm’s website:

legalconsolidated.com.au. The Appointor (after the Family Trust is set up) puts

the main assets into the trust. If the Settlor is a family member, then there are

adverse tax consequences.

Who gets what in a Family Trust?

Who gets what in a Family Trust is up to the Trustee (acting under the advice of the

Appointor). Therefore, the class of beneficiaries is as wide as possible - including the

dreaded mother-in-law and the divorced spouse!

Why have your mother-in-law as a beneficiary?

Beneficiaries have no rights to demand any asset under a Family Trust. Merely being a

beneficiary gives no rights or property in the Family Trust. They only have a “mere hope”

that they may get some income or capital from the Family Trust.

Does the Family Court honour the Family Trust?

You must be kidding. The Family Court has been snubbing its nose at Family Trusts

since the 1990s. The Family Court merely treats the Family Trust assets as belonging to

the Appointor or even the Trustee.

Does Centrelink pay tribute to the Family Trust?

Similarly, Centrelink changed the laws. Effective 1 April 2002, like the Family Court,

Centrelink “looks through” to the real controllers of the Family Trusts. There is a sad

paper prepared by Legal Consolidated on this dark side of Centrelink’s attack on the

pensioner. This came about from Centrelink and the ATO data matching.

What happens if the Family Trust goes broke?

The Trustee of the trust is indemnified out of the assets of the trust. In contrast, the

beneficiaries of the trust are generally not liable or exposed to the losses in the Family

Trust. They may lose their “loan accounts” or ‘unpaid present entitlement’ but usually no

more. This means that should the family business find itself in difficulty with creditors,

provided you have followed the advice from your Accountant, advisor and Tax


Lawyer, it is likely that the only assets that can be called upon to pay these debts are

those owned by the Family Trust and the Trustee.

Sadly, personal assets owned by the Trustee outside the trust may be available for

discharging any trust liabilities. So, it is a good idea to use a corporate trustee for your

Family Trust. Just make mum or dad the director (whoever has the least assets). Don’t

risk both of them.

Of course, if you are forced to give a guarantee for the Family Trust, then you can lose

everything. If you are upset by that, then don’t sign guarantees.

Practice Hint

Mum and dad were directors of their Family Trust corporate trustee. The bank required

mum and dad to both be guarantors. The accountant cleverly removed mum as a

director. The very same bank, for the same loan, now only required dad be a guarantor.

In summary, the Trustee and directors of a corporate Trustee generally goes down with

the insolvent Family Trust. Apart from the Trustee, most others involved in the Family

Trust are usually protected from being sued or bankrupted. The trust can limit the

personal liabilities of individual members of the trust business. For example, the

Appointor and Beneficiaries generally don’t go down with a Family Trust. The Trustee is

generally the only one with exposure.

What happens if your Trustee goes broke? - Asset protection

In the above example we were looking at what happens if the Family Trust gets into

trouble. But what happen if the Trustee of the Family Trust, itself, goes insolvent or

bankrupt? If you are the Trustee of the Family Trust and end up in personal financial

trouble or bankrupt, then you can’t remain as Trustee. In any event, the Appointor will

sack you.

The Trustee going bankrupt generally won’t affect the Family Trust. The Family Trust just

gets itself another Trustee.

The real power behind a Family Trust is the Appointor. The Appointor can direct that all

capital and income be paid out of the Family Trust to a beneficiary. With all that power

what happens if the Appointor (god) goes bankrupt? To date the Trustee in Bankruptcy

has been unsuccessful in “standing in your shoes” and directing the trustee to distribute

all the wealth of the Family Trust to the bankrupt Appointor. The argument is that the

Appointor’s job of bossing the Trustee around is a “duty”. This is not property.


Nevertheless, you should put in the deed that you give up your job to another person if

you are insolvent or bankrupt.

How long can a Family Trust exist?

Like a company, a trust offers a greater degree of stability than say a sole proprietor or

partnership structure. Death dissolves neither a company or trust. A trust can operate up

to 80 years in Australia (even longer in South Australia). (Self-Managed Super Funds are

strangely not caught by the 80-year rule. A SMSF can go on forever while you have

members.) Companies can go on forever provided you comply with the legislation (i.e.

pay ASIC’s fees).

Can Family Trusts avoid the death taxes - Capital Gains Tax & Stamp Duty?

Family Trusts reduce de facto death taxes because case law has held that the rights of

beneficiaries in Family Trusts don't constitute an “interest” in your Will. Interestingly, the

assets of a Family Trust do not form part of a deceased estate. A person could have

millions in their Family Trust and yet die a pauper.

The only exception to this is “Loan Accounts” or “Unpaid Present Entitlements”. These

are monies that someone has “loaned” to the Family Trust. This asset belongs to the

person making the loan. Your accountant may suggest that the person forgives the

money owed by the Family Trust. You can build a Deed of Debt Forgiveness on our

website: https://www.legalconsolidated.com.au/intro-deed-of-debt-forgiveness/. See the

Sample, on our website, to see why there is no adverse tax consequences or commercial

debit forgiveness issues.


What are the Advantages of Family Trusts?

Family Trusts provide great flexibility and less governmental interference than companies.

Companies are over regulated. You also get asset protection and income-streaming.

Succession planning is achieved by merely changing the Appointor. You can build a

Deed of Variation to Update the Appointor on our law firm’s website:

https://www.legalconsolidated.com.au/intro-family-trust-appointor-update/. Changes to

Appointors are not subject to Will challenges, except from a spouse or a defacto.

Wealth in your Family Trust doesn’t “belong” to you; the Appointor just “controls” it.

Therefore, your Will can’t touch or effect those assets. The Family Court often sees fit to

ignore a Family Trust structure. However, a spouse can have a Pre-Nuptial Agreement

(legally called a “Binding Financial Agreement”). The Family Court has to follow a legal


Binding Financial Agreement. A Binding Financial Agreement only became operational in

December 2000.

How often should my Family Trust Deed be reviewed?

Most pre-1992 Family Trusts need to be amended to include “streaming provisions”. This

allows you to distribute one type of income to one person and another sort of income to

another. The income can then be distributed with reference to its source.

For example, you may want to distribute dividends with franked credits to a high-income

earning beneficiary. Similarly, you may want to distribute income subject to capital gains

tax to a lower income earner.

Legal documents need to be maintained on a regular basis. This is because there are

constant changes to the legislation and case law.

As an introductory point on the importance of having an appropriately drafted trust deed,

Chapter 31 of the CCH Australian Master Tax Guide states that:

“Drafting Trust Deeds

Resettling the trust or amending the trust deed may have undesirable stamp duty

consequences (although rectification of the trust deed is possible to give effect to

the true intention of the parties, e.g. Carlenka 95 ATC 4620).”

Build your Family Trust Deed update here: https://www.legalconsolidated.com.au/trusts/.

