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

1. Trust structuring
Matthew Burgess – Partner
March 2012

2. Overview
 The right structure
 Asset protection
 Read the deed!
 Updating trust deeds
2
#16592097

3. The old world – discretionary trusts
 Flexibility
 Retained profits
 CGT discount
 Division 7A
 One family
 Partnerships of
discretionary trusts
3
#16592097

4. The old world – companies
 30% tax rate
 No CGT discount
 More than one family
 Top up tax dividends
 Larger business
 Shares held by
discretionary trusts
4
#16592097

5. What has changed
 Bamford etc
 Division 7A
 TR2010/3 and PSLA 2010/4
 The ‘interim’ legislation
5
#16592097

6. Problem areas
 Problem area no. 1 - streaming
 need an attribution clause
 otherwise – proportionate approach
 ATO attitude – Bamford DIS
 is the ATO right?
6
#16592097

7. Problem areas
 Problem area no. 2 – the interim rules
July 2013 at the earliest – 3 years
the process/steps
unrealistic timeframes for distribution
resolutions and minutes
timing generally
7
#16592097

8. The six steps for trust distributions
 Step 1 – application of Division 6 without
modification
 check definition of income for what is included
 capital gains
 franking credits
8
#16592097

9. The six steps for trust distributions
 Step 2 – calculate adjusted Division 6 percentage
 exclude amounts to which beneficiaries are specifically
entitled
 relevant for ‘unstreamed’ amounts
 proportionate approach
 blending of income, dividends and capital gains
9
#16592097

10. The six steps for trust distributions
 Step 3 – apply Subdivision 115-C
 is discount amount included in income?
 capital gains
 capital distribution if not (and if possible)
 quantum approach
10
#16592097

11. The six steps for trust distributions
 Step 4 – apply Subdivision 207-B
 dividends
 Step 5 – Division 6E recalculation
 Step 6 – overall calculation
11
#16592097

12. Problems with the interim rules
 Streaming power – read the deed
 Specific entitlement
 capital gains
 dividends
 associated expenses
 ‘recorded in is character’
12
#16592097

13. Problems with the interim rules
 Chains of trusts
 Allocation of expenses
 resolution timing
 deed provisions
13
#16592097

14. Are capital gains income?
 Depends on the definition of income
 Section 95 – yes – Discount capital gain
is part of assessable income
 Income on ordinary concepts – no: need
capital distribution power
14
#16592097

15. Are capital gains income?
 No definition – no
 Trustee can determine – trustee decides
 Discount amount
15
#16592097

16. Timing of resolutions
 What does the deed say?
 30 June and 31 August resolutions
 Withdrawal of IT 328
 Resolutions v minutes
 What to do
 Default or accumulation?
16
#16592097

17. What you cannot stream
 Negatively geared shares
 Capital gains – market value substitution
rule
 Deemed capital gains
17
#16592097

18. What you cannot stream
 50% discount depending on the income
definition
 Where net financial benefit flows
elsewhere
18
#16592097

19. Getting it wrong
 Franking credits are not income
 Mixture of normal income, franked dividends and
capital gains
 Capital gains end up in companies
 Default beneficiaries
19
#16592097

20. Conclusions
 Read the deed
 Income definition in particular
 does this include CGT discount
 separate capital distribution (is there power in the deed)
 Section 95
 Trust law income
 Different from tax law income
 Preference – trustee has ability to determine
20
#16592097

21. Some possible solutions for structuring
 Horses for courses
 Separate trusts for shares/dividends
 Beware of family trust elections
 Beware negatively geared shares
 Pooling of dividends
 ‘Recycle’ bucket company dividends to overcome
negative gearing
21
#16592097

22. Some possible solutions
 Business Licence
 Corporate beneficiary owns business
assets
 Business held by a company and shares
held by a trust
 Separate trust for capital assets, to deal
with capital gains
22
#16592097

23. Some possible solutions
 Still be wary to distribute the discount
amount
 Read the deed
 Trust ordinary income with corporate
beneficiary
 Using a company for investments
23
#16592097

