Business succession and Estate Planning

Transcription

1 March 2013 Business succession and Estate Planning In this bulletin: The importance of structuring a superannuation limited recourse borrowing correctly The importance of considering business succession as part of your estate planning The risks of renting investment property to family Special disability trusts update An example of the importance of making a will - Pierpoint v Liston Contact Paul Paxton-Hall Director Level 10, 15 Adelaide Street, Brisbane Qld 4000 Telephone: paul.paxton-hall@foxthomas.com.au

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3 Contents The importance of structuring a superannuation limited recourse borrowing correctly... 4 Background... 4 Taxpayer alert 2012/ Moral of the story... 6 The importance of considering business succession as part of your estate planning... 7 Overview... 7 What is a business succession agreement?... 7 Advantages... 8 Matters to consider... 8 Valuation alternatives... 8 Terms of payment... 8 How should insurance be effected?... 9 Deductibility of TPD insurance premiums through superannuation Conclusion The risks of renting investment property to family Background Facts Issue Held Lessons to be learned Special disability trusts update An example of the importance of making a will Introduction Facts Decision doc March

4 The importance of structuring a superannuation limited recourse borrowing correctly Background 1. For some years now superannuation law has permitted certain borrowings by a selfmanaged superannuation fund 1 (SMSF). In particular, the superannuation law now provides that an SMSF is not prohibited from borrowing money, or maintaining a borrowing of money, provided borrowing arrangements satisfy the requirements in SIS. 2. SIS provides that a SMSF can borrow if the following conditions are met: (1) the assets purchased have to be held in a separate security trust; (2) the moneys borrowed must be used only for the acquisition of the assets; (3) the trustee of the superannuation fund must have the right to acquire legal ownership; and (4) the right of the lender against the trustee of the superannuation fund for default must be limited in recourse to a right against the asset purchased only. 3. A diagrammatic representation of how a limited recourse borrowing arrangement is structured is: Lender first mortgage repays loan non-recourse loan Superannuation Fund Property purchase moneys Initial payment income/rent Buys asset Security Trust House 1 Section 67A Superannuation Industry (Supervision) Act doc March

5 Taxpayer alert 2012/7 4. The press regularly publishes articles around the uptake of limited recourse borrowing arrangements by SMSFs into residential property. Indeed, there has been quite a bit of criticism in the way these sorts of investment structures are being pushed by developers/promoters. TA2012/7 is a timely reminder of some of the pitfalls that have to be watched. Clients who are considering borrowing money through their SMSF to acquire property need to be properly advised well in advance to ensure that they understand fully how these sorts of investments need to be structured and of the pitfalls. 5. TA2012/7 comments around investment structures that have at least one of the following features: (1) the borrowing and the title of the property is held in the individual's name and not in the name of the trustee of the holding trust/security trust. The SMSF funds part of the initial deposit and the ongoing loan repayments; (2) the title of the property is held by the SMSF trustee and not the trustee of the holding trust; (3) the trustee of the holding trust is not in existence and the holding trust is not established at the time the contract to acquire the asset is signed; (4) the SMSF trustee acquires a residential property from the SMSF member; (5) the acquisition comprises 2 or more separate titles and there is no physical or legal impediment to the titles being dealt with, assigned or transferred separately; or (6) the asset is a vacant block of land. The SMSF intends to use the same borrowing to construct a house on the land. The land is transferred to the holding trust prior to the house being built. 6. These 6 features, commented on by the ATO, raise a number of issues as to the legality of the structure (and therefore the integrity of the strategy overall); namely: (1) the investment arrangements may be in breach of the sole purpose test in section 62 of SIS; (2) section 67 of SIS prohibits an SMSF trustee from borrowing money or maintaining existing borrowing. The only exception to this restriction is if the limited recourse borrowing arrangements in section 67A of SIS are strictly followed; (3) the asset acquired is not a single acquirable asset as required under section 67A of SIS as it comprised of 2 or more proprietary rights; (4) the acquirable asset is subject to a charge which would prohibit an SMSF trustee from borrowing money, or maintaining a borrowing of money under the requisite limited recourse borrowing arrangements excluded in SIS; and (5) the deposit paid by the SMSF and/or loan repayment by the SMSF may be considered as a payment of superannuation benefits which contravenes Part doc March

6 of SIS where the title of the property is not held by the trustee of the holding trust. 7. If a fund finds that its structure allows for one or more of these arrangements and therefore the limited recourse borrowing arrangements in SIS, then the implications could be that: (1) the members of the SMSF may be required to include the SMSF loan repayments in their assessable income; and (2) the income and its associated deductions from the investment should be declared by the individual member or members of the fund rather than by the superannuation fund itself. 8. Clearly, there are very serious implications from getting the structure wrong. Moral of the story 9. Get good advice early is the clear moral of the story. Anyone looking at borrowing through their SMSF needs to be aware that whilst there are considerable advantages in adopting this strategy, it is not for everybody and has to be approached carefully. 10. Beware of those who offer a cheap package to set up your structure. This is one area where it will very much pay to get it right at the outset doc March