It includes:

A. The general “Streaming provisions”

B. Franking credits

C. Attribution relating to distributing capital gain to beneficiaries

D. The ongoing extension of the Capital Gains Tax regime since 1985

E. Estate Planning – who controls the Family Trust when you die

F. Wealth Transference and Estate Planning issues

G. Stopping the majority of Appointors taking all the proceeds of the trust over the

minority

H. The trustee’s ability to indemnify – so it can borrow money from a bank


I. Getting the Small Business CGT Concession

K. Asset Preservation

We ensure that the amendments don't constitute a resettlement in line with the ATO's

Statement of Principles August 2001 and the High Court's decision in Commissioner of

Taxation v Commercial Nominees of Australia Ltd [2001] HCA 33 (31 May 2001).


Strange Developments in Family Trust Law

Cajkusic & Anor v FC of T (No 2) 2006 ATC 4752

A) The facts:

Similarly, to many trust deeds, the Cajkusic Family Trust deed contained a very broad

definition of income. Clause 8(u) stated:

8. … The Trustee shall have power to determine what amount or amounts shall be treated as income of the Trust Fund and what amount or amounts shall be treated as capital and generally to determine the treatment and characterization of all receipts and payments by the Fund and in particular to determine that the income of the Fund for the purposes hereof is an amount equal to “the net income of the trust estate” within the meaning of section 96 of the Income Tax Assessment Act…

The Cajkusic family trust lodged its income tax return of the 1998 year. This showed nil

net income, a carried forward loss of $26,141 (based on taxable income of $28,697) and

prior year losses of $54,838. These income tax return figures matched that in the 1998

trust accounts.

The Commissioner disallowed deductions that were considered not to constitute proper

expenses of the trust. These were:

• $190,000 paid to an employee benefits trust;

• $7,125 for costs relating to the employment benefits trust; and

• $54,838 for prior year tax losses.

When these deductions were removed from the equation, the section 95 net income of

the trust and the net accounting income each summed $225,822.

Members of the Cajkusic family were the trust’s default income beneficiaries. Due to the

fact that there was no trustee income resolution, the Commissioner included the section

95 net income of the trust in the assessable income of each of the appellants in

accordance with section 97.

As could be expected, the default income beneficiaries were not pleased. They argued

that for the purposes of section 97, there was no income of the trust estate that they were

presently entitled to.

Initially, the assessment was disputed at the Administrative Appeals Tribunal. It went on

appeal to the Full Court of the Federal Court. The Commissioner later applied for a

Special Leave Application in the High Court of Australia, however this was rejected.


B) The judgment

In their joint judgment, the Full Court of the Federal Court noted that the Trustee, properly

and in accordance with clause 8(u) of the trust deed, treated the disallowed deductions

as being on revenue account.

The Commissioner submitted that “what is income for trust law purposes, section 97

purposes, cannot be governed by what is said in the trust deed…as that would be

remarkable. You could just define your way out of what the [Act] provides”. However, the

Full Court held that it does not follow that, just because the trust deed gives the trustee

absolute discretion as to what receipts are treated as income and what outgoings are

treated as outgoings relating to determining income for section 97 purpose (the

distributable net income), that you can define your way out of the Act.

Instead, liability for tax on the section 95 net income falls where the 1936 Act intends it to

fall. If there is no section 97 distributable net income to which any beneficiary is presently

entitled to, then liability for the tax on any section 95 net income falls on the trustee under

sections 99 or 99A of the Act. On the other hand, if there is any section 97 income to

which beneficiaries are presently entitled, then any section 95 net income (whether this is

greater or smaller than the distributable net income) falls to be taxed in the hands of

those beneficiaries in proportion to their respective shares of the section 97 income – see

also Zeta Force Pty Ltd v FCT (1998) 84 FCR 70.

The Full Court of the Federal Court concluded that the Cajkusic family trust had no

distributable net income. The rule in Upton v Browne (1884) 26 Ch D 588 was followed -

losses in one year must (in the absence of any contrary direction in the trust instrument)

be made up out of profits of subsequent years, and not out of capital. There can be no

profits properly distributable in cash until all past losses are paid. This meant that the

distributable net income of the Cajkusic family trust for 1998 was negative. Therefore,

none of the beneficiaries were entitled to anything (including section 95 net income).

Instead, the liability for tax on the section 95 net income was held to fall wholly on the

Trustee under section 99A.

C) The Commissioner’s view

The Commissioners Impact Statement evidences the Commissioners deep disapproval

for the Federal Court’s decision in Cajkusic in relation to the effect of the trust deed on

the income of the trust estate. The Commissioner clearly stated that it did not understand

the case to provide authority for the proposition that the trustee under the terms of a trust

instrument can govern what is income for the purposes under section 97(1). The Impact


Statement gives a clear direction that the Commissioner will continue to follow the

reasoning of the High Court in ANZ Savings Bank case, where it was held that the trust

deed could not alter the character of certain amounts in the hands of the trustee. Here,

the whole of an annuity amount was income of the trust estate within the meaning of

section 97(1), notwithstanding that the deductible amount was exempt income of the trust

for tax purposes and was treated as capital under the deed.

Kennon v Spry [2008] HCA 56

A) The facts:

Dr Spry created a trust by parole (verbally) in 1968. He married Helen Spry in 1978, and

had four daughters soon thereafter. The term of the parole trust were put into writing in

1981, where Dr Spry was settlor and trustee (where he had the power to remove and

appoint new trustees). The beneficiaries were his children, his siblings and spouses, and

their children.

Dr Spry first amended the Trust in 1983, excluding himself as a beneficiary and

appointing his wife as trustee on his death (and his daughter Elizabeth on his wife’s death

or resignation). Mrs Spry remained a discretionary beneficiary (‘normal’ beneficiary with

no rights).

Dr Spry and Mrs Spry began experiencing marital difficulties. In 1998, Dr Spry varied the

trust again, to exclude himself and his wife as capital beneficiaries. He appointed two of

his daughters to become trustees upon his resignation or death – however there was to

be no distribution of income or capital without Dr Spry’s consent. Crucially, Dr Spry did

not challenge the idea that the reason for the amendment was to remove the trust assets

from the reach of the Family Court – indeed, this was the main purpose of the

amendments.

In 2001, Dr Spry and Mrs Spry separated, and their marriage dissolved on 17 February

2003. In January 2002, Dr Spry established four trusts – one for each of his daughters.

He applied 25% of the capital and income of the 1981 trust to each daughter’s trust. He

later appointed Mr Edwin Kennon as joint trustee of each of his daughter’s trusts. In April

2002, Mrs Spry went to the Family Court to get orders for property settlement and

maintenance. She wanted the 1998 amendments and the January 2002 dispositions to

their children quashed. She wanted 50% of the assets, including 50% of those held in

their individual or joint names, the trust, or held by their daughters.


B) The judgment

This decision highlights the fact that the Family Court is one of the most powerful Courts

in Australia. The High Court ultimately held in Mrs Spry’s favour, and confirmed the ability

of the Family Court to make finding as to the property interests of beneficiaries in a family

trust, even where that beneficiary does not control the trust either directly or indirectly.

Gummow and Hayne JJ (French CJ agreeing) found that a spouse is still a beneficiary,

despite divorce. Further to that, they held that under the Family Law Act, property ought

to be given a wide interpretation. It followed that the rights as a beneficiary were deemed

to be ‘property’. French CJ noted that a beneficiary who does not the control the trustee

has a right to due consideration and due administration of the trust, however, it is

intrinsically difficult to value that beneficiary’s ‘property’ in this sense.

