Testamentary discretionary trusts – are they right for me?

How to create your strategic plan

Of course things quickly get complicated when you have established a multitude of companies and trusts to minimise tax and manage risk. Here are a few key points when thinking through the entire estate planning exercise:

1. Is there enough in the share of the estate to make it worthwhile to establish a trust? If the share of the estate is small perhaps for ease of administration a trust does not need to be set up. Consider if there are any tangible financial benefits or tax reduction options that suit.

2. Does the estate trust need to be commenced or can the person just dispense with it? In some cases it is more appropriate to just distribute the share of the estate but you need to confirm the power to do this if that is intended.

3. What is the real intention behind the trust? Is it to protect the asset from divorces, insolvency or a spendthrift family member? Often the prime motivation to establish a trust is to ensure people are protected from their own circumstances, such as a tenuous relationship, risk in business from creditors or their own vulnerability.

4. What kind of trust is appropriate for each beneficiary? Should there be an independent trustee holding control of the trust and assets? Should siblings jointly control each of their trusts? What are the practical implications of investing the assets over a long period and to suit each family group? These are important questions and not one size fits all.

5. What is a beneficiary is disabled or unable to manage their financial affairs? A special disability trust can be established in the Will and it will preserve the Centrelink pension entitlements if the person is assessed at a level of disability that complies. A main residence can be gifted into these trusts for the long term accommodation of the person even if they share with others with the support of  a carer. Careful drafting is required to ensure the model rules for the trust are created.

6 . What powers do the trustee have over the trust and who can they appoint to replace them as trustee? Often the cascading effect of  the estate trust is intended so that the capital is preserved and invested at least until the third generation has been appointed at a set age to act as trustee. There can be a requirement the trust must continue until certain specified beneficiaries reach that prescribed age as the will maker decides.

7. What powers should the trustee have? Can they invest in shares, real estate, a main residence, managed funds, exchange traded funds and can they borrow money against the capital of the trust? It is important to define the rights of the trustee so when managing investment accounts they have either the freedom or the restriction to deal with these assets.

8. What effect do the New tax Rules have? Section 102AG(2AA) was introduced to the ITAA starting July 2020. This imposed a new test income is not excepted income if it is generated from assets:

  1. acquired by or transferred to the trustee of the trust on or after 1 July 2019, and
  2. are unrelated to property of the deceased estate.

For example, if the deceased leaves $100,000 in a testamentary trust, this is excepted income as it formed part of the deceased estate. If this amount is invested, any return on the investment is also excepted income. However, if the trustee borrows $100,000 from a lender and injects it into the trust, this amount and any return is not excepted income. The borrowed funds have no connection to the deceased assets, so it does not satisfy the test under section 102AG(2AA).

The most important step is to take the time to get strategic advice for your individual estate plan. It is so easy to spend an hour by web conference talking to an experienced estate lawyer, who can have a detailed conversation with you and your accountant and financial advisor. Create the plan you need.

Super and Family Might Not Mix!

A Super argument.

It is incredible the sheer number of self-managed super funds (SMSF) being established in Australia and the rate does not seem to be abating any time soon. I guess people feel that they can do just as well at investing their money as some fund managers. We see a very strong trend for money in super to intermingle because they are in a new relationship, are family or it is a business partner. This can be a result of a joint venture approach into a property investment or an attempt at keeping the family money together.

The problems arise when people with different financial needs and estate plans get together. All members must be individual trustees of the fund unless a company is used. All members must be Directors of a trustee company and most are shareholders as well. That means they all have to sign off on compliance documents including investment strategies and binding nominations where a member dies.

The choice of trustee can be critical as we can see from the case of  Notaras v Notaras in the Supreme Court NSW. This is an unfortunate dispute between brothers – Brinos and Basil. The two brothers were the sole trustees and only members of their SMSF. Relations between the two had broken down due to a separate property dispute in the Supreme Court, the outcome for which  was decided in favour of Basil. Not a lot of brotherly love at that point.

In December 2010, Brinos had made withdrawals of over $220,000 from the SMSF’s bank accounts. This was $57,839 more than Brinos was entitled to as a member. Subsequent to the withdrawals, the SMSF’s accountant (who was also Basil’s wife) sent a letter to Brinos, including tax returns and member statements that needed signing. Brinos returned the documents without signing them. While the judge in the case did not explicitly find that Brinos refused to sign them (partly because Brinos had not been expressly asked to do so in the letter), his Honour found that the ‘net effect…was that no further steps were taken… with a consequence that the trustees of the Fund [had] put themselves in breach of the Act’.   Basil sought an order that Brinos be removed as a trustee and replaced with a company. The company, Bazport Pty Ltd , had Basil as the sole director and shareholder. Brinos was not a happy camper.  Surprisingly, the order to remove Brinos was granted. This was an strange result in that it contemplated the trustees of the fund becoming both Basil, as well as his company Bazport. Because the judge still considered Brinos to be a member despite having only a ‘nominal interest’, the judge noted that Basil and Bazport would be seeking permission from the ATO to have the SMSF exempt from the relevant requirements of the Superannuation Industry (Supervision) Act. That is, an exemption would be sought from the requirement that each member be a trustee or a director of the corporate trustee.(thereby excluding Brinos)  The eventual result of Basil’s request to the ATO will probably not be made public. What is quite certain, however, is that the exercise of resolving the dispute via the Supreme Court was likely to have been time-consuming and very costly.

