Is your Estate succession plan safe? Part 2: VLRC rejects notional estates – some cautionary warnings

November, 2013

On 15 October 2013, the Victorian Law Reform Commission (VLRC) released its final report on Victoria’s succession laws. The VLRC recommended that the notional estate provisions that exist in NSW should not be adopted in Victoria.

Leaving aside whether Parliament adopts the VLRC’s recommendation, the rejection of “notional estate” provisions in Victoria does not mean that inter vivos (during life) transactions made in cases with no connection to NSW cannot be subject to attack under a testator family maintenance claim (TFM Claim).

Importance of private property rights – generally

Several submissions made to the VLRC stated that the notional estate provisions should not be adopted due to their imposition on inter vivos private property rights. Those submissions reflect the current law that, broadly, people can deal with their property during their life however they wish (as long as on lawful terms).

For instance, a person may (outside NSW generally) gift most of their assets during their “twilight years” if capable, and thus reduce the size of their estate and the amount of money which could be the subject of a TFM Claim.

The Supreme Court of Victoria’s Submission to the VLRC

Of particular interest was the Supreme Court of Victoria’s submission to the VLRC, as it has jurisdiction over probate matters, including larger TFM claims. The Court considered the introduction of notional estate provisions. However on balance, the Court gave qualified support to the principle that the law ought not to detract from the general proposition that persons are able to deal with their property as they wish.

Caution: artificial arrangements

However, the above is a general principle which is not always upheld. Practitioners should carefully note a cautionary warning in the Supreme Court’s submission, that if there is evidence in Victoria of people “entering into artificial arrangements designed to avoid their moral obligation…“, then the introduction of a “notional estate scheme” may be necessary.

This cautionary warning raises 2 important questions, which are discussed below:

(1)               What is in an artificial arrangement that may in future be subject to notional estate provisions?

(2)               Could an “artificial arrangement” be attacked even without a notional estate scheme?

What is an artificial arrangement?

It is unclear what an “artificial arrangement” is, as referred to by the Supreme Court. Macquarie Dictionary states that “artificial” means “feigned; fictitious; assumed”.

Clearly, a simple gift of a real property (including the transfer of legal title) is not an “artificial arrangement”. That is so, even if the transaction is made for the purpose of reducing the value of a person’s estate or frustrating a TFM claim, leaving aside the doctrine of “sham” which is discussed below. However, many succession plans do not involve simple gifts, given the significant CGT and duty that generally arise from such transactions.

Artificial – Part IVA?

The general anti-avoidance tax laws (eg Pt IVA of the ITAA 1936) perhaps give some guidance on what types of arrangements could be “artificial”. Practitioners may recall that the explanatory memorandum to the original enactment of Pt IVA explained that it was designed to target “…tax avoidance arrangements that … are blatant, artificial or contrived“. Practitioners would be well aware that Pt IVA applies (or the ATO may determine that it applies) to much more than “artificial arrangements”.

Are round robin arrangements artificial?

Adopting this analogy with Pt IVA, query whether some “round robin” arrangements, such as a “gift and loan back” arrangement (which purports to reduce the size of the donor’s estate during his or her lifetime) could be deemed to be artificial arrangements which attempt to frustrate a TFM claim?

Take for instance the recent case of Symond v Gadens Lawyers Sydney Pty Ltd [2013] NSWSC 955 (reported at 2013 WTB 46 [1967]). In that case, there were a number of complex transactions which took place which involved an element of “round robin payments by promissory notes“. The tax expert engaged by Mr. Symond (who had over 25 years practice experience in taxation law) stated, in the context of a foreseeable Pt IVA audit and assessment, that “the circularity of those steps ‘exhibited contrivance’ of a kind that was likely to attract the Commissioner’s attention.”.

With estate and succession planning, there are “round robin” arrangements which are promoted by some advisors that could be described (particularly by an aggrieved party) as contrived or artificial. These types of arrangements are often proffered as having the same practical effect as a gift of the physical assets, but without the same tax consequences, the most simple of which is the common “gift and loan back” arrangement.

Gift and Loan back?
Lisa is domiciled in Victoria. Lisa’s net assets consist of business real property in Victoria with a current market value $6.1m (and a cost base of $2.1m) and her home of modest value.Lisa has two adult children, Mark and Shane. Lisa wishes for the property to pass to Shane, as she feels that she has already provided for Mark during her lifetime and that Mark would squander any further financial provision made to him.Lisa sees her trusted advisor, who informs Lisa that she could achieve her goals in the following ways:
1. Make a new Will to provide that on Lisa’s death, the property passes to Shane (with the substantial risk that Mark will make a TFM Claim);
2. Gift the property to Shane immediately (resulting in circa $330,000 of duty and a $4m taxable capital gain); or
3. Make a new Will per [1] and enter into a ‘gift and secured loan back’ arrangement (gift $6.1m to Shane and immediately loan back $6.1m from Shane, or vice versa).
Lisa’s advisor explains that adopting [3] could avoid Mark making a TFM Claim, but without the tax consequences that would arise with a physical gift of the property to Shane.

 

Leaving aside the risk that the recently amended anti-avoidance provisions could apply, or that the transaction may not be legally effective, could the “gift and loan back” be the type of artificial arrangement the Supreme Court was referring to?

Of course, there are many estate and succession plans which have much more complex arrangements and structures than a “gift and loan back” arrangement. The common theme of these arrangements is that they attempt to shift equity out of a person’s assets so that the “gross” assets which form part of a person’s estate (and may be subject to a TFM Claim) have little or no net value.  If an estate or succession plan is structured or implemented poorly, it is not difficult to envisage those arrangements being characterised as “artificial or contrived” in some circumstances.