In any case, it did not matter that the trustee power to distribute was held by Dr Spry (not

a beneficiary) and the capacity to benefit was held by Mrs Spry (a beneficiary). It was

sufficient that these were held within the same marriage, albeit with different people.

Although Dr Spry argued that to recognize Mrs Spry’s interest as a beneficiary was

‘property’ would be to ignore the legitimate interests of third parties (namely his four

daughters), this was expressly rejected by French CJ and Kiefel J. Kiefel J noted that the

Court often made orders that indirectly affects third parties – and that was unremarkable

in itself. To gain the interest of the Court, the third party’s interest would do well to be

remote and uncertain – which the interests of Dr Spry’s four daughters was not (as they

were firstly his daughters, and secondly were always subject to his control under the

trust). Although third party rights must still be considered by the Court, the Court will look

at the source, nature and character of the trust assets. Where this test supports a

conclusion that the property in the trust is a product of marital contributions and where the

trust was seen as way for to support the marital partners and children, the Court will more

readily ignore the trust structure and apply the assets of the trust to satisfy property

settlement orders. In any case, the trust assets would have been unarguably property of

the marriage but for them being put into the trust.

French CJ held that where property is held under a trust by a party to a marriage and the

property has been acquired by or through the efforts of that party or his or her spouse

(whether before or during the marriage), it does not necessarily lose its character as

property of the parties to be marriage, just because the party has declared a trust where

he or she is trustee and can, under the terms of that trust, give the property away to other

family members at his or her discretion. He also held that the power conferred under

section 79 of the Family Law Act to vary the legal interest in any property of the parties to

a marriage is confined to circumstances arising out of the marriage relationship only.


Gummow and Hayne JJ suggested that the Family Law Act should be read in a fashion

which advances, rather than constrains the subject, scope and purpose of the legislation.

Of considerable note to legal professionals, is the idea that legal professional privilege

may not apply when considering issues under the Family Law Act (even when one

applies the dominant purpose test set out in Esso Australia Resources Ltd v FCT (1999)

168 ALR 123).

Bamford v Commissioner of Taxation [2009] FCAFC 66 (3 June 2009) (upheld by the

High Court in Commissioner of Taxation v Bamford [2010] HCA 10, 30 March 2010)

A) Précis

It was your usual scenario: Mum and dad were directors of a company. (We all know this

is poor asset protection. Only one should be director – and have no assets.) They set up

a family trust with their family company as trustee. Beneficiaries included mum, dad, the

children and the Church of Scientology. They made some superannuation contributions

to themselves as employees. They had some carried forward losses. Like most trust

deeds, the power to recognize income and net income was wide. The trustees had

discretion. The trustees used this to gain tax advantages.

Considering this is the way a lot of people run their affairs, there’s nothing controversial

about it. Until the ATO comes a-knocking at your door and tells you that you owe some

obscene amount of money. As is often the case with the ATO it can’t even back its

decision with High Court authority. You have two options: either keep quiet and pay, or

kick up a storm like the Bamfords. Tax professionals were walking blind as to three of the

important issues that affect each trust each year:

• How to treat a ‘share’ of the income;

• What is meant by ‘income’; and

• How important the trust deed is to determine income.

In the dark ages before 2009, accountants and tax lawyers moonlighted as prophets.

They had to guess what the High Court position would be, and act accordingly. About the

most direction that had previously been given is from the Full Federal Court in Cajkusic v

FCT back in 2006. At this time, the High Court refused a Special Leave Application to

give the area some clarity. And the Commissioner continues to express his displeasure

with this decision in every forum available.

Bamford’s judgment was handed down on 3 June 2009 in the Full Court of the Federal

Court of Australia and it was cemented by the High Court in Commissioner of Taxation v

Bamford [2010] HCA 10 (30 March 2010). Although it has not solved everything, it


certainly has eliminated some uncertainty as to how the Court views the operation of

section 97 and how income is a deed dependent concept. The ATO has since handed

down the dreaded Decision Impact Statement and Practice Statement PS LA 2010/1.

The Facts

2000

In May 2000, the Trustee made a $175,000 superannuation contribution on behalf of Mr

and Mrs Bamford as employees, to their self managed superannuation fund. To fund this

contribution, the Trustee borrowed from a bank. This incurred $16,702 in interest

expense for the 2000 year.

The Trustee recognized both the contribution amount and interest expense as expenses

in the Trust’s profit and loss statement. When preparing the Trust’s income tax return, the

Trustee recognized that the contribution amount and interest expense were deductions

for the purposes of calculating the section 95 net income. For the 2000 year, it was

resolved that the Beneficiaries would be allocated:

JH Bamford – the first $643

HJ Bamford - the next $643

Narconon Anzo Inc – the next $12 500

Church of Scientology - the next $106 000

PJ & DL Bamford - the next $68 000, shared equally

Church of Scientology - the balance.

The income tax return for 2000 disclosed the following distribution of net income:

JH Bamford $643

HJ Bamford $643

Narconon Anzo Inc $12 500

Church of Scientology $106 000

PJ Bamford $33 872


DL Bamford $33 872

After auditing the trust, the Commissioner of Taxation determined that both the $175 000

deduction for superannuation contributions and $16 702 as interest expense should be

disallowed as they attracted the attention Part IVA anti-avoidance provisions.

2002

The Company incurred interest expense of $17 553 from the superannuation contribution

made in 2000. Again, the Trustee recognized the interest expense in the Trust’s profit

and loss statement. This showed net profit of $55 675. However, the income tax return for

the Bamford Trust recognized a net capital gain of $29 227 and carry forward losses of

$26 448. In both May and December 2005, the Commissioner informed the trustee that

$16 100 of the carry forward losses were not available to the Trust in 2002. Citing Part

IVA anti avoidance provisions, he went on to determine that this amount was not an

allowable deduction to the trustee in their calculation of net income under section 95.

The trustee accepted that the $175 000 contribution and corresponding interest expense

was not (and never was) deductible in calculating net income under section 95. On or

about 30 June 2002, the directors of the trustee company held a trustees meeting. This

concerned how the trustee should exercise its discretion to distribute to beneficiaries. It

was held that the first $60 000 (including capital gain) was to be distributed to PJ Bamford

and DL Bamford in equal shares, and any remainder to the Church of Scientology. The

tax return showed that the net capital gain of $29 227 was distributed to PJ and DL

Bamford.

In or about February 2006, the Commissioner issued the trustee a notice of original

assessment for 2002 under section 99A. It stated that the Trust’s taxable income was

$16 100, with tax payable being $7 567 (46.5%). The Commissioner relied on the

Zeta Force Pty Ltd v FCT (1998) 39 ATR 227, noting that the excess of tax income over

trust income must be taxed to the beneficiaries in proportion to the amounts awarded to

each.

B) The judgment

Stone and Perram JJ noted that Bamford circled around two interconnecting issues:

1. What does the expression “the income of the trust estate” mean?

2. Can the terms of the trust deed determine what the income of the trust estate is?

What is income?