7 The importance of considering business succession as part of your estate planning Overview 1. A business relationship between 2 or more parties (however structured, i.e. by way of partnership, company or trust) can come to an end for a number of reasons. These include: (1) death; (2) TPD; (3) trauma; (4) bankruptcy of a member; (5) divorce; (6) retirement (at an agreed retiring age or earlier); or (7) dismissal because of breach. 2. Whilst all such termination events can be dealt with in a partnership agreement, shareholders' agreement or unitholders' agreement, it tends to happen that insurable events (i.e. death, TPD and trauma) are dealt with separately in a buy-sell agreement or similar styled document e.g. "business succession agreement". What is a business succession agreement? 3. A business succession agreement (BSA) is an agreement whereby a party to the business structure agrees that, upon a certain trigger event, the continuing partners will have an option to buy the interest of the outgoing partner and the outgoing partner has the right to require the continuing partners to acquire their interest. 4. A BSA is normally styled as a put and call option. It can operate for individuals or related entities depending upon the structure of the entity concerned. 5. The provisions in a BSA bind the estate of each natural person who is a party to it. The BSA will take effect prior to any disposition in that person s will, effectively overriding the provisions of their will. 6. BSAs have 2 key components; namely: (1) the put/call option provision; and (2) the funding agreement. 7. The funding agreement obliges the partners to effect insurance cover for the agreed contingencies i.e. death and TPD doc March

8 Advantages 8. The advantage of a BSA is that it brings certainty to the ongoing business relationships of continuing partners where a trigger event/insurable event has been suffered by one of the partners. So, for example, it ensures that if A and B are in partnership and B dies, then A is not required to continue in business with B's estate but, rather, is able to acquire B's interest at a predetermined valuation. 9. A well constructed BSA will also deal with the vexed issue of valuation in the event of a trigger event being suffered - worked out between the parties beforehand in an objectively considered way. Matters to consider 10. A well constructed BSA will: (1) define relevant trigger events; e.g. whether trauma is to be covered or not; (2) determine valuation methodology for an outgoing partner's interest; (3) determine arrangements for payment; and (4) specify the methodology for funding the acquisition of an outgoing partner's interest by way of insurance. Valuation alternatives 11. Valuation methodology will normally be considered by the parties to a business structure in an appropriate shareholders/unitholders' agreement. The parties are free to determine their own basis of valuation which could, for example, include a valuation based on a multiple of earnings or perhaps net asset value. 12. Alternatively, parties to the BSA may have their own particular views on valuation. Frequently a fixed dollar amount will be provided annually. 13. Obviously, the amount of insurance effected by respective partners to the business needs to adequately cover the likely value. The document ought to deal with the contingency of insurance proceeds either: (1) not exceeding the likely valuation; or (2) not being paid at all e.g. an insurer debating the extent of disability and therefore denying the claim. Terms of payment 14. The BSA should not require payment for the interest of the outgoing partner until after insurance proceeds have been received. 15. In the case where there are no insurance proceeds paid e.g. the insurer has denied the claim, then provision ought to be made for payment over a period of time. Query whether security from the continuing partners ought to be obtained in this instance doc March

9 How should insurance be effected? 16. Insurance can be effected by: (1) the business entity itself; (2) each individual (a self-funded policy); or (3) surviving partners (a cross-funded policy). Primarily for potential CGT reasons, the self-funded insurance option is to be preferred. 17. Under the self-funded insurance model, the price to be paid for an outgoing partner's interest in the business should be: (1) a nominal sum e.g. $10; and (2) the amount by which the market value of the interest transferred at the date of the trigger event exceeds insurance proceeds received by the outgoing partner or his/her estate. On this basis if insurance proceeds exceeded the market value, then the purchase price to be paid would be $10 only (on the basis that the insurance proceeds received by the outgoing partner reflected the price to be paid). In this scenario, the CGT market value substitution rule under section of the Tax Act applies to ensure that the cost base for CGT purposes is the market value at the date of the trigger event. 18. Self-funded insurance also provides greater flexibility by way of estate planning (particularly depending upon the entity who is the owner of the policy). So, for example, if the owner of the policy was the individual, then proceeds could drop down into the deceased partner's testamentary trusts under their will. Similar provisions apply if insurance is effected through superannuation. 19. Advantages of effecting insurance through superannuation are: (1) the deductibility of premiums; and (2) ensuring that proceeds are able to fund tax effective income streams by way of pension payments. 20. However, matters that need to be considered in relation to the use of superannuation funds holding life/tpd cover are: (1) issues surrounding premium payments and contribution caps (see below); (2) the possible CGT payable on trauma; and (3) ensuring that the sole purpose test is able to be satisfied doc March