24. New structures versus restructures
 Easier for new structures
 Revenue costs of restructure
 Stamp duty, properties not shares
 Capital gains tax
24
#16592097

25. Key issues
 We have started doing some things differently
 Asset protection from relationship breakdowns
 Estate planning
 Other recent cases
 Audit process
 Deed updates
25
#16592097

26. Div 7A & UPEs
Matthew Burgess – Partner
March 2012

27. Summary
 UPE refresher
 ATO view – TR 2010/3 and PS LA 2010/4
 Solutions - the subtrust approach
 The impact of not adopting the subtrust
approach
27
#16592097

28. Summary
 Alternatives to the PS LA options
 Restructuring business entities to prevent UPEs
arising in the future
 WHAT should have HAPPENED BY 30 JUNE 2011
 Questions
28
#16592097

29. Section 2 loans
Unpaid present entitlement can be a Div 7A loan if:
 explicit agreement between the company and
trustee
 implied agreement by crediting a loan account
with authorisation by the company (express or
acquiescence with knowledge)
 note assumed family knowledge
29
#16592097

30. Section 2 loans
 the terms of the trust as set out in the Deed
permit the trustee unilaterally to apply the UPE
by way of a loan to the trust
Investigate further if
 UPE described as a loan in accounts
 UPEs added to or set off against other loan
accounts
Take action by 31 December 2011
30
#16592097

31. Section 3 loans
 ATO view - Unpaid present entitlement can be a
Div 7A loan if......
 provision of ‘financial accommodation’
 company acquiesces (i.e. by company not calling
for UPE funds)
 with knowledge of the use of the funds for trust
purposes
31
#16592097

32. ‘Knowledge’
 Where trust and corporate beneficiary part of
same family group
 in absence of sufficient evidence to the contrary
 ATO view is company has requisite knowledge of
the use of the UPE for trust purposes
32
#16592097

33. UPE Solutions - manage
 Broadly, two ways to prevent Division 7A
 First - ensure funds are held on sub-trust for the
sole benefit of the private company
 PS LA 2010/4 sanctioned arrangements
–
–
–
–
33
#16592097
option 1 – a 7 year ‘interest’ only ‘loan’
option 2 – a 10 year ‘interest’ only ‘loan’
option 3 – specific investment in main trust
‘Return on investment’ arrangement (option 4)

34. UPE Solutions - restructure
 Second - ensure no UPE arises
 Asset licenses
 Rollover of assets
 Pay UPE and acquire depreciating assets in
company
 Other planning strategies
34
#16592097

35. Why we care now
 Unlike a number of other controversial ATO views
the ATO has not withdrawn from its position
 many will have received an ATO letter identifying
the clients that have company’s that have
received trust distributions
 Fundamentally action in respect of the 30 June
2010 distributions by trusts to companies needed
to occur by 30 June 2011
35
#16592097

36. Sub trust overview
General guidelines - ATO accepts sub trust if
 sub-trust invests in main trust on commercial
terms
 all benefits flow to sub-trust and company
 all benefits actually paid by lodgement day of ITR
of main trust for year of benefit
36
#16592097

37. Sub trust options
 Apply above or adopt specific options from PS
LA 2010/4
 option 1 – a 7 year ‘interest’ only ‘loan’
 option 2 – a 10 year ‘interest’ only ‘loan’
 option 3 – an investment by the main trust in an
income producing asset
 option 4 - ?
37
#16592097

38. Option 1
 Better than a Div 7A loan – interest only
 Option 1 – UPE funds repaid within 7 years
interest at Div 7A benchmark interest rate
(7.40%) or
 Payable by ITR due date
38
#16592097

39. Option 2
 UPE funds repaid within 10 years RBA small
business variable overdraft rate for prior May
(10.65%)
 ATO: terms of investment must be documented
and need to be legally binding
 could be as part of ITR working papers
39
#16592097