Almost incredulously, the term ‘income’ is not defined in the Tax Acts. Case-law provides

that at the least, ‘income’ must be determined in accordance with the ordinary concepts

and usages of mankind – see Commissioner of Taxation v Montgomery (1999) 198 CLR

639 at 661. According to Emmett J and applying FCT v Whiting (1943) 68 CLR 199 at

215, it is an important assumption underlying Division 6 that a beneficiary who derives a

share on the net income should be able to pay the tax out of that income – otherwise that

would put the beneficiary in a difficult position. Liability for tax on trust receipts should

correspond with enjoyment of those receipts. Emmett J submits in 58 that the concept of

income is consistent with beneficiaries being treated as presently entitled for the purpose

of section 97 to any amount to be received under the trust deed. The intention of Division

6 means that they should also pay tax on these amounts. Therefore, whether the trust

deed permits the trustee to treat capital receipts as income, the beneficiary becomes

automatically entitled to that share of the capital gain and thus must include that share of

the net income in their assessable income. The Trustee would not be liable under section

99A.

Cajkusic provided that ‘income of the trust estate’ meant income of the trust as

understood in trust law. There, although some expenses had been disallowed as net

income of the trust (defined by section 95), they could still be deducted from the income

of the trust estate for the purposes of section 97(1). The reason they could do this was

that the trust deed gave the trustee the express power to treat those expenses as being

on the revenue account. In this case, the Commissioner argued that “what is income for

trust law purposes, section 97 purposes, cannot be governed by what is said in the trust

deed [as that] would be remarkable. You could just define your way out of what the

Income Tax Assessment Act provides.” The Full Court in Cajkusic determined that the

Commissioner was wrong in this respect. In Bamford, the Commissioner attempted to

argue that this was merely obiter dicta. However, Stone and Perran JJ at 75 expressly

held that it actually formed part of the decision’s ratio decidendi.

The Commissioner invited the Court not to follow Cajkusic. As Courts in both Cajkusic

and Bamford are at the same standing, namely the Full Court of the Federal Court of

Australia, the Court in Bamford could choose not to follow Cajkusic only if they were of

the option that it was clearly wrong. As Stone and Perran JJ held at 76 “we are not of that

view”. At 77, they expressly provide that “… the terms of the trust may have the effect of

altering the income of the trust for section 97 purposes”, and that “this interpretation of

section 97 does not, as the Commissioner’s submissions at times appeared to assume,

have the consequence of thwarting the operation of the Act”.


Tax is on the net income of the trust. If there are beneficiaries who are presently entitled

pursuant to section 97, then section 97 says that those beneficiaries pay tax on their

share of the net income of the trust. Where there are no eligible beneficiaries, the trust is

obliged to pay tax under sections 99 or 99A. The only purpose of the concept of “income

of the trust estate” in section 97(1), is to determine the ‘share’ between the beneficiaries

and the trustee. It is not, in itself, a metric by which tax is imposed.

What is “that share of the net income”

There have been two competing approaches to the share of the net income that a

beneficiary is presently entitled to:

• Quantum approach; and

• Proportionate approach.

Section 97(1) says:

(1) Subject to Division 6D, where a beneficiary of a trust estate who is not under

any legal disability is presently entitled to a share of the income of the trust

estate:

(a) the assessable income of the beneficiary shall include:

(i) so much of that share of the net income of the trust estate

as is attributable to a period when the beneficiary was a

resident; and

(ii) so much of that share of the net income of the trust estate

as is attributable to a period when the beneficiary was not a

resident and is also attributable to sources in Australia;

Quantum Approach

This approach first appeared in Richardson v FCT (1997) 37 ATR 452.

Let’s say you are Trustee of the Bernie Trust. Trust income is $20,000. You distribute

$10,000 each to beneficiaries Bert and Ernie. But taxable income is $25,000. Why is

“trust income” different to “taxable income”? “Taxable income” is what you have to pay

thanks to the Income Tax Assessment Acts. “Trust income” is the income as defined in

the Trust Deed. These can be different, and often are to each other.

The Quantum approach says that “that share” is the specific dollar amount that Bert and

Ernie are presently entitled to – not the taxable income. Bert and Ernie would include


$10,000 each in their individual income tax returns. But the ATO is not happy – there’s

$5,000 ‘taxable income’ that no one has paid tax on. As the Trustee, you end up being

the unlucky schmuck paying 46.5% tax on the $5,000 residual income (section 99 ITAA

1936). Bert and Ernie gleefully run off into the sunset.

Proportionate Approach

The beneficiary pays tax proportionately on the share of income that they are presently

entitled to. In our Fed-Ex Trust, Bert and Ernie are entitled to $10,000 each of $20,000

income. Under the proportionate approach, they are entitled to 50% of the income. So

when the taxable income is $25,000, Bert and Ernie pay tax on 50% of that, being

$12,500. As the Trustee, you do a merry jig because you don’t pay tax on the $5,000

differential.

In Bamford, the Commissioner argued for the Proportionate approach in all

circumstances. The Bamfords argued that the circumstances should dictate whether the

proportionate or quantum approach should apply.

The Court didn’t like the Bamfords’ view. It said that the proportionate approach always

applies. A “share” doesn’t change depending on the circumstances. It doesn’t matter that

trust income is different from net (taxable) income, or whether or not beneficiaries are

entitled to a fixed or proportionate amount of trust income.

Some commentators argue that the proportionate approach was settled even before

Bamford. The Full Court of the Federal Court in Bamford applied Cajkusic v

Commissioner of Taxation [2006] FCAFC 164 which relied on Zeta Force Pty Ltd v

Federal Commissioner of Taxation [1998] FCA 728. There, the Court supported the

proportionate approach. Sundberg J held that the natural meaning of “share” was

“proportion”. It was not a “portion” or “part”. Different concepts of income could mean

different outcomes for income. He held that if Parliament wanted the court to apply the

quantum approach to a “share” they would have used the word “amount” instead.

C) What does Bamford’s mean for your trust deeds?

If you use a deed that is drafted with Bamford in mind, capital gains are taxed in the

hands of the beneficiary. The Trustee is no longer taxed at penalty rates where there is

no other income.

Bamford also means that the beneficiary’s liability is proportionate to either their fixed

dollar or variable percentage of their interest in the income. If you don’t have a Bamford


complying deed, your beneficiaries might be taxed on income that is higher than what

they actually receive.

2. PARTNERSHIPS

Splitting Income

The use of a partnership as a device for splitting income between the various members of

a family has declined because of the greatly increased use of (discretionary) Family

Trusts. Family Trusts have 100s of beneficiaries who can absorb tax. Partnerships can

only use the partners to absorb tax. However, a partner in a partnership can be a Family

Trust.

Unlimited Liability

Another disadvantage is that partners have unlimited liability. Shareholders in a company

aren’t responsible if the company can’t pay its debts. (I note however that this “limited

liability” does little to protect the Directors or de facto Director’s of the insolvent company.)

For a partnership, if your business partner borrows money for a Rolls Royce and

disappears, you are left having to pay the whole debt.

How do I establish a Partnership?

A verbal or written partnership (very common) has become a delight to the ATO. It is easy

to have a lawyer prepare a written partnership Deed. However, written partnerships

between the members of a family may not be effective to create a partnership for income

tax purposes. At the very least, you need an intention to conduct the business as a

partnership. The intention must be borne out in the way in which your business is in

practice conducted.