10 Deductibility of TPD insurance premiums through superannuation 21. Premiums paid by superannuation funds for TPD insurance are only deductible to the fund where they are attributable to the fund's liability to pay a disability superannuation benefit. However, premiums paid for "own occupation insurance" as opposed to "any occupation insurance" are only partially deductible. 22. A TPD policy needs to meet the new definition of a "disability superannuation benefit' equivalent to any occupation to be fully deductible to the fund. Conclusion 23. Business succession agreements can be quite complicated documents. They will necessarily need to reflect the structure that an individual has in their business arrangements. Don't let the complexity swamp you though. We can assist you through the complexity to ensure the crafting of a business succession agreement that suits your requirements and those of your "partners". It will provide you enormous peace of mind and of your family to know that in the event of your death or disablement, the business will continue on and hardly miss a beat! 2013.doc March

11 The risks of renting investment property to family Background 1. A recent decision of the Administrative Appeals Tribunal has thrown up for consideration again the potential pitfalls that confront a landlord renting domestic premises to a family member If terms of the leasing arrangement cannot be justified on an arm's length basis, then there is a risk that the ATO will determine that the basis of the arrangement is private and domestic. If that happens, income earned will lose the requisite characteristics of assessable income denying an entitlement to a deduction for interest and other expenses associated with the investment. Facts 3. Ms Bocaz owned 2 residential properties jointly with her son. One of the properties was rented to her former husband until his death. The son occupied the other. 4. It was alleged by the ATO that the rent paid by the father was less than a market rent and the ATO purported to deny deduction claims. Issue 5. Was the rental arrangement between both the former husband on the first property and the son on the second property a private or domestic arrangement given that the rent paid was something less than market value? Based on authority, if that could be established by the ATO then Ms Bocaz would lose her deduction. Held 6. The Tribunal held that the evidence suggested that the former husband was paying less than market rent, mainly because he had carried out significant repairs to the building when he first moved in and maintained the premises. This had been the rationale behind a lower rent. 7. The Tribunal referred to an important earlier case that has established the law in this area as follows: "The mere fact that the rent is thus below market rental will not preclude deductibility of the whole of the outgoing. But where the circumstances are such that the explanation for the low rent lies in the private relationship which the parties occupying the premises have to the trustee, it is not possible to say that the whole of the outgoings have the character of outgoings incurred in gaining or producing assessable income. The explanation is to be found rather in private or non-income earning considerations." 8. The Tribunal took the view that here there was a plausible reason as to the slightly reduced rent and accordingly found in favour of Ms Bocaz by allowing relevant deductions on account of outgoings which exceeded income. 2 Bocaz v- Commissioner of Taxation [2012] AATA 847 (30 November 2012) doc March

12 Lessons to be learned 9. The clear lesson here is a frequent lesson in tax law; namely, the importance that arrangements between 2 parties are fixed on an arm's length, commercial basis. In the case of renting residential property to family members, incidents of a commercial arrangement would be: (1) the existence of a tenancy agreement; (2) rent determined by an independent third party e.g. local real estate agency; (3) professional management (although this is not essential); and (4) clear accounting entries showing the cash-flowing of rental payments to the landlord doc March

13 Special disability trusts update 1. As a result of legislative changes that came into effect on 1 January 2011, Centrelink requires trust deeds for Special Disability Trusts (SDTs) established before 1 July 2011 to be varied in order to remain compliant. 2. The purpose of SDTs is to enable immediate family members to make financial provision for the reasonable care and accommodation needs of a person with a severe disability. Whether or not a person is eligible to be the beneficiary of an SDT will depend on an assessment by the Centrelink Special Disability Trust team against specific criteria for the person's medical impairment, care needs and capacity to work. 3. SDTs can hold assets up to a certain value ($596,500 as at 1 July 2012, indexed annually) plus any exempt assets (e.g. the beneficiary's principal residence) without these assets impacting on the beneficiary's social security payments. Funds in an SDT may be used to pay for reasonable care and accommodation costs of the beneficiary and the expenses associated with doing so (e.g. trust administration expenses). An amount up to $10,500 (as at 1 July 2012, indexed annually) may be expended from an SDT on discretionary items, provided the expense complies with the legislative requirements. 4. SDTs may be established as an inter vivos trust (i.e. the SDT is established by family members who wish to make contributions to the SDT during their lifetime) or as a testamentary trust (i.e. the family member includes an SDT in their will and the SDT does not come into effect until their death). 5. The legislative changes that came into effect on 1 January 2011 included changing the purpose of an SDT from "sole purpose" to "primary and other purposes". If you are a trustee of an SDT created before 1 July 2011, you will need to ensure the trust deed is amended to reflect these changes by executing an appropriate deed of variation and arranging for it to be lodged with Centrelink. 6. Similarly, if you made a will prior to 1 July 2011 that contained an SDT, you will need to update your will to ensure the SDT will be compliant. 7. If you are uncertain whether an existing SDT or an SDT under your will requires amendment, or if you wish to discuss whether an SDT may be suitable for your estate planning purposes, please contact Sharon Winn or Emily Simeoni doc March