40. Options 1 and 2 - risks
 how is ‘legally binding’ possible?
 documentation issues ‘investment agreement’
 if merely allocation of main trust income (as
draft allowed) – not legally binding
 if actual loan - parties are main trust and subtrust?
 can this loan in itself cause Div 7A issues? –
interposed entity rules
40
#16592097

41. Options 1 and 2 - risks
 potentially best solution for 2011 year
 implement ‘investment agreement’
 ‘investment agreement’ needs to be drafted
correctly to preserve the position and satisfy the
ATO requirements
 arguably still a UPE if documented correctly
 cash flow ‘interest’ due by lodgment date for 2012 ITR
 although ‘interest’ must accrue from 1 July 2011
41
#16592097

42. Options 1 and 2 - outcome
 ‘interest’ is ultimately assessable to company
beneficiary of the subtrust
 if applied to income producing assets then ATO
position that ‘interest’ is deductible to main trust
that retains use of the funds
 given that the ‘interest’ is potentially funded out
of the trust income it can give rise to a neutral
outcome
 no separate tax return
42
#16592097

43. Option 3
 Specific investment by trust in income producing
(or capital appreciating) asset
 Separate accounts and ITR (not required for
options 1 and 2)
 Arm’s length return
 Payments must be made to company each year
by ITR due date
43
#16592097

44. Option 4
 Not specifically recognised in final practice
statement
 UPE in favour of company, placed on sub-trust
 Sub-trust invests funds back into main trust
 Main trust pays ‘rate of return to sub-trust’
 Contemplated in draft PS LA 3362
 Contemplated in TR 2010/3 at example 8 (an
‘investment on terms’ as opposed to legally binding
loan)
44
#16592097

45. Option 4 - outcomes
 Possible to argue not a ‘loan’ but an ‘investment
agreement’
 Repayments linked to performance of trust
business/investment
 Lower or nil if losses in trust
45
#16592097

46. Rollover business into company




Restructure using trust-to-company rollover (122-A)
Sell business into company and operate in company at 30% tax rate
Could use small business concessions, if possible, rather than 122-A to
uplift cost base
Potential stamp duty issues
Assets
Trust
100% shares
Company
46
#16592097

47. Asset licence – depreciating assets



Commence or transfer business to operate in the company, retain capital
assets in trust (can also use 122-A rollover)
Business assets licence (‘goodwill licence’)
Stamp duty issues if transferring assets
Trust
Licence to use
assets
Company
47
#16592097

48. Asset licence – business operated
by Trust



Continue to carry on business in Trust
Pay the UPE to the Company
The company uses the funds to buy depreciating assets for the business
and license back to the Trust
Trust
Licence to use
assets
Company
48
#16592097

49. Business licence
 Trust ‘licences’ business assets and operations to
a company
 under written licence agreement
 supply all assets, rights, customers lists etc
 Licence fee arm’s length e.g. % of company turnover
 Licence agreement terminates with say 1 month’s notice
and all assets revert to trust
49
#16592097

50. Business licence (cont)
 If licence agreement structured correctly then
 no CGT etc
 limited stamp duty costs
 company taxed at 30% on operating profit less licence
fee
 future CGT issues for business sale should remain with
trust
 NOT a goodwill licence (Murry)
50
#16592097

51. Special purpose company
 Instead of option 3 – establish SPC
 Trust distributes AND pays the entitlement to the
company which acquires the depreciating assets
 lease or licence for a fee to operating trust
 appropriate fee for depreciation deduction claim
 Division 7A payment rules
 109CA extended ‘payment’ definition
 109CA(5) – ‘otherwise deductible’ rule
51
#16592097

52. Special purpose company
 Division 43 improvements – funded / acquired by
SPC on trust’s land
 Division 7A payment rules
 otherwise deductible for use
 issue if land owned by trust is sold – payment that is
not otherwise deductible
 agreement for market value compensation
 Capital appreciating assets
52
#16592097