Partnerships don’t have to be equal. Otherwise, Dad may lose control of the business.

Dad can have 51%. The children can have the rest. Another method for control is

providing in the partnership agreement for the appointment of a managing partner with

full power of management and control.

To prepare a Partnership Deed go to www.legalconsolidated.com.au. You can create

your own over the web in minutes yourself.

Does a Partnership need its own tax accounts and tax return?

Yes. However, it is the partners who end up paying the tax. When the partnership

accounts are prepared, regard should be had to the terms of the partnership agreement


(the failure to do so had unfortunate consequences in Schultz's case (1964) 111 CLR

482.

A partnership doesn't have to distribute income based on your interest in the partnership.

For example, you may have only a 50% interest in the partnership but get 80% of the

income because your “silent partner” wants to reward the extra time you spent working.

If mum and dad are the sole partners in a Partnership, seek written advice if you

distribute income other than 50/50. Don’t even think about doing this unless you have a

written trust deed.

Division 6AA - Does the Tax Commissioner hate children?

Division 6AA imposes penal tax rates on "unearned income" derived by minors (Income

Act 1936). If your 17-year-old son works at McDonalds, then the tax rate is just what you

and I suffer. That is “earned” money. But if the child gets “unearned” money from, say a

trust, then the tax rate is often 66%! Diverting income to children may be ineffective in

reducing tax.

You can lock income away from wayward adult children in the partnership. However, this

“uncontrolled partnership income” often suffers penalty tax.

Accordingly, income-producing partnerships are often only of benefit in tax planning for

partners over 18 years and people you trust with money.

Can a partnership contribute to Super?

A company or trust can claim deductions for all superannuation contributions made on

behalf of employees up to the regulated limits.

CGT roll-over relief

If you are an individual, then you reduce your Capital Gains Tax bill by 50% - if you

comply with all the conditions (such as holding the asset for 12 months and one day).

Trusts get this as well. Sadly, companies lose this advantage. Further, you may also get

the Small Business CGT concessions. This is provided you follow the Legal Consolidated

SAS test: Are you small? Are you active? Are you significant?

Can you share the profit equally?

Most partners allow for unequal distribution of profit provided all partners agree. A

partnership may also be so constituted that one of the partners has the power to direct

the net partnership profit among the partners. Partnerships so formed are uncommon.

This is because the joint and several unlimited liability leads partners to require certainty


as to their respective rights. Income derived by a partner as a result of such a distribution

is not subject to additional tax. This is because the tax provisions apply only to an

uncontrolled share in partnership income; i.e. the question is not whether the

determination of the amount of the share is controlled, but whether the share of

partnership income, once ascertained, is effectively controlled by the partner. A net

partnership loss may be subject to allocation in a similar fashion. Care must be exercised

in drafting the partnership agreement to ensure that the income is not derived by the

partner having the power of direction but is merely dealt with as he or she directs (Jones

(1963) 109 CLR 342; 13 ATD 6).

Can one partner get income and the other get losses?

Profits cannot, for tax purposes be allocated to one partner and another incurs a share of

partnership loss. There is only one net amount. Either net income of the partnership or a

partnership loss is available. The practice of the Tax Commissioner in assessing partners

who receive distributions in the form of salaries, as well as in the form of shares of net

profit or loss after payment of salaries, where there is a net loss, is concessionary only

and not one which the partners could oblige the Commissioner to adopt.

Mr & Mrs McDonald had a house …

But it is all different for mum and dad that lease out their rental property.

Have a look at McDonald's case 87 ATC 4541. Mr & Mrs McDonald acquired a rental

property as “Joint Tenants”.3 They agreed that any net profit is apportioned 75% to the

wife and 25% to the husband. On the other hand, they agreed that the husband wholly

absorbs any loss. (Mr McDonald, we assume, was making a bucket of money and paying

a lot of it in tax. Mrs McDonald we assume was paying tax at a lower rate. Consequently,

Mr McDonald wanted losses to reduce his tax. Mr McDonald wanted income because her

tax rate was less than her husbands.)

Commercial partnership can cut the cake in many different ways. However, the court held

that there was no partnership at general law. Therefore, the husband was entitled to

claim only half of the losses (not all of the loses). His wife could only have half the profits.

Importantly, the position may have been different had there been a written partnership

deed. (see Case 12/95 95 ATC).

3 “Joint Tenants” have to have equal holdings in the asset. For example, if you have two people, then to remain as joint tenants they have to be 50/50. To keep three people as Joint Tenants they have to be 1/3, 1/3 and 1/3.


3. A Company (Pty Ltd, Limited and No Liability)

A person may rush off and buy a Proprietary Limited Company at

https://www.legalconsolidated.com.au/company/.

In the good old days, your personal assets were protected if your company was broke.

This is called “limited liability”. The tremendous benefits of limited liability are a thing of

the past because:

1. The Corporations Law can hold executive, non- executive and de facto

(shadow) directors responsible for the companies’ debts.

2. Landlords and banks generally require you, as the director, to sign personal

guarantees. These guarantee the companies’ contractual obligations and

debts.

3. The ATO can bankrupt the directors for failing to pay PAYG and

superannuation and leave the company intact and solvent.

All Australian companies and their shares are controlled by a great deal of legislation.

Most of this is contained in the Corporations Act 2001 (Cth). This is the second largest

single piece of legislation in Australia (after the Tax Acts). This increases the expense

and time to manage and comply with all the government regulations.

Talk it over with your Adviser, Accountant and Tax Lawyer before you build a company.

How many Directors do you need in a company?

There is good news. Companies may now have only one shareholder and director

(making it easier for sole traders to incorporate). To reduce the administrative burden on

small business, various accounting and other requirements are removed. Further

improvements increase the capacity of companies to distribute capital to shareholders.

This allows companies to stream all capital contributed for shares to the shareholders

who did not contribute it.

Another interesting point is the so-called "dividend access" shares. This may be issued to

family members without giving them any control over, or substantial equity, in the

company but enabling company profits to be distributed to those shareholders. This is

contingent on minors being of sufficient maturity to understand the general nature of their

contract with a company. This is also subject to certain other qualifications. For example,

such shares may be issued to minors (although dividends derived by minors are subject

to the higher Division 6AA ITAA1936 penalty rate of tax).


Other advantages of a company are: unlike a natural person, it does not die thus avoiding

any difficulties relating to devolution of property. A company provides shareholders with

the benefits of limited liability and is a well-recognised commercial vehicle with a

reasonably solidly established body of law concerning its operations. On the other hand,

a director has substantial and stringent legal duties and, in certain circumstances, is liable

for the debts of the company.

Tax advisers should be aware that the Commissioner regards the use of a family

company to split an individual's personal exertion income among family members as a

potential tax avoidance arrangement. The general anti-avoidance provisions of Pt IVA

can strike down such arrangements unless the family company has either significant

income-producing activities or assets, or engages a number of employees (Taxation

Ruling IT 2121). Note that the simple disposition of an income-producing asset by an

individual to a company wholly owned by that individual will not generally attract the

operation of Pt IVA. An example being where an individual incorporates a company to

which he or she transfers a rental property or share portfolio (Taxation Determination TD

95/4).

