Season 8 Episode 3
Martin: Welcome to The Business Owners Podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory team.
Hello everybody, we are here today with my tax partner Ross Higgins, welcome Ross!
Ross: Great to be here, Martin
Martin: So Ross is joining us for a series about tax issues for business owners, and today we are going to talk about a couple of things that are often taboo subjects. They are not raised by advisers, and they are sometimes uncomfortable to discuss with our business owner clients. And those two things are death and divorce. Both of which can of course not only be very significant events from a personal and financial perspective, but there is also tax all over them, as Ross is about to tell us. Now what do they say about death in taxes, Ross? That there are two certainties in life, is that right?
Ross: Yes, and I think there is great ring of truth about that.
Martin: So, let’s start with death, I thought there was no inheritance tax in Australia, so what is the issue?
Ross: Well, that’s right. Since the late 70s there is no inheritance tax, but you have to be careful to take advantage of forward planning in relation to possible death, sometimes when you raise this with clients, they say “oh, it’s morbid”. But it’s funny since a very young age I have taken the view that these things happen and it’s much better to plan and be prepared. If you’ve had a life of building up wealth, working hard, you’ve got a family that you care for and so forth, planning for death, having a will, having powers of attorney, all those sort of things, these are gifts to your family, these are for the benefit of them. Not for you, these are for the benefit of your family. So when you say “I just want to keep things simple”, or “Do I really need a Will?”, or “I don’t want to think about that” you are doing it for them. So it’s a very important thing, you’ve got a plan to make wealth, you’ve got a plan to trying keep it and lower risk as you going through your life, and then you plan to pass it on successfully, your legacy. And it’s important for all those phases to get it right.
One thing which I like to say in relation to Victorian law is “what happens if you don’t have a Will?” and the other day a fella rang me, and he said “Yeah I don’t have a Will, it’s one of those things I should possibly get” and I said “Well, say you’ve got $100k in the bank and a family home. If you die then first $100k goes to the spouse, and then the family home goes one third to the spouse and two third to the 2 and 3 year old children that you’ve got. So, therefore, two little children own two third of your house”. And that’s great for them, but I think for a lot of people that’s an enormous shock. And they would not necessarily expect that. In fact intuitively most people, if you ask them, they think “Oh, well, if I die without Will, it just will go to my spouse, won’t it?” I say “Well, actually no, only partly”. So therefore if you want that situation, which I mentioned not to be the case, then you should make a Will.
The other key thing is that sometimes you make a Will, and if you have just a simple Will and it goes, for example, to a child and at the time that child has become an adult child and is running a business and happened to be bankrupt at the time that you die, then if’ it’s just a simple Will the situation that can be that you are writing a cheque out to the creditors of your child, and your child does not benefit from that inheritance. Which is a crying shame.
Martin: Oh, that’s it. And we spent an awful lot of time talking about asset protection with our clients, and when we talk about asset protection, we attempt to think about yourself and your own creditors, but you have just shown a brilliant example where you actually need to start thinking about the risk profile of the next generation, that’s so important.
Hey Ross, you are a tax guy, are there any tax benefits in making a Will over and above the asset protection benefits that you have mentioned?
Ross: Well, I mentioned having a more sophisticated Will can potentially protect assets that are coming through to children, say, from bankruptcy. They can even have some potential benefits in protecting from some family law issues in certain cases… that’s a very complex area.
But in more sophisticated Wills you have these things called testamentary trusts. People sometimes say “oh that sounds great, can I set one of those up?” and you say “Well, actually it’s a creature of your Will, it’s testamentary which means it arises on death!.
And what’s the benefit of this? Well, it means that unless the beneficiary has chosen otherwise, which they can in many cases do, the moneys going to them go into a testamentary trust for them. So it’s just like a discretionary trust with all the powers of discretion to allocate income and capital to that child or that child’s spouse or that’s child’s children, children’s children and so forth. So in Victoria these testamentary trusts can go on for 80 years, just like when you set up a discretionary trust from day to day. The one key advantage, apart from the usual asset protection and income and capital distribution flexibility, is that it arises out of the deceased’s estate, and if you allocate income to minor children (children under the age of 18), then that income is taxed to them as if they were adults.
You might know that at the moment the tax-free threshold is $18,200. So for example, if there were several children involved who you could distribute to, you could allocate $18,200 to each of them towards their schooling, towards their maintenance and so on and so forth and it all would be completely tax free. Say a grandfather dies, it might then go to a grandmother, then the grandmother dies and grandmother’s Will might become the most important one, that then provides for the testamentary trust, it can then go for 80 years, so it can potentially provide that for the great grandchildren, the great-great grandchildren and even great-great-great grandchildren going down the line. And you still can have these benefits going on for many years all time back to the deceased estate. So a lot of people don’t realise this and when they see money coming out of the estate they just swipe it out, but that might be a short term benefit, paying off the home mortgage or something like that. But it might be better to take some money out and pay off a home mortgage and keep some money in a testamentary trust for the benefit through the generations. Again, seek advice.