53. UPE – complying loan
 Strictly it is a UPE that is a ‘financial
accommodation loan’
 BUT needs to satisfy 109N requirements
 Risk - cannot do so without in substance
becoming a loan at law
53
#16592097

54. End option 1 or 2 ‘loan’
 ATO position PSLA 2010/4 – para 74 & 86
 needs to be repaid
 Alternative rely on para 120 & 121
 end of loan period becomes a section 3 loan
 turn into a complying loan
54
#16592097

55. Accounting issues – Option 1 & 2
 ATO guidance no separate accounting or tax
returns
 ‘Interest’ return journalised – then paid
 Separate line item/s in accounts?
55
#16592097

56. Timing – 2010 UPE
30 June
2010
UPE arises
from 2010
trust
distribution
30 June
2011
2011
ITR due
date
30 June
2012
2012
ITR due
date
Record
2012
accrued
interest
PS LA
subtrust
options
if no
subtrust
loan
arises
56
#16592097
109N loan
agreement
P&I
repayment
Pay 2012
accrued
interest

57. Timing – 2011 UPE
30 June
2011
UPE arises
from 2011
trust
distribution
2011
ITR due
date
PS LA
subtrust
options
30 June
2012
2012
ITR due
date
Record
accrued
interest
(2012
part year)
30 June
2013
Pay 2012
accrued
interest
Record
2013
accrued
interest
109N loan
agreement
P&I
repayment
if no
subtrust
loan
arises
57
#16592097

58. Other strategies ?
 Secured loans (including converting 7 year loans)
 Capitalisation and on lending
 Rollover of investment agreements
 Dividend recycling
 Absolutely entitled trusts
 Limited and corporate partnerships
58
#16592097

59. Estate planning update
Matthew Burgess – Partner
March 2012

60. Estate planning overview
 Different strategies
 More than a will !
 Protecting wealth
 creditors (bankruptcy)
 matrimonial breakdown (divorce)
 family provision application (challenge against estate)
 ‘spendthrift’ beneficiaries
60
#16592097

61. Case study
100%
(4)
61
#16592097
Liz
Shane
(9)
(12)

62. Option 1 – ‘traditional’ approach
Assets
Estate
Debts
Liz
(4)
62
#16592097
(9)
(12)

63. Option 1 - ramifications


Bankruptcy
Simplicity
Divorce
Cost
Estate challenge
Spendthrift
Tax on income
63
#16592097

64. Option 2 - testamentary trust
 Trusts established pursuant to a will
 Takes effect upon death of the willmaker
 Concessional tax treatment:
 distributions to minors from inter vivos trust
 $416 tax free
 balance taxed at up to 66%
 distributions to minors from testamentary trust
 $16,000 tax free (applying LITO)
 balance taxed at marginal rates
64
#16592097

65. Option 2 - example
Trustee
Liz
Testamentary
Trust
Estate
Trust Beneficiaries
Liz
(4)
65
#16592097
(9)
(12)

66. Option 2 - ramifications

Estate challenge

Bankruptcy
Divorce*
Spendthrift
Tax on income
66
#16592097

67. Bankruptcy provisions
 May 2004 draft legislation – very significant
 Withdrawn July 2004 – but did not go away
 Bankruptcy requires
 debt
 failure to meet that debt
 creditor seeks to appoint trustee in bankruptcy
67
#16592097

68. Clawbacks
 Bankruptcy Act voidable transactions
 undervalue transactions – 4 to 5 years
 transactions to defeat creditors – no time limit
 preference payments – 6 months
 Corporations Act voidable transactions
 uncommercial transactions – 2 years
 involving related entities – 4 years
 for the purpose of defeating creditors – 10 years
 Start the clock running
68
#16592097

69. Richstar
 Corporations Act v Bankruptcy Act
 At least a contingent interest
 Trustee the alter ego of the beneficiary or
otherwise subject to effective control – as good
as certain they will benefit
 Something akin to proprietary interest
 Combination of beneficiary, trustee, appointor
and control
69
#16592097