Hot CGT issues in a company

Where the business of a company is structured to have a small amount of issued capital

and a large amount of loan funds (provided by the proprietors of the issued capital) the

cost of the shares would not substantially increase the cost base of such shares. (The $2

shelf company is a bad idea if you are hoping for growth - capital gains). In some such

cases, it may be desirable to inject additional funds into the company as capital.

However, if the shares in the company were issued or allotted prior to the introduction of

the Capital Gains Tax (20 September 1985), great care must be taken to ensure that

sections 149-55 and 149-35, which may deem a pre-CGT asset to have been acquired

after 19 September 1985 where there is a substantial change in the underlying beneficial

interests, or the share value shifting provisions of Division 19B are not triggered.

If the business of the company commenced before 20 September 1985 but substantial

share capital was issued on or after that date, it may be advantageous to sell the assets

rather than the shares, as a substantial amount of goodwill may be exempt from CGT. If

the sale consideration includes a share of future profits, the implications of Taxation

Ruling TR 93/15 will need to be considered. Broadly, that ruling requires the vendor to

pay tax on the market value of the right to profits. The right itself is an asset. Therefore,

you have CGT questions. Note that when shares in a company are sold the proceeds of

the proposed roll-over relief, applicable (from 1 July 1997) where active assets of a small


business are sold and the proceeds reinvested in active assets of another business

(where total assets do not exceed $6m), will not be available.

Companies should not be used to hold capital-appreciating assets. To the extent that

dividends distributed to shareholders represent the indexed component of a capital gain,

which is tax-free, those dividends will not be franked (franking credits do not arise where

no tax is paid). Accordingly, a resident individual shareholder may pay tax on what would

otherwise be a tax-free amount. Alternatively, a lack of franking credits may erode the

value of the company's shares.

4. What is a Unit Trust?

A Unit Trust is similar to a Family Trust but is used - you guessed it - for businesses

rather than a single family. The Unit Trust is simply an extension of a Family Trust into the

field of commerce. A Family Trust is controlled by one or two people (usually a husband

and wife.) The husband and wife have complete discretion as to whom they distribute

income to each financial year. Such a “trust” is not usually shared outside a family!

Hence, the need for a Unit Trust. (For more information on Unit Trusts see

www.legalconsolidated.com.au or get one at www.legalconsolidated.com.au).

How does a Unit Trust work?

At the end of each year, income is distributed to the Unit Holders in proportion to the units

that the beneficiary holds. The Trustee has no discretion.

Units may be held by Family Trusts, companies or by individuals.

Can’t I just use my Family Trust to do all this?

A Unit Trust serves a different purpose to a discretionary Family Trust. A Unit Trust has:

• negotiability (you can buy and sell units)

• fixed annual entitlements to income and capital (the trustee cannot reduce your

entitlements)

A Unit Trust can have discretionary units. However, the discretion is restricted to income

(not capital). A Unit Trust should generally not be used as a substitute for a Family Trust.

Rather, it may be prudent to have your Family Trust owning the units in the Unit Trust.

What happens if the Unit Trust goes broke?

Unfortunately, unit holders can be liable to pay any shortfall of assets on the Unit Trust

going broke, especially if the trust is not properly drafted and maintained by your

professional advisers.


In Broomhead Pty Ltd (in Liquidation) v Broomhead Pty Ltd (1985) VR 891 Justice

McGarvie stated that the unit holders in a Unit Trust were liable to indemnify the trustee

against liabilities incurred in carrying on a business. In this case the share of each

beneficiary’s liability was limited to the proportion of his or her beneficial interest.

Cashing in and transferring of units

The ownership of the trust funds is divided into a number of equal units. The units are

recorded on a register and are transferable like shares in a company.

Well-constructed Unit Trusts include mechanisms for cashing in (redemption) and

transferring the units. Of particular importance is the procedure for determining the price

at which units are to be redeemed.

Units in the Unit Trust can be readily traded and people holding them can participate in

the profits of the business on a set percentage.

What do you consider when setting up a unit trust?

Some of the issues to be considered when setting up a unit trust are:

1. the composition and control of the trustee company, the method of arriving at

decisions (e.g. whether unanimity should be required in certain cases) and the

method of removing the trustee and appointing a new trustee (the fact that two

or more unrelated parties may be associated in the operation of a unit trust and

the fact that the unit trust, unlike a discretionary trust, will normally be under the

control of more than one person, increases the risk of disputes as to the

management of the trust assets and the construction of the relevant

documents);

2. the powers of the trustee to determine whether receipts, receivables, outgoings

and other charges are on income or capital account with particular regard to

the effect of special tax concessions;

3. the extent of control which should be exercised by unit holders over the

activities of the trustee;

4. the means of transferring units or permitting unit holders to have their units

transferred or redeemed;

5. whether units should, in any circumstances, be subject to compulsory

redemption and how this should be achieved;

6. the means of introducing new unit holders;


7. the extent of the indemnity which should be provided to the trustee for

breaches of trust and the effect of these provisions upon potential lenders to

the trustee;

8. the means of excluding a unit holder (frequently the trustee of a discretionary

trust for the family of a particular principal) from a continued interest in the unit

trust following the death of the principal in a manner which is both fair to the

family of the deceased principal, but not onerous for continuing unit holders;

and

9. the protection of unit holders from personal liability to the extent that this is

possible.

5. Some special trusts

5.1 Hybrid Discretionary Trust

A hybrid discretionary trust represents a mix of a fixed / unit trust and a discretionary

trust. The beneficial interest in the trust has both fixed and discretionary components.

• It is the most flexible structure in the majority of occasions.

• Income ‘must’ be distributed to the unit holders in proportion to the units.

• Capital Gains can be distributed to discretionary beneficiaries.

Example: The Happy Family Trust has four beneficiaries, Andrew, Mark, Jane and Sue.

Andrew and Mark each have a fixed entitlement to the assessable income derived by the

trust. The trustee has a discretion as to which beneficiaries, being Andrew, Mark, Jane

and Sarah, may become entitled to non-assessable gains.

By dividing the beneficial entitlements in this manner, the trustee may choose to distribute

any non-assessable amounts to beneficiaries who do not hold a fixed entitlement in the

assessable income or capital of the trust. Splitting the distributions in this manner has the

potential to avoid the operation of the cost base adjustment rules and to also prevent a

reduction in any deductible interest expense of beneficiaries who have borrowed to

purchase fixed entitlements in the trust property.

Sadly, thanks to the ATO’s interpretation it is no longer possible to negatively gear using

these structures. We have applied for a number of private rulings on this. All have been

unsuccessful. For the ATO risk and reward must be linked, but even when they are

negatively gearing doesn’t seem possible.


To prepare a Hybrid Discretionary Trust go to www.lawcentral.com.au. You can create

your own over the web in minutes yourself.

(For more information on Hybrid Discretionary Trusts see www.legalconsolidated.com.au

or get one at www.lawcentral.com.au.)

5.2 Special Disability Trusts & Testamentary Disability Trusts

Introduction

Death is inevitable. For most people this inescapable truth is both frightening and

depressing. For people with severely disabled children, there is even greater concern.