Martin: That’s just a brilliant point, Ross. And I am thinking for the business owners who are listening, they may very well be set up financially, they may have enough assets to look after themselves, they might have paid the home off, etc. So for people like that, what an opportunity to say “Well, no, actually when my parents die I’m just going to keep their money in that testamentary trust and my children and in due course their children can get a benefit of it”, and savings for over 80 year period of the trust could be enormous. And it’s a way to establish some dynastic wealth.
Ross: Yes, absolutely. And the thing is that who’s likely to die first: you or your parents or your grandparents? And so sometimes that means you ideally should have a discussion about family wealth with your parents. And even if your parents are a bit uncomfortable in some respects, just say to them “Look, I would appreciate it if you would have a Will which provides for a testamentary trust for me in your Will because that will protect the money in case I happen to be bankrupt at the time, which I don’t expect to be by the way, but nevertheless it’s going to have these benefits for me going down through the generations.” And if it’s not provided in a Will there is a bit of a backstop in a tax legislation where you can create a testamentary trust within three years but it’s a very limited type of trust, which is effectively like a fixed trust for particular children, it’s not that full-blown testamentary discretionary trust which can effectively go for 80 years down through the generations.
Martin: Yeah, so you started off this session, Ross, by saying it’s really an altruistic selfless act to set yourself up right, because it’s not for your benefit, it’s for your kids. And of course a flip side of that is the imperative for the kids to actually have a discuss with their parents and say “Look Mum, look Dad, it’s time for you to set things up right for me and for my children. Either the children that I have now, or that may follow”. Have you got any tips for adults children of parents who might have substantial assets and they don’t know what they’ve got, and they don’t know how it’s structured?.
Ross: Look, with some families they tend to be open about these things, but certainly in past generations that hasn’t been the typical situation. I certainly know of many wealthy families where they hide their wealth from the kids, sometimes thinking that it’s better for them to have more of a normal life and just not to realise that they are actually going to inherit a lot of money. But regardless of that, you should still ask your parents to consider this for your benefit, not necessarily having to reveal to you their personal details, but just asking them if they wouldn’t mind going and seeing a lawyer, their own independent lawyer and asking them about testamentary trusts, because of the benefits that it holds. Also having Powers of Attorney at some stage, it’s more likely with long age and health and so forth these days that most people might have a period of needing someone to look after them and possibly losing capacity before they die. And if you don’t have certain powers of attorney in place, then if you lose capacity your spouse can’t even use money out of your own bank account without going off to VCAT to get an order as to who is going to effectively be your power of attorney. And then if the family is fighting over it, and various people want to play that role then sometimes VCAT will appoint an independent trust company and that all can get very uncomfortable. So it’s much better if you write down what you want in your Will and in your Power of attorney, and the people who you trust carry out your wishes and look after your interests.
I wanted to raise another thing where it comes to what’s actually in your Will and these days a lot of people are challenging Wills, or kids are looking at it and saying “ooh, not entirely happy with this Will, I am really the one that’s working in my parents’ business, and I want to inherit the whole business. And my other sibling can get more cash and other assets, but I don’t really want to go 50/50 with my sibling, and them be involved in a business which they’ve got nothing to do with. So I would like to rearrange the deck chairs”. Now again, it’s another reason why you should go and try to have the conversation with the parents before they die, but if that doesn’t happen and you look at the Will, and you are not very happy with the way how the things are distributed, then you should immediately go off to lawyers and you can rearrange the deck chairs. And in fact the tax legislation provides for that. And if you rearrange the deck chairs by way of a deed of arrangement or in some cases you can go and get court orders, but you don’t have to do that, then you can still get the rollover which the tax law provides. The rollover is critical because it means when someone dies, generally there is a rollover of any tax liability, it’s not treated as a disposal, you don’t trigger all sorts of gains that’s you have disposed of all your assets when you die. And you want to keep that protection, but you can rearrange the deck chairs, enter in one of these deeds of arrangements and still get that rollover. And then you have got the right assets going into right direction, even though perhaps your parents didn’t really do that.
Martin: That’s great to know, and that rollover aspect is so important. Yes, it’s a very important ability as you say to change things up and move around the deck chairs.
