Estate Planning Blog

Annual Estate Planning Update - March 2013

Every year, changes occur that potentially impact on an individual's deliberate or inadvertent estate planning and asset & wealth management generally.  Those changes can come from 3 sources, ie changes to:

• the individual's own circumstances, such as the commencement or cessation of a domestic relationship of a family member or the transfer of wealth away from personal ownership, eg into superannuation or a family trust
• governing laws
• the interpretation of governing laws by the Courts or revenue authorities such as the ATO.

The purpose of this blog and update is to highlight the impact that 9 of the latter 2 groups of changes over the past year have had on an Australian resident's estate planning and asset & wealth management.

1. Taxation of Superannuation after a Fund Member's Death

The federal Government has decided to address (unfortunately only) one of the many practitioner and community concerns raised following the release of an ATO draft ruling in mid 2011.  While death benefit taxes remain a reality for most adult children receiving superannuation death benefits from their parents' member entitlements, the situation in terms of taxation of an SMSF or other superannuation fund immediately after the death of a fund member has been addressed.

If a fund member dies while in benefits phase, having already started to receive a pension or annuity, the federal Government has announced that the fund member's account is to remain free of tax during the period between the fund member's death and the payment of a lump sum or the commencement of a death benefits pension, eg to a:

• surviving domestic partner
• child with a significant disability.

In addition to relief from income tax during this period, any sale of assets as well as in specie transfer of assets to a fund member's dependant or deceased estate are free of CGT provided the payment or transfer occurs as soon as practicable after the death of the member.  As a result of only a limited improvement to the taxation of superannuation post death, there is still a need to plan for the incidence of death benefit taxes and CGT, eg when

• funding superannuation
• deciding whether to take a lump sum death benefit shortly before death
• preparing death benefit nominations, enduring powers of attorney and Wills.

2. Limited Recourse Borrowing by an SMSF

In the current régime of historically low contribution limits into Australian superannuation, the use of limited recourse borrowing arrangements (LRBAs) has at least provided a means for acquiring potentially appreciating assets in an SMSF even when the fund does not presently have sufficient funds to purchase them.  Increasingly LRBAs are being used where the lender is a related party, eg a proprietary company with retained profits or a fund member in receipt of an inheritance.

The ATO has provided clarification as to its view on what constitutes a "single acquirable asset" and in doing so has taken a view that is less restrictive than in the past, eg it accepts that a strata title unit can also include any car parking spaces that are tied to that unit and still be a single acquirable asset.

There is still no clarification, however, as to whether the interest rate for an LRBA can be less than market rates, eg when the trustee of an SMSF is borrowing from a related party such as one of the fund members.  There is often an income tax detriment for such lenders to charge interest, but it remains unclear as to whether the ATO might view the interest foregone by an SMSF trustee as part of the fund member's contributions, thus impacting on the contribution limits.

The presence of debt in an SMSF may also impact on the wording of asset specific binding death benefit nominations, eg where one child is earmarked to receive currently geared business premises held within a parent's SMSF.

3. Removal of the 50% CGT Discount for Non-Residents

Australian CGT is payable even when an asset has merely kept pace with inflation.  For Australian individuals and Australian controlled trusts, the incidence of CGT is at least reduced by the general 50% discount for assets held for more than 12 months, as well as any other CGT concessions that might apply such as the main residence exemption and the small business CGT concessions.

For a long time, the general 50% discount was also available for non-resident individuals and non-resident controlled trusts, but that exemption has will now cease for future financial years.

This can be a disadvantage for an individual who is presently overseas, but with plans to return to live in Australia at some point in the future.  Wills benefiting that beneficiary can be drafted to ensure the executor is given the option to place any inheritance that might pass for the primary benefit of that beneficiary in an Australian resident controlled trust for the period while the beneficiary is still contemplating returning to live in Australia.  Similarly, the control of an existing family trust may be varied so that the trustee remains an Australian resident controlled trustee during that "contemplation" period.

4. Changing the Control of a Family Trust

While the method of taxation of family and other non-superannuation trusts is still to be resolved for future income years, there have been major positive developments in relation to changes being made to the control and administration of a family trust.

After a 13 year period where the ATO took a much wider view than state and territory revenue offices of what might trigger a resettlement of a trust and thus a CGT event, the ATO has changed its stance.  It has accepted that a change to the control or administration of a trust that does not create a fixed entitlement for a beneficiary is unlikely of itself to trigger a CGT event.  The change in the ATO's view is consistent with the recent Court decisions.  An ATO determination has provided 3 examples of where a change of control is unlikely to trigger a CGT event.

This restores current or contingent changes to the person holding the power to appoint a trustee to the status of a valuable and often crucial estate planning mechanism, given that family trusts so often cannot be controlled via a Will.

5. Life Insurance and an SMSF Investment Strategy

In the past, there were no express legislative provisions requiring the trustee of an SMSF or other superannuation fund to consider the life insurance needs of fund members in the investment strategies put in place for each fund member.  The federal Government has introduced amendments to the superannuation law that now require trustees to do so.