The issues surrounding what happens to profoundly disabled people when their parents

die is one of the leading causes of anxiety for those parents.

To make matters worse, governments and Centrelink have put many rules in place to

stop people planning for disabled people’s needs.

Fortunately, parents of disabled people can now achieve some peace of mind. From

September 2006, special treatment is given to certain trusts set up for disabled people.

These new ‘Special Disability Trusts’ allow parents and family to make provision for

disabled people after the parents die.


What is a ‘Special Disability Trust’?

It is a private trust set up for the benefit of a severely disabled person. If the sole purpose

of the trust is the maintenance and care of a disabled person, then the trust may be given

concessional treatment under the Social Security Act 1991 (Cth) and the Veterans

Entitlement Act 1986 (Cth). This reduces the draconian effects of the dreaded

‘Deprivation Rules’.

The Deprivation Rules work in two insidious ways. Firstly, let’s say you have too much

money to receive a government pension due to means testing. You decide to give some

money to your family. Sorry. The Deprivation Rules mean that you are deemed to still

have that money in your possession for another 5 years - even if the gift put you below

the means-tested threshold. The injustice of the Deprivation rules is that, secondly, the

person you gave the gift to is still recognised as receiving the money – which may affect

their Centrelink entitlements. The government taketh, then it taketh some more.

How does a Special Disability Trust help?

Basically, gifts made in a Special Disability Trust or a Testamentary Disability Trust are

no longer subject to the Deprivation Rules. The disabled person’s Centrelink benefits

won’t be reduced because of ‘means testing’. The family member giving the money won’t

lose out. This means that now, even middle-class people – who are punished the most by

the Deprivation Rules – can look after their disabled children.

How much money can be put into the trust?

Family members can put up to a total of $500,000 plus annual indexation into the trust.

This is in addition to their residential home.

Up to this amount, the capital and the income of the trust are not means-tested by

Centrelink. The disabled person’s pension or Centrelink payments are not reduced.

What are the requirements?

There are a number of conditions and requirements. These must be met before the trust

is eligible for the concessions. The main requirement is that the beneficiary of the trust

has a certain level of disability. There are two tests, depending on the age of the child:


• If they are under 16, they must be ‘profoundly disabled’; or

• If they are 16 or over, they must qualify for a disability support pension or

equivalent

6. Unit Trust vs. Company

On the face of it, owning units in a Unit Trust is similar to owning shares in a company.

However, The High Court of Australia has stated that a unit in a Unit Trust is

fundamentally different to a share in a company. A shareholder has no interest in the

assets of the company. A Unit Holder holds a proprietary interest in all the trust property:

Charles v Federal Commissioner of Taxation (1954) 90 CLR 598.

Therefore, a unit holder can lodge a caveat over land held in the Unit Trust. A

shareholder in a company has no such right.

Other differences are:

• A trust comes into existence as the result of a private rather than a government act.

There is less governmental regulation of trusts.

• A company is a legal entity in itself. A trust is not a separate legal person and offers

more flexibility.

• In a Unit Trust, the trustee holds property such as shares in a company, on trust for

the Unit Holders. The Unit Holders are regarded, like beneficiaries under a trust, as

equitable owners of the investments held by the trustees.

• A company is linked together by a contract in the company’s Memorandum and

Articles or Constitution. On the other hand, investors in a Unit Trust are not necessarily

in any contractual relationship with each other. There is more flexibility in a Unit Trust.

• Although a trust is not a corporation or company, a person connected with a trust may

be a company.

• You can sell both shares in a company and units in a Unit Trust. You can draft your

Unit Trust so that you have to offer your units to other unit holders before you sell them

on the open market. Shareholders in a company can enter into similar restrictions

through a shareholders’ deed. (However, there is often higher stamp duty on the sale

of Units.)

• Employee Share Scheme concessions aren’t available for Unit Trusts.


7. Family Trust vs. Company - is it a fair fight?

The factors relating to the question as to whether Family Company is to be preferred to a

Family Trust have been altered considerably in recent years. The imputation system in

relation to dividends and the abolition of undistributed profits tax (particularly where the

family income consists wholly or mostly of dividends or other property) is beneficial to the

family company.

Of course, as much flexibility as possible should be maintained in any set-up. In some

cases, this may be obtained by having a discretionary Family Trust with both individual

and company beneficiaries. The shareholders of the company being those persons whom

it is desired should eventually benefit. Ultimately, however, whether a family company or

a discretionary Family Trust is the appropriate vehicle will depend upon the

circumstances of each case. Considerations other than tax (e.g. the costs of establishing

and maintaining a particular structure) must also be taken into account.

Can you gear into a Family Trust and a Company?

Yes, you can. Negative gearing transactions may involve the use of Family Trusts or

companies. For example, in Janmor Nominees 87 ATC 4813, a Family Trust was allowed

a deduction for interest payable on loans used to purchase an investment property even

though the interest ($14,251) considerably exceeded the rent earned in the year in

question ($6,915). This decision is significant in the context of highly geared residential

properties, which generally produce significant revenue losses (ignoring capital

appreciation).

However, it cannot be assumed that interest on all negatively geared investments are

deductible.

Generally, the “loss” can only be offset by other “income” in the trust. Otherwise, you

need to try to carry forward the “loss” into subsequent financial years. Sadly, only income

and capital gains can be passed onto the beneficiaries. Much like companies, losses are

quarantined and remain stuck in trusts. Beneficiaries can’t directly gain the benefit of

losses.

Claiming seminars off the tax – which vehicle is best?

No structure is better than any other. If you are running a business, you have a lot more

scope in claiming tax deductions. Nevertheless, both business and individuals may be

able to claim certain training expenses off the tax.


Firstly, there is a blanket prohibition on claiming entertainment expenses – section 32-5

ITAA 1997. However, this prohibition on the deductibility of entertainment does not apply

to the cost of food, drink, accommodation and travel that is reasonably incidental to a

person's attendance at a "seminar'' lasting at least 4 hours: see section 32-35 and

Taxation Determination TD 93/195. Meals, rest or recreation breaks do not affect the

continuity of a seminar and are not taken into account in determining its duration.

What can a “seminar” include? A seminar includes a conference, convention, lecture,

meeting, award presentation, speech, question-and-answer session, training session or

educational course.

An expense is not deductible, however, if: (a) the seminar is a "business meeting''; or

(b) the main purpose of the seminar is the promotion or advertising of a business or of its

goods or services or the provision of entertainment. A seminar is a business meeting if its

main purpose is to enable discussion of the affairs of a particular business between

persons associated with that business.

Deductibility is not denied, however, if the seminar is organised by or on behalf of the

employer solely for training employees, partners or directors. This is in matters relevant to

the company's business, or enabling employees, partners or directors to discuss general

policy issues relevant to the internal management of the employer's business. This is

when it is conducted in conference facilities operated by a person whose business

includes organising seminars or making property available for conducting seminars.

9. STRANGE DEVELOPMENTS

“Is there life after Richstar?”

Australian Securities & Investments Commission: in the matter of Richstar Enterprises

Pty Ltd (ACN 099 071 968) v Carey (No 6) [2006] FCA 814 (Richstar)

Richstar is a case dealing with the ‘legal fallout’ from the Westpoint collapse.