Further, it is not implausible that any future changes to address “artificial or contrived arrangements” made to avoid certain persons receiving a share of an estate, as alluded to by the Supreme Court of Victoria, could apply to arrangements “entered into” many years prior to any future law changes. For this reason, we recommend that any estate or succession plan be reviewed to make sure it is not “artificial or contrived”.

Could artificial arrangements be unwound without legislative change?

Even without notional estate laws, some inter vivos transactions may be subject to attack for the purpose of an aggrieved person making a TFM Claim. The Supreme Court’s submission notes that a number of cases have come before it in which there is evidence of uncommercial transactions during the lifetime of a testator, often very close to the end of that person’s life, which arise in circumstances that warrant careful investigation as to whether the transaction was valid. These cases may come before the Court as applications to set aside transactions due to undue influence, unconscionability, lack of capacity or in other ways. An example of this is the recent case of Mataska v Browne [2013] VSC 62. This case should be noted with extreme caution, as the principle which the case stands for can subject certain inter vivos transactions to scrutiny or even unwind those inter vivos transactions for the purpose of bringing a TFM Claim.

Mataska v Browne –inter vivos transaction attacked by an aggrieved child

Mataska v Browne concerned the estate of a testator (the Mother) who died aged 89. Several years prior to her death, the Mother executed a will appointing Child A as executor and sole beneficiary of her estate (to the complete exclusion of Child B). A few years later, the Mother sold her home and purchased a new property (the Property) as joint tenants with Child A (the Transaction).

The Mother died just over 12 months after the Transaction. The effect of the Transaction was that Child A received the Property (which passed via survivorship rather than by the Mother’s Will). Without the Property, the Mother’s estate was worth less than $10,000, meaning a TFM Claim by Child B would not be financially worthwhile.

Despite not being a beneficiary of the Mother’s Will, Child B brought proceedings for a limited grant of letters of administration, that Child A be passed over as executor and a declaration that Child A holds the Property on trust for the Estate. In other words, Child B sought to attack the validity of the inter vivos Transaction made by the Mother so that a TFM Claim against the Mother’s estate would be financially viable.

The Court agreed with Child B that the circumstances of the Transaction required “careful investigation” to determine whether it was valid. Further, the Court held that Child A (as executor of the estate) would not carry out that investigation, as Child A was in a clear position of conflict between her duty to the Mother’s estate and her personal interest in ensuring that the Transaction was upheld. This is despite Child A being the only beneficiary of the Mother’s estate. Accordingly, the Court ordered that Child B be given a limited grant of letters of administration.

The ultimate outcome concerning the validity of the Transaction and the ultimate distribution under the estate is not known (the matter may well have settled during mediation, given the potential for the parties’ costs to erode the majority of the value of the estate). However, the case demonstrates the potential for an aggrieved child to take legal action against the executor. Even where excluded from the will, he or she may be able take control of an estate for the purpose of scrutinising and potentially unwinding suspect inter vivos transactions of the deceased. The case also demonstrates the benefit of appointing a genuinely independent executor, where estate disputes are likely to arise.

Mataska v Browne could also apply to other inter vivos transactions, such as sham transactions. Further, it is not difficult to foresee that this principle may even be extended to certain “artificial or contrived” transactions on the grounds of public policy (see Barns v Barns [2003] HCA 9).

Sham transactions and artificial transactions

Transactions that are “artificial or contrived” are generally legally effective if correctly implemented. However, transactions which are a sham are not generally legally effective. A sham is something that is intended to be mistaken for something else or that is not really what it purports to be, as the parties to the transaction share a common intention that the transaction will not create the legal rights and obligations that it appears to.

For instance, could a “gift and loan back” arrangement be scrutinised or attacked by an aggrieved child in a similar manner to Mataska v Browne, if both the parent and child consider the “gift and loan back” as nothing more than a contrived device to defeat a TFM Claim? This same could be said for any other “round robin” arrangement.

Barns v Barns: Against public policy?

Assuming that the “gift and loan back” arrangement (or other round robin arrangement) is not a sham, could those arrangements be unwound if they are “artificial”?

The case of Barns v Barns [2003] HCA 9 considered, but did not resolve exactly what transactions or arrangements that attempt to contract out of the family provision laws will be void against public policy. When the High Court has the chance to further consider the matter, could the Court hold that certain “artificial” arrangements, such as round robin arrangements, be void as against public policy?

That path is supported by Gleeson CJ’s comments in Barns v Barns regarding the operation of and the policy rationale for family estate provision laws:

That policy is of public, as well as private, importance. To implement that policy, the legislature has conferred upon courts a discretionary jurisdiction to make provision out of a deceased person’s estate in a manner that, to a greater or lesser extent, may override testamentary intention. A construction of the Act that permits a testator to nullify its operation by agreeing in advance to dispose of his or her estate in a certain fashion tends to defeat the purpose of the legislation.”

Estate and succession planning: Risk Mitigation

Of course, this is not to say case law will bring in de-facto notional estate provisions. However, the absence of notional estate provisions does not mean that certain inter vivos transactions cannot be scrutinised or attacked by an aggrieved beneficiary for the purposes of bringing a TFM Claim. This is particularly the case where those transactions are artificial, contrived or a “sham”.

A consideration of these risks should be a part of any robust estate or succession plan and there may be solutions to minimise these risks. As always, the devil is in the detail which inevitably requires intense analysis of a client’s full history, facts and current circumstances.

**** First published in Thomson Reuters Weekly Tax Bulletin – Issue 48, 15 November 2013

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Martin Checketts
Partner
Private Advisory
mchecketts@millsoakley.com.au

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