The case shows that clients must consider very carefully before establishing an SMSF and pooling  investments with a family member, especially where there are shared business interests. There are other relationships which may represent a higher degree of risk that a dispute will arise. These include: parent–child SMSFs, SMSFs with in-laws and SMSFs shared between business associates. What about making decisions? Does it have to be unanimous?  Following on from the issues raised by Notaras  the topic of trustee decision making is intriguing.  Remember that Self managed super funds are private trusts and as such disputes about the control of the trustee are a matter for the relevant state court. People should be more aware, that there is a general legal principle , where joint trustees are appointed, they must act unanimously.

This principle was affirmed by Kaye J in Beath v Kousal [2010]. This means that it is almost impossible to make decisions if joint trustees cannot agree.  However, this general legal rule can be displaced by the “governing rules” of the fund (usually attached to the trust deed) where they provide that decisions can be made in some other manner. One example is, the rules might state that where there are deadlocks between trustees in making their  decisions,  can be resolved on the basis that votes by each trustee, are weighted according to their account balance as a member of the fund. If you read the Deed carefully in many cases this provision does not exist and the deadlock will remain. A really important question to ask in the case of SMSFs where trustees cannot agree is: Can the trustee be removed, other than by a court?   In order to avoid a costly court process and likely time delays, a properly drafted trust deed and associated governing rules can provide for a procedure by which a trustee can be removed, and a new one appointed. An appropriate process may be that the member or members who have greater than half the total account balance are able to appoint a new trustee and remove an existing one. Not all governing rules are the same, and many will not provide for this as a solution.

It is very interesting that the case of  Notaras, did not contain any discussion about the trust deed or governing rules of the rights of Basil and Brinos’ as trustees and members of a shared SMSF. It appears that under the governing rules of Basil’s SMSF, he did not have adequate power to remove Brinos, despite Basil clearly being the member with the majority account balance.   In addition, the governing rules also determine whether the power to hire and fire a trustee (i.e., the appointor power) comes with extra duties or “fiduciary” obligations attached, such as the obligation to exercise the power in good faith (see for example Berger v Lysteron Pty Ltd [2012]). Unless the rules specifically provide that the power does not have to be exercised in good faith, the decision to remove and appoint a trustee will always be subject to attack on grounds that one party was not treated fairly. So a smart thing to do is review carefully the words in the trust deed and rules. You should ensure it will protect the interests of the members with the majority of benefits, by the governing rules stating that the power to appoint a new trustee, can be exercised without associated fiduciary duties (these duties would be similar to those of a trustee). Very few governing rules will provide for this so it is a very important process to check what they state.

What about forcibly removing a member? A trustee who cannot agree with fellow trustees is most likely to be a member of the SMSF, although it is possible they are not. One person on their own cannot act as a sole trustee (which is different from a family discretionary trust) Super funds require at least two individuals or a company to act as trustee. What happens if an individual trustee refuses to  reply to correspondence and generally refuses to participate in the management of the fund? Investments may be affected if no action is taken. Contracts might not be signed and opportunities lost. The question then arises, is it possible to forcibly remove by law the offending person as a member? The governing rules usually provide for a mechanism to remove a member. However, the bigger hurdles are the requirements under the regulations, where in broad terms, prior consent of the member to be removed, is required. Of course, this may be impossible to obtain where there is a dispute between them as is generally the case.

A strategy for SMSFs to consider to overcome this potential impasse is for the member with the larger account balance to obtain a signed consent up-front from the other member (in their capacity as both trustee and member) that, upon the occurrence of certain events (for example, disagreement about a material SMSF decision, relationship breakdown or legal dispute), the trustee can remove the other member from the fund and transfer their benefit to another complying superannuation fund.   Another option for a person ‘stuck’ in an SMSF with a trustee/member who will not cooperate is to remove their member benefits and account balance from that fund (and roll over funds into a new SMSF). However, legally and sometimes practically, this itself may require the consent of the other trustees (for example, authority to deal with the bank).

Some suggestions and conclusions.  The problem of a difficult trustee can prove extremely expensive and hard to resolve due to the law of trusts, as well as laws protecting the interest of members of superannuation funds. This can be made even more difficult by documents that do not confer strategic powers. In conclusion, a wise approach is to consider carefully who to share investments with by membership in a SMSF. Once you are together as members and trustees, you are bound by law to act according to the law and the trust deed. This includes situations where you have a very large difference elsewhere such as divorce from a spouse, a fight over an estate or an argument in relation to management of a business. The clear message from these cases is make sure the trust deed covers the possibility that a dispute might arise and has a means of breaking any deadlock. Further, strategically drafted trust deeds and governing rules, as well as good initial planning, can assist in curing problems, or more preferably, prevent them. As a final note, for those who are already members of a SMSF, it worthwhile getting the structure and terms of the trust deed reviewed and considering whether the current structure is prone to problems. It is never too late to agree on a change before a problem arises.