Act in haste or repent at leisure

The case of Lewski v Commissioner of Taxation [2017] FCAFC45 shows that asset protection is all about timing.

A wife and husband became beneficiaries under a family trust in 1997.

In conjunction with this setup, the wife gave her husband complete authority to handle all her financial affairs and she authorised him to act as her agent in relation to them.

In 2008, the wife lodged an amended tax return for the 2007 tax year, returning $62,000 as income received as beneficiary of the trust, in circumstances where the trust had sought to set-off against its income for that year, the losses it had incurred in earlier years (the carry-forward losses).

The ATO undertook an audit in 2012 and in August 2015 the Commissioner issued an amended assessment. The Commissioner disallowed the carry – forward losses and assessed her income to be $10m. Ouch.

The husband was aware of the 2007 distributions at the time they were made because he made them or at least participated in making them.

In 2012, the husband also became aware of the Commissioner’s views as regards the amended assessments even though they did not issue for another three years.

In December 2015, aware of the dire situation she was facing, the wife executed a deed of disclaimer in relation to any entitlement she had to income under the trust since 2006.

But it was far too late. The knowledge of her husband, as her agent, was taken to be her own knowledge (in accordance with standard common law principles) and the 8 year delay in disclaiming the entitlement was far too long. The Court held that the wife was taken to have had knowledge of and to have accepted, the distributions from the trust well before December 2015 – being the date of the disclaimer.

If you need to get rid of income or assets to which you may be entitled as beneficiary under a trust, ensure your deed of disclaimer is made at the right time!

Marriage breakdown and tax to boot – a bad combination

John and Christina were getting a divorce. John agreed to transfer the house in his name  to Christina, Christina was to transfer to John one half of  her share portfolio, Christina’s sports goods company Liontree Pty Limited was to transfer an apartment  that it owned to John and Liontree was to pay John $350,000. All this was to be sanctioned by the Family Court.

You might think that all these transactions were not going to incur any income tax or other tax impost (like CGT), because they were to be made pursuant to Family Court orders.

Think again. The payment of the $350,000 to John will be taken to be assessable income to John (TR2014/5). Further, it will also be taken to be a Division 7A deemed dividend.

Even though the payment could be franked which would reduce John’s tax somewhat, what is worse is that the transfer of the apartment to John will also be a deemed dividend.

Christina on the other hand is delighted. Liontree will not have to pay any CGT on the transfer of the property to John, because the transfer is pursuant to Family Court orders. Phew.

However, someone forgets to ask Christina about her share portfolio. She has been trading them for years to the point that they are considered trading stock as far as the Tax legislation is concerned. And section 70 of the Income Tax Assessment Act 1997 provides that the disposal of trading stock outside the ordinary course of business is taken to be a disposal at market value. So 100 percent of any profit on the shares transferred to John will be added to Christina’s assessable income.

It always pays to get good business advice and good tax advice wherever you are moving assets about – even in the Family Court.

The new insolvent trading defence

The Federal Parliament recently passed an Act to create a safe harbour for company directors from the insolvent trading provisions of section 588G of the Corporations Act if the company is undertaking a restructure outside a formal insolvency process.

These reforms are intended to encourage company directors to keep control of the company, engage early with possible insolvency and to take reasonable risks to facilitate the company’s recovery instead of simply placing the company prematurely into voluntary administration or liquidation.

It is all in new section 588GA of the Corporations Act 2001.

To receive the benefit of the defence, the director has to be personally involved in the turnaround strategy. It is not enough to rely on others in the company to develop or implement the turnaround strategy.

Directors who merely take a passive approach to the business’s position or allow the company to continue trading as usual during severe financial difficulty, or who apply recovery plans that are fanciful, will fall outside this new safe harbour.

Directors relying on the defence must ensure that there is a direct or indirect connection between the debt and the proposed turnaround strategy. This means that it should be OK to incur new debts by way of operational expenses in the usual course of trade where they are incorporated in the turnaround strategy.

This will require directors to apply ongoing diligence and it may entail careful consideration of specific significant decisions such as major asset purchases or a major change in the activity of the company’s business.

Protection is allowed if the course of action is reasonably likely to lead to a better outcome – i.e. better than an immediate appointment of an administrator or liquidator of the company – s 588GA (7).

It is likely that company directors will not have the benefit of the defence if they substantially fail to pay company employee entitlements when they fall due or substantially fail to comply with taxation laws, unless the director can convince the court that exceptional circumstances apply.

So the answer is – get advice early and apply Plan ‘B’ as soon as possible. It could well save your skin.