Intergenerational wealth transfer mechanisms that backfire

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The baby boomers are by far the wealthiest and best educated generation in Australian history. Their approach to retirement has lead estate planners to focus on the protection of underlying wealth (in addition to its “mere” creation).

What intergeneration wealth transfer mechanisms are they looking for? Anything that does not back-fire. For example:

(A) Your client’s son, aged 27, has just married. If your client gives him a $100,000 deposit to enable him and his wife to purchase a home unit and the marriage fails soon thereafter, your client has just lost $100,000 (and his son has too). But why not suggest to your client that he lend his son the $100,000 under a written loan agreement secured by a registered mortgage? The loan agreement can provide for a modest interest rate and if the marriage fails, your client gets his money back: a simple strategy which can ensure a good night’s sleep for many years.

(B) You recommend testamentary trusts in your client’s will, but:

(i) although income is annually determined for distribution to his infant grandchildren, it is never applied and therefore accumulates as a debt owing to those infants and so when the time comes to wind up the trust and for the beneficiaries to take the capital, the capital is substantially eroded by the necessity to pay these debts to the grandchildren.

(ii) the trustee gets too little legal and accounting advice too late. The trustee must be someone that the testator can “trust”.

(iii) to “save costs”, a beneficiary of the testamentary trust is also appointed as its trustee (instead of a third party), and distributes all or most of the income or capital to themselves.

(iv) the will drafter fails to take advantage of “Bamford” in that the testamentary trust does not incorporate powers for a trustee to determine what is and what is not included as income for the trust, and the trustee has no ability to determine whether or not to include net or gross capital gains as trust income.

(v) the testamentary trust fixes quantified amounts of distribution to be made to beneficiaries, rather than percentages, so as to fall foul of “Bamford”.

(vi) the 24-month rule in s118-195 ITAA’97 is misunderstood in that whilst the beneficiary of your client’s main residence exchanges contracts in relation to the sale of that property within 24 months of the date of death of your deceased client, the settlement of the sale takes place after the expiration of that 24 month period, thereby creating a taxable capital gain.

(vii) the will provides for the main residence to pass to the trustee of the testamentary trust instead of to the legal personal representative of the deceased or directly to a beneficiary meaning that the application of the CGT exemption in s118-195 is questionable by virtue of PSLA 2003/12.

(viii) the baby boomer is not aware of the S118-125 exemptions which provide for the main residence CGT exemption to be pro-rated by reference to the number of days that were non-main resident days of both the deceased and the beneficiary (or LPR) compared to the total ownership period of the dwelling by the deceased and by the beneficiary.

(ix) the ATO has indicated that the position in PSLA 2003/12 is subject to CGT event K3 which covers assets passing to tax advantaged entities (like charities). CGT event K3 operates to ensure that, where assets pass to concessionally taxed entities from a deceased estate, a capital gain or loss is recognised in the deceased’s final tax return, preventing the owners of concessionally taxed assets with embedded capital gains from avoiding capital gains tax when they are later disposed of by the concessionally taxed entity.

CGT event K3 has in the past been avoided by ensuring an asset does not pass to a concessionally taxed entity until after the deceased’s standard amendment period (generally 4 years after the assessment) has expired.

The changes announced in the 2011-2012 budget, designed to ensure that amendments would be made to ensure that where CGT event K3 happened outside of the deceased’s standard amendment period, a CGT liability still arose in the deceased’s tax return, were abandoned in late 2013. However these developments need to be communicated to your client.

(xi) your client is not told that if you can control the corporate testamentary trustee company, you can control the testamentary trust from the grave! Many fail to understand that a willmaker’s capacity to corporatise the testamentary trustee is allowed by s136 of the Corporations Act and this means that your client can:

(i) ensure that the constitution of the chosen corporate trustee of the testamentary trust confirms, for example, that a member may only transfer their shares to their lineal descendants, or linear descendants of nominated family members,

(ii) specify how shareholder and director decisions should be made, for example, that particular decisions may only be made by unanimous or special majority resolutions,

(iii) have a requirement that each shareholder should be entitled to appoint and remove a representative director,

(iv) have specific directions as to what is to happen upon the occurrence of specified events,

(v) direct the involvement of any independent (i.e. non-family) advisers in the management of the company and also direct the extent of their involvement and

(vi) contain triggers for the transition of control to particular people, for example, on family members reaching a specified age.

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