The decision dealt with the question of whether an interest in a family discretionary trust

could be included in a receivership order, in other words, ‘whether a beneficiary’s mere

expectancy in a discretionary trust may be subject to a freezing or receivership order

under section 1323 of the Corporations Act 2001 (Cth).

Answer: It depends, but Yes, where the person controls the trust.


A) Background:

1. In January 2006, KordaMentha were appointed as receivers to the collapsed

Westpoint property development group. Westpoint’s debt shortfall is somewhere between

$400 and $500 million. $300 million is owed to approximately 4,000 mezzanine investors.

2. The Westpoint 1323 order:

In April 2006, ASIC obtained orders under section 1323 of the Corporations Act 2001

(Cwth) to appoint receivers to the property of certain Westpoint group entities. Section

1323 provides the court with extremely broad powers to prevent persons who may have

acted in breach of the Corporations Act 2001 (Cth) from dealing with money or property

concerned with the contravention.

3. In Richstar No 6, ASIC sought to extend the classes of property the subject of the

Westpoint 1323 Order to property of which the Defendants were:

• sole or joint trustees; or

• general beneficiaries

In this case, Justice French of the Federal Court made some very significant rulings about

the use of family discretionary trusts to protect assets from creditors.

B) Findings

The Court considered the rights of a beneficiary under a discretionary trust and

distinguished between a beneficiary who controls a trust and a beneficiary who does not.

The Court concluded that:

In the “ordinary case”, a beneficiary of a discretionary trust at arm’s length from the

trustee does not have a contingent interest in the trust property, only an expectancy of a

distribution. As a consequence, there is no interest that would fall within the definition of

‘property’ in section 9 of Corporations Act 2001 (WA), and therefore no property that can

fall within the control of the receiver under 1323.

In the exceptional case, a beneficiary who effectively controls the trustee of a

discretionary trust may have what approaches a general trust power and thus a

contingent proprietary interest in the income and capital of the trust. In other words,

where the trust is really a vehicle at the will of or under the effective control of a

controlling person (either personally as trustee or as appointor or as a director or

shareholder of the corporate trustee) that property can be deemed to be property of the

controlling person for the purpose of section 1323.

The Court said:


The difficulty with applying the notion of contingent interests to beneficiaries of a discretionary

trust lies partly in the uncertain scope of the distribution be it income or capital, which may be

made in favour of any given beneficiary. I am inclined to think that a beneficiary in such a case, at

arms length from the trustee, does not have a ‘contingent interest’ but rather an expectancy or

mere possibility of a distribution. In some discretionary trusts, and there is an example among

those of which Mr … is a beneficiary, charities as a class are included in the class of beneficiaries.

It could hardly be said that every charity in Australia has thereby acquired a contingent interest in

that trust. On the other hand, where a discretionary trust is controlled by a trustee who is in truth

the alter ego of a beneficiary, then at the very least a contingent interest may be identified because,

to use the words of Nourse J, ‘it is as good as certain’ that the beneficiary will receive the benefits

of distributions either of income or capital or both. (paragraph 36)

“…the beneficiary who effectively controls the trustee’s power of selection because he is the

trustee or one of them and/or has the power to appoint a new trustee has something approaching a

general power and the ownership of the trust property”. (at paragraph 37)

The example given by the court in clause 41 gives this principle a huge potential

coverage:

By way of example, Mr …. is a beneficiary of the Agribusiness Annuity Trust of which Eagle Bluff

Nominees Pty Ltd is trustee. He is the director and secretary of that trustee company. He is the

original appointor under the trust and his wife, …, the current appointor. The trustee has a wide

discretion including the power to prefer one or other beneficiary to the total exclusion of any other

beneficiary. Mr …. would appear, through his trustee company, to have effective control of the

assets of the trust. At the very least he has a contingent interest in the sense used earlier. His

interest would appear to amount to effective ownership of the trust property. The property of that

trust is, in my opinion, amenable to control by the receivers under s 1323. (at paragraph 41)

Quietly, in January 2011 ASIC dropped the actions against the Westpoint directors.

Everyone pays their own costs and goes home. No apology was every made to the

Westpoint directors. This is another example of the bully boy populist mentality of large

government organisations such as ASIC and the ATO.

C) ASSET PROTECTION STRUCTURING AFTER RICHSTAR

I would like to consider the potential impact in structuring discretionary trust for asset

protection planning.

Independent Appointors

As we have said before, the appointor is the ultimate controller. He or she is God.

An independent appointor (such as an accountant or financial adviser) would be one

possibility of diversifying control of the trust).

Some trust deeds, (such as the Legal Consolidated one) have if upon an appointor being

declared bankrupt, he has to resign or is sacked as appointor. The reason for this was

concern that a trustee in bankruptcy may step into the shoes of the appointor despite of

the decision in Re Burton (1994) 122 ALR 399, and attempt to exercise the power of

appointment.


A further possibility would be that the appointor decisions should be made unanimously.

We believe the appointment of an independent appointor and the requirement that the

appointor must act unanimously may avoid the expensive operation of the Richstar

decision. However, this only works if it can be established that the ‘independent’

appointor was independent and not used, or accustomed to act at the direction of the

other appointor.

Independent Trustees

It might be difficult to establish an independent trustee in the normal circumstances if you

have chosen an individual as trustee. In relation to a corporate trustee there might be

more possibilities and flexibility.

Shares in the corporate trustee could be owned by another family trust directly or

indirectly controlled by the spouse. Or you can go one-step further, and the shares could

be owned by an unrelated party. What is the danger of the shares owned by an unrelated

party if the only function of the company is to be a corporate trustee?

The more entities and the more unrelated the entities are in the chain of ownership, the

more indirect and remote will be the ownership and the ‘effective control’ as required by

French J in Richstar.

The use of various strategies should diffuse ownership and control and will make it more

and more difficult for the receiver to identify the relevant trusts.

D) WHERE DO WE GO FROM HERE?

Richstar should be confined to the facts and the context of s 1323 of Corporation Act

2001 (Cth). Nevertheless, diffuse the control of the trust by the appointment of

independent

• Appointors; and

• officers and shareholders of the corporate trustee.

Asset Protection Lessons

The ‘at risk’ person, the person whose assets you are seeking to protect, should most

conservatively not be in ‘effective control:

• A trustee

• An office holder of the corporate trustee

• A shareholder of the corporate trustee

• An appointor of the trust


Nevertheless, it would be worthwhile to reconsider either when setting up a new trust or

reviewing a current trust structure who should fulfil the various roles such as appointor,

trustee and default beneficiaries.

However in practice it could be difficult to identify an appropriate independent person.

Further, there is always the risk that this person may abuse the power. To find the

balance between optimal asset protection on one side and maintaining the flexibility and

control of the trust on the other side will be a challenge we have to deal with.


Business Structures – which is the best?

Structure Advantages Disadvantages

Sole Proprietor

Partnership

Family Trust

Unit Trust

Company

Paper prepared for · Estate Planning vs. Doing it Over the Coffin “A vital focus of every...

Documents

Transcript of Paper prepared for · Estate Planning vs. Doing it Over the Coffin “A vital focus of every...