The effect of this amendment may be to see more life insurance proceeds available when fund members die prematurely.  Hopefully it will also see those proceeds working to maximise the benefit to the insured or the insured's intended beneficiaries, eg by maximising the income tax benefit of the proceeds via the use of child death benefit pensions or superannuation death benefits trusts, thereby providing a surviving parent with more funds to raise and educate a child.

It is also important that the death benefits do not end up funding challenges in the Superannuation Complaints Tribunal (not possible if the fund is an SMSF), deceased estate challenges or (if the superannuation fund is subject to NSW law) notional estate challenges.

6. Valuation of Assets for Non-Arm's Length Transfers

There are also now express provisions regarding the method of valuation of assets being transferred into an SMSF, eg business real property or listed securities.  In relation to business real property, it will be necessary to obtain a written arm's length valuation of business real property that meets the legislative requirements. 
In relation to listed securities, the federal government has announced (but not yet made law) that these transfers should be done on-market, instead of off-market which was previously allowed.

7. Use of Family Law Orders to Realign Asset Ownership

One benefit of family law proceedings is that the ownership of assets can be realigned without necessarily triggering CGT or state or territory duty.  This has meant that parties to a marriage or other domestic relationship with no wish to separate from each other have contemplated issuing family law proceedings in order to achieve a more satisfactory alignment of asset ownership.

For example, one of the parties might be in a risk occupation and have a hostile family member likely to challenge their estate on death.  Moving assets to the other party may, at least in the longer term, remove that risk or thwart that challenge.

The Family Court has now ruled that it will not issue orders where there is no breakdown of the marriage or other domestic relationship, even though there may be asset protection advantages for the parties.

8. Use of Capital Reserved Trusts and Lifetime Gifts

The wide powers of a Family Court, extending to many opposite and same sex domestic relationships, makes it difficult to thwart a claim by a domestic partner once a breakdown of a domestic relationship has occurred or even once a domestic relationship has been established.  (Binding financial agreements, while often a very useful tool, need both full disclosure of assets by, and the informed agreement and consent of, each party to the relationship.)
The same situation does not generally apply to bona fide transactions before a relationship becomes subject to family law, eg before the earliest of a threshold of 2 years cumulative cohabitation is reached, a child is born of the relationship or marriage occurs.

This means that to minimise risks of a family law challenge, bona fide transactions need to occur prior to the relationship being subject to family law, eg by the transfer of assets to a trust where the capital is reserved for 3rd parties, eg children.  Alternatively, outright gifts could be made to those 3rd parties.  In both cases, it is imperative that delivery of the transfer of assets occurs, eg in the case of cash that assets move from the donor's bank account to the recipient's bank account.  Where there are loans back to the donor, it is important that the loans remain enforceable, eg by the loans being secured against real estate via a 1st of 2nd mortgage.

It is also important to recognise that a Family Court will look at the substance, rather than the formalities of a transaction, in determining when an asset should form part of the pool of assets to be apportioned between the parties or whether the asset should be still viewed as a resource when determining apportionment of other assets.

9. Statutory Wills and Codicils and Testamentary Trusts

With Tasmania leading the way, Australian states and territories now have provisions enabling their Supreme Courts to order the creation of statutory Wills or codicils, eg for people who have lost testamentary capacity or did not have that capacity in the 1st place.  Until recently, such orders were only made to ensure that an inappropriate person would not benefit from a deceased estate merely by being the closest next of kin, eg a father who had had no role in caring for a disabled child or contact with that child.

In 2012, the Queensland Supreme Court ordered that an existing Will of a man who had lost capacity be amended by statutory codicil to include testamentary trusts to protect the interests of beneficiaries who were in business and thus had future creditor risk.

It will be interesting to see if the Australian Courts take the view in the future that the interests of beneficiaries would have been better served by the inclusion of testamentary trusts.  They may decide to award damages to beneficiaries who missed out on the benefit of a testamentary trust because of a failure of a lawyer or other professional advisor to raise the advantages of a testamentary trust to a willmaking client.

10. Previous Changes

For many people, the reality is that they turn their minds to addressing estate planning issues less frequently than annually.  For those people, longstanding changes may have had an impact on the existing planning decisions they had previously made but have not got around to revising.  Examples of such changes include the:

• major changes to the superannuation landscape that have occurred, notably the tax free treatment of pension income when fund members are at least 60 years of age and the restrictions on contributions into superannuation
• greater scope for using cascading and asset specific binding death benefit nominations in an SMSF and ATO confirmation that nominations to SMSF trustees do not have to lapse after 3 years (assuming the SMSF deed is suitably drafted)
• changes to the income taxation of trusts and life interests that have already occurred and the need for reimbursement provisions to ensure that a life or remainder tenant is not unduly out of pocket from the payment of any CGT liability
• inclusion of more flexibility in how the income of a special disability trust can be spent – the federal government has recently notified trustees of the requirement to update special disability trust deeds to comply with the latest changes
• extension of the powers of the Family Court to include most opposite and same sex de facto relationships.

Note:  This Swan & Yii – Asset & Wealth Management Lawyers March 2013 Estate Planning Blog has been prepared for educational and general information purposes only and should not be relied on as (or in substitution for) legal, accounting, financial or other professional advice.