70. Richstar - effect
 Freezing order only
 Single judge decision
 French J
 Subsequent cases
 Public Trustee v Smith
70
#16592097

71. Matrimonial breakdown
 Asset or resource?
 Kennon v Spry
 Harris v Harris
 Inter vivos trust v testamentary trust
 Gift and loan back
71
#16592097

72. Spry – reheated

Kennon v Spry – 2008 High Court decision

Court ordered payment of discretionary trust
funds to satisfy an order under a property
settlement

Dr Spry appealed

Facts
 Dr Spry not a beneficiary
 Dr Spry was trustee
 transferred trust property to other trusts –
transactions set aside
 irrational behaviour
72
#16592097

73. Spry - the decision

The trust property was the property of the parties to
the marriage

The order of the family court to ‘do all things’
included making a trust distribution

Only extension of law is the definition of ‘property’

Family Law Act supports argument that ‘property’
includes assets that a party to the marriage may be
ultimately entitled to
73
#16592097

74. Spry – Practical implications

Other decisions after Spry

Less is more
 The ‘Part IVA’ of family law world
 50% x 5% x 5%
 Another checkpoint for
‘Richstar compliant’ checklist
74
#16592097

75. Keech
 Trust established by father of husband
 Acquisition of home lived in by husband and wife
 Specific evidence that father intended to protect
assets to the 'bloodline’
 No evidence of a ‘fraud' Trust
75
#16592097

76. Harris
 Assets at most a resource
 History of wider family involvement
 Pattern of distribution still relevant
 Must have clear evidence if puppet argument to
succeed
 Wrongful distributions (read the deed)
 Contribution issues still a relevant factor, even if
a resource
76
#16592097

77. Option 3 – lifetime disposal
Appointor/trustee
Shane, or
after Shane’s
death, Liz
Shane
transfer
77
#16592097
Family
Trust

78. Option 3 - ramifications


Tax
Bankruptcy
Duty
Divorce *
Transaction costs
Estate challenge
Spendthrift
78
#16592097

79. Family provision applications
 Eligibility:
 spouse
 children
 dependents
 Estate assets v non-estate assets
 joint tenancies
 superannuation nominations
 related entities
79
#16592097

80. Family provision applications
 Tax/duty
 Lifetime disposals
 Use of contractual rights (options)
 NSW rules – ‘notional estate’
 Beware loans/unpaid present entitlements
80
#16592097

81. Option 4 – corporate model
Will/letter of wishes

- shareholdings
Tailored constitution:
- appointor powers
- loan accounts
Trustee Pty Ltd
- general directions
- eligible shareholders
- share rights
- director representation
Trust
- independent directors
- voting rights
Trust deed:
- beneficiaries
- distribution entitlements
- control mechanisms (e.g. appointors)
81
#16592097

82. Option 4 - ramifications


Complexity
Bankruptcy
Estate challenge*
Divorce *
Spendthrift
82
#16592097

83. Atia v Nusbaum
 Gift and loan back strategy
 parties mum & son
 if legal documents done – binding
 fallout
 query family trust use, not mum
83
#16592097

84. Amending trust deeds
 Resettlement issues
 income and capital entitlements
 default beneficiaries
 vesting date
 Creation of a new trust
 Statement of principles
 Stamp duty and CGT
 Clark decision
84
#16592097

85. Trust deed reviews
 Rule 1 – read the deed
 Checklists and training
 Risk management – get all aspects right
 Actively implement 1 of 3 models
85
#16592097

86. Clark
 Commercial Nominees confirmed
 Significant variations available at law
 Always read the deed
 Stamp duty (other states & trustee duty)
 Private rulings
 Splitting & cloning
86
#16592097

87. Super strategies
 Special purpose trust
 Embed into will or do post death
 ATO attitude
 'Quick death' tax
87
#16592097

88. Contact details
Presenter:
Matthew Burgess
Position:
Partner
Direct line:
07 3233 8918
Email:
mburgess@mccullough.com.au
88
#16592097