It is said that the holy trinity of financial planning is wealth creation, wealth distribution and wealth preservation. We spend our working lives creating what we have. We carefully plan who we may pass that wealth to. But what have you done about preserving the wealth to ensure that you can keep what you have for your retirement?
Financial success is a Statement of Claim away from insolvency, poverty and failure.
With over 800,000 trust tax returns lodged each year, the most commonly relied on strategy for wealth accumulation and protection in Australia is the trust.
From an asset preservation perspective, the family discretionary trust is the most personally effective way of holding and managing wealth with some confidence. An important role for the trustee of the family discretionary trust is to preserve the wealth away from the many that seem to want to target what one has spent a lifetime creating. The simple family discretionary trust is far superior to the superannuation fund in preserving future wealth at the time it is needed most, at the time of deciding to retire.
If the trust is so important, why do so many ignore the basics and undermine their own financial security?
Trust creation checklist
The asset protectiveness of the trust starts with its creation. If you can answer these questions, the creation of your trust will have established a solid foundation for protection:
- Can you avoid an attack of sham? Was your purpose to conceal assets or to create a trust?
- Does the paperwork at trust creation time support the trust creation?
- Do you hold the original trust deed and any amendments to it?
- Is the settlor someone known to you and the family for whom the trust has been created?
- Did the settlor in fact pay the original settlement amount to the trustee?
- Can the trustee identify where that original settlement amount was banked?
- Is your settlor willing to attest to their intention to create the trust for your family?
- Can the settlor of your trust survive a cross examination of why the trust was created?
All of these questions go toward establishing that the trust was validly created, for a valid purpose, and was properly independent of you. If you can answer yes to all of them, you have the beginnings of confidence in a secure wealth preservation structure.
Supporting the creation of a trust
As simple as this may sound, it is vital that the facts at the time of trust creation support the creation of a trust. In the 2014 case of Coshott v Prentice the Federal Court accepted that a trust deed existed but the facts did not lead to the conclusion that the trust came into existence at the material time that the bankrupt and the bankrupt’s family hoped to rely upon. The Court did not even consider the sham argument, it simply recognised that the facts did not support the creation of the trust.
The trust deed is the constitution of the trust and it represents the road rules pursuant to which the trustee must operate the trust. Any claim against a person who is in any way connected to the trust, whether as a beneficiary, appointor, trustee or director of a company that is the trustee, will depend upon the terms and conditions of the trust deed as to whether that claim may pass through the person and into the trust assets.
The trust deed describes the nature of the relationship between the wealth within the trust and each person who is connected to it. The family discretionary trust works as an asset preservation structure because commonly the nature of the beneficiary’s interest in the assets is both remote and conditional. It is the trust deed that describes this interest. You need the original trust deed to prove what that original interest was and what it continues to be at the time of challenge. Failure to provide the trust deed leaves open the risk of other ‘evidence’ indicating a greater right or entitlement to the person under a bankruptcy claim.
The settlor is the person who first put the terms of the trust deed to the trustee, along with a sum of money, and invited the trustee to become the trustee of the trust. It is an important origination role that goes to the heart of the trust creation.
Australia is relatively unique in the common law world for requiring the settlor of the trust to be someone other than the true guiding mind behind why the trust was created. This is because of a little known and misunderstood rule in Section 102 of the Income Tax Assessment Act 1936 (Cth). This section allows the Taxation Office to impose taxation on whoever settled the trust if that person also has an ability to bring the trust to an end. So as to avoid the risk of the Taxation Office taking such a claim, traditional thinking has evolved to require that the settlor is not to be a person who can benefit from the trust.
Proving the settlor
So can you prove who the settlor really was? Not by just looking at the terms of the trust deed and identifying who it says. The identity of the settlor is a question of fact. If the person named in the trust can be shown to have paid the identified sum to the trustee, you will have proven who the settlor was/is. If the truth is that they are listed in name only and never gave the money to the trustee, the true settlor will be whoever first paid something to the trustee. If that is you, then you will be the settlor. This may create a Section 102 problem such as occurred in the Case R40, 16 Taxation Board of Review decision from the 1960s.
Proving who the true settlor was/is, proving that they in fact paid the first settlement amount, and proving that amount was received, are all about proving the essential building blocks of the trust.
John Kakridas failed to do this, contributing to the Federal Court agreeing with the Australian Taxation Office in the 1990 decision of Faucilles that part of his trust was a sham. The Federal Court found that Kakridas intended that the terms of the trust deed cloaked his real intentions. This adverse finding was in part supported by the fact that Kakridas did not present evidence from the person who was named as the settlor of this trust, his accountant’s wife, and the Court drew an adverse view as to her intention to create the trust. Part of his trust failed and it was determined to be a sham.
If you can rely on your settlor, are you prepared for them to be cross examined? Many will identify their settlor as their accountant, lawyer or other professional. Often this is not by choice but rather by default. The professional recommends the adoption of a trust and when establishing this they effectively nominate themselves, usually without any intention to in fact pay the settlement amount.
Who should be the settlor?
Having the professional as the settlor can be helpful in the future if the trust is being challenged but it will expose that accountant, lawyer or other professional to be cross examined and perhaps be challenged as to why the trust was set up in the first place. Every challenge by a bankruptcy trustee of wealth sheltered in a trust will involve an examination of all of the players at the time, because the settlor role in creation is so essential that it must be expected that the settlor will be asked to affirm their role. Any professional that is stated to be the settlor will then be exposed to cross examination and the risk of admitting that they recommended the trust to the principal person as an asset preservation device, not for the true reasons for adopting a trust. This may not be fatal to the claim but it will be very damaging. Courts are inclined to accept the testimony of professionals who have no interest in the outcome of a case.
The best settlor is a close family friend who has no other role in the trust and who is willing to put real money to the trustee and will be able to attest to this fact. If they play no other role they cannot be questioned about any other reason for the trust’s existence.
Trusts are essential asset preservation strategies. This article itself has profiled some Court decisions from the 1960’s to the present that highlight that it is the fundamentals of trusts that will always be examined when wealth is under attack. Trusts are too important to be carelessly created. Above is a checklist, if you have read this far, return to the 8 questions and re-challenge yourself about your trusts. If you can answer yes to every question, you have the beginnings of a robust trust structure to rely upon. A failure of any one means that the trust is not as secure as it could have been.
Can a trust creation issue be fixed? Simply put, no. As some of the cases referenced in the article suggest, what is important are the facts that existed at the creation time.
Take care to protect your trust’s creation so that it can carefully protect your wealth in the future.