14 An example of the importance of making a will Pierpoint v Liston Introduction 1. This decision of the Queensland Court of Appeal reveals the importance of having proper succession arrangements in place particularly as a parent. Facts 2. Sherri-Ann Buchanan was killed in a motor vehicle accident aged 25 years, leaving behind two small children. She died intestate. 3. The administration of her estate was granted to her mother, Lenora Liston. Lenora was also appointed as trustee of the estate. This case concerned an application brought by Sherri-Ann's on-again off-again partner Allan Pierpoint who is also the father of her two children. 4. Allan sought a declaration from the Court that he was Sherri-Ann's de facto partner and orders that the grant of letters of administration granted to Lenora be revoked and a grant made to him. The application was dismissed at first instance and Allan appealed. 5. Sherri-Ann's estate was relatively modest and was comprised principally of superannuation death benefits in the amount of $375,000. There was also $12,000 received from another insurance company, a small sum in a bank account and household and personal effects. Decision 6. The determination as to whether Allan was Sherri-Ann's de facto partner at the time of her death was an important one as it substantially affected how the estate was to be distributed under the laws of intestacy. That is, if Allan was found to be Sherri-Ann's de facto, then under the Succession Act 3 he would have been entitled to $150,000 as well as the household chattels and one-third of the remaining estate with the other two-thirds divided equally between her children. Otherwise, the whole of the estate would be divided equally between her two children and Allan would receive nothing.. 7. The Court at first instance undertook a careful and thorough analysis of the law as to the meaning of a de facto partner 4 and came to the conclusion that as at the time Sherri-Ann's death, Allan and Sherri-Ann were not in a de facto relationship. The evidence consisted of Allan's account of the relationship, evidence from others who observed them including friends, neighbours and family members, school records, tax returns and Centrelink records. The relationship was volatile and marked by periods of separation and reconciliation and the making of a domestic violence protection order against Allan. On appeal, the Court agreed with the first finding that no de facto relationship existed between Sherri-Ann and Allan for a continuous period of 2 years prior to her death as required by the relevant legislation (Qld), part 3, division 2 and Schedule 2. 4 Section 5AA of the Succession Act 1981 and section 32DA of Acts Interpretation Act doc March

15 8. In regards to the request to remove Lenora as the administrator and trustee of the estate and have Allan appointed in her stead, the Court initially found that even though Allan was the father of the children, and the children were living with him, his interests did not align with those of his children in relation to the estate and it was inappropriate for him to seek the grant on their behalf. On appeal, the Court agreed with this decision finding that Allan was not a suitable person to undertake the role citing his mental health (being schizophrenia) and other personal issues as being factors in the decision. 9. However, the grant of administration granted to Lenora and her appointment as trustee of the estate was revoked and granted instead to the Public Trustee. This was ordered not due to any misconduct on Lenora's behalf (although her unduly delay in paying the children's school feels was described as being very concerning) but rather the Court felt that on a broader view, it was in the best interests of the children that she did not continue to administer the estate and be trustee of their inheritance. Conclusion/Implications 10. The decision demonstrates the necessity of having a will or succession plan in place so that intestacy and subsequent litigation battles can be avoided. This is particularly true in situations such as this where relations between those surviving you are not well established or favourable. In order to avoid costly litigation and protect and provide for those nearest and dearest to you, particularly your children, you should seek expert estate planning advice. For further information, please contact: Brisbane Paul Paxton-Hall Director Phone: paul.paxton-hall@foxthomas.com.au Sharon Winn Special Counsel Phone: sharon.winn@foxthomas.com.au Goondiwindi Norman Fox Director Phone: norman.fox@foxthomas.com.au Cameron Cowley Senior Associate Phone: cameron.cowley@foxthomas.com.au Emily Simeoni Solicitor Phone: emily.simeoni@foxthomas.com.au St George Michael Cowley Director Phone: michael.cowley@foxthomas.com.au 2013.doc March

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