Ross: It can be important in successions because who’s going to take over the business and who is the proper one to take over the business, some of those discussions might not be heard, and the Will also might not reflect the best sort of succession. But death is a key point at which you can move things around with rollover, so it’s there to be taken advantage of. And even if the Will doesn’t provide the framework that you would have liked, you can agree with the other beneficiaries to rearrange that, and in some cases also you can sell assets or, if you decide to sell a business, you can also sell the business from the estate, even though it was not provided for under the Will. And if you do it within a certain period of time you can still take advantage of the small business concessions that might have applied to the deceased, because there is a sort of grandfathering of those concessions on death, but you have to do it within a certain period of time and satisfy certain things, but those benefits potentially are there. So death is a key opportunity in fact sometimes to take advantage of these concessions.
Martin: So for business owners who haven’t transitioned in their life time or, more importantly, their families, again a really pivotal point to take advice. Because if you can crystallise those concessions that could be very valuable.
I want to turn now to relationship breakdown, because if we call death and taxes a certainty, another thing that, it is not a certainty, but unfortunately it is very common, is relationship breakdown. Talk to us about the tax consequences when relationships break down.
Ross: Look, I just say relationship breakdown, of course, covers both formal marriages and also de-facto relationships, including same sex. The concepts are really family law type concepts.
Now again here there is an opportunity to take advantage of capital gains tax rollover previsions, which normally might not apply. If you transfer from one partner to another, you don’t get a rollover during life, usually in fact there is deemed disposal at market value even, if you do it for no consideration. Now that might not matter with things like the family home, because of the exemption, but for other assets if you transfer them between spouses you get deemed full market transfer.
Martin: And let me just stop you there, Ross, because I am tipping a lot of people don’t know that. People think that it is just all under the tent, it’s all in-house and you can swap things around between spouses. But as you say other than the transfer of a family home, that’s actually not the case. That’s a full on taxing event.
Ross: That’s right. No general exemption for private use assets but a lot of things like if you transfer an investment property from one spouse to another, or a portfolio of shares from one to another even for no consideration, unfortunately the commissioner doesn’t take much attention to love and affection and says “It’s a taxing event, I will have my revenue:”
Martin: And similarly, an associated point for those who seek to avoid their family law obligations by given the assets brothers, fathers, sisters, etc, it’s exactly the same thing. And not only they are creating a problem in the family court, but they are creating tax for themselves.
Ross: Yes, that’s absolutely right and sometimes duty as well, and all sorts of issues. So one thing about relationship breakdown is that there is an opportunity to split assets with capital gains tax rollover, that’s generally between the spouses but there are also some rules that allow you to effectively transfer things out of certain entities and get some concessional treatment as well. It’s rather complex but it’s just important to know that these rollover opportunities exist, and it’s important to plan to come within these rollover rules if you don’t want to trigger tax liabilities. And there are some duty concessions as well in relation to relationship breakdown.
In some cases you might not want to use the rollover. If you are fall within certain circumstances, the rollover is automatic. That means that if you don’t want to fall within a rollover, you have to make sure that you plan not to use the rollover. You might say “Why would not you want to use a rollover” well, each person’s circumstances have to be considered and certain assets they might want to go under a rollover, and certain assets they might not to go under a rollover. And an example, when you might want not to choose a rollover is when dealing with a small business and the opportunity to take advantage of a small business concessions. It may be that you would rather have a tax event and would tax an advantage of a small business concessions, which might in some cases lower your tax down to zero, maybe even enable you to get money into super and to have a permanent tax saving rather than a rollover. So if you have a relationship breakdown situation coming up, again, another reason to get advice and start doing some proactive planning about how you might like to deal with your assets that might be split between the parties.
Martin: And I don’t want to sound flippant but it does sound like a fantastic opportunity, a silver lining if you will, coming out of this situation.
Ross: I was surprised once I turned up to a meeting with some legal counsel and they had drafted things up between the parties but they have done it in such a way that rollover would not apply and they have just said “We are commercial Counsel and not tax Counsel”. But that just doesn’t cut it. The tax consequences were significant. And so then instead we worked with the husband and a wife from an independent point of view of putting forward a tax and duty solution and we were able to get family lawyers on both sides happy as there was a much better outcome as a result of taking taxes into account.
Martin: Absolutely, in my experience good family lawyers are right across this, but many of them aren’t, sadly. And a lot of money can be left on the table.
Martin: Thank you so much for today, Ross. We have covered an awful lot. In particular you have educated me around the opportunities that can surround these very sad life events of death and relationship breakdown.
So it has been very useful and again the key message of this is just seek some good advice at these pivotal moments, because if you do, you can get much better results. Thank you!
Ross: Thank you.