Introduction
Gift duty is to be abolished from 1 October.
This will be seen by many as an 'open door' through which they can move assets into trusts immediately, without needing a gifting programme over many years.
However, we certainly recommend caution before proceeding, along with a full examination of the consequences.
Gift duty has been the "silent police" for many commercial and family transactions. Because it will be quicker to alienate property, and there is greater scope to distance assets away from potential claims, we expect to see an increase in legal challenges to gifts made by parties that have been disadvantaged by the gift.
Accordingly, it is important any restructuring be well thought out.
You probably set up your trust for one of three reasons:
1. To protect your assets from creditors.
2. To protect your assets from family or partners.
3. To protect your assets from the Government.
This paper analyses these three areas and how the abolishment of gift duty might affect your planning going forward.
Trusts and Creditor Protection
There are many people in business who are now struggling to make ends meet. There are also people who hold concerns for their futures.
They will be relying on the fact that after 1 October, they can transfer their assets to their family trust to protect their assets from creditors.
Equally, of course, creditors will be looking to challenge those transfers. They will often have a very real chance of succeeding.
Regal Castings
This point was demonstrated in the Supreme Court decision in Regal Castings Limited v Lightbody.
Facts
In Regal Castings, Mr Lightbody transferred his one half share in his house, his only substantial asset, to his family trust. This was done in the usual way and included the usual gifting programme at $27,000 per annum.
However, before these transactions had commenced, Mr Lightbody had provided a personal guarantee to Regal Castings so that Regal Castings would continue to supply products to Mr Lightbody's company.
The obvious then occurred. Mr Lightbody's company failed and Regal Castings pursued him under this guarantee. Regal Castings got judgment against Mr Lightbody and then bankrupted him.
The trouble was that Mr Lightbody held no assets. Regal Castings then sued Mr Lightbody's trust, seeking the return of the one half share of the house.
Decision
Regal Castings' claim was based on s60 of the Property Law Act 1952. This has recently been replaced but the new Act contains similar provisions.
This section provided that where a debtor transfers property with the intent to defraud creditors the Court has the ability to reverse the transaction. Only a purchaser who at the time of the transaction had no notice of the intention to defraud is protected against such an order.
In these circumstances the Court found that there was an intention to defraud and the trustees had knowledge of the intention to defraud.
The Property Law Act 2007 and the Insolvency Act 1967
In fact the provisions in the Property Law Act 2007 go further than they did in the 1952 Act.
They provide that dispositions of property through gifting by an insolvent debtor can be reversed
without the need to show an intent to defeat creditors. As such, it is now going to even easier to unwind these types of transactions.
The Property Law Act deems someone to be insolvent if he is unable to pay all of his debts as they fall due. Under the previous regime a debtor would have staggered the gifts and could point to the money owing to him or her by the trust. This would have showed that the debtor was balance sheet solvent at the time of the sale of the debtor's home.
If the total property value is gifted, there is no longer the loan back from the trust to prop up the debtor's personal balance sheet.
Would such a gift mean that the debtor is insolvent, and could a creditor set the transfer aside under the Property Law Act?
It seems to us that the test under the Property Law Act is not a balance sheet test but a cashflow test. "As they fall due", means when the debts become legally due for payment, and the debtor does not necessarily have to have sufficient cash on hand at all times to pay its due debts. The debtor does not need to show that the debtor can immediately repay all the debtor's borrowings to the bank, they only need to show that they can meet those borrowings as they fall legally due for payment.
It is our view that provided the settlor can show cashflow solvency at the time of the disposition, the Property Law Act provisions won't bite the debtor. As such, large gifts that effectively render the settlor balance sheet insolvent, will not on their own offend the Act.
However, the debtor will undoubtedly be in a much more precarious financial position as technically the debtor has no recourse to the trust's assets.
It is imperative that the debtor can show that the debtor has access to a sufficient cashflow to meet the debts as and when they fall due for payment.
Apart from the terms of the Property Law Act there is also a provision in the Insolvency Act that provides that gifts to a trust can be challenged if they are made within two years of bankruptcy. These can be claimed back by the Official Assignee.
What is the lesson from this?
There are many barristers that are keen to test the rigor of the new regime where large gifts to trusts are inevitable. The provisions in the Property Law Act are quite inviting and aggrieved creditors will view them with interest in the event of a debtor's bankruptcy.
As such, before proceeding with gifting all of your assets to your trust in a one-off amount you should undertake a full examination of the consequences.
Apart from the usual consequences including the loss of absolute control of the assets, the need to ensure your trust is under the control of all trustees and administered correctly, tax consequences of the disposition and other obvious issues, an assessment needs to be made as to whether there are any potential claw-backs by creditors.
Because it is going to be quicker to dispose of property, and there is greater scope to distance assets away from potential claims, I would expect to see an increase in legal challenges to gifts made by parties that have been disadvantaged by gift.
On this basis it is important that any restructuring is well thought out – there should be no rush to complete the restructuring during October.
We will be getting clients to complete the statement of assets and liabilities at the time they gift their assets across to the trust, with a statement concerning the matters specified in the Property Law Act (concerning the cashflow solvency and the business they are engaged in).
We may also look to address the relevant matters in the Insolvency Act.
So what does this mean for you?
If you are a debtor, it is still worthwhile using your family trust to try and protect your assets from creditors.
The best time to do that is before you are in a situation of having significant creditors.
However, even if you have significant creditors, it is better to transfer your assets into your family trust than to not do so, because not all creditors will be willing to pursue you through the Courts and to have those transactions unwound.
Trusts and the Family Protection Act 1955
The Family Protection Act ("FPA") provides that if the Will of a deceased person does not provide adequate provision for the proper maintenance of immediate family members, the Court may make such provision.
In these circumstances the Court might determine that the deceased failed to meet his or her moral obligation to a beneficiary.
The cases in this area remain unpredictable.
The classic example of this is where one child is excluded from a parents Will.
How do Trusts help people exclude beneficiaries?
Trusts can be used as a vehicle to eliminate a person's ability to challenge the distribution of assets under the Family Protection Act. Assets which are validly transferred into a trust during a person's lifetime are not subject to a claim against their estate.
The problem is that safety is not achieved until the gifting programme is complete because the debt back is treated as an asset in the person's name.
After Gift Duty is abolished
Once gift duty is abolished, a person wishing to exclude people from their estate can give all of their assets to a Trust in one go. An estate will not be challenged if there are no assets in it.
What if I change my mind and wish to include the excluded person?
If you set up a Trust which excludes one of your children as a beneficiary, you can easily add that child as a beneficiary later.
Trusts and Relationship Property Matters
There is a general misconception that assets owned by a Trust are safe from relationship property claims.
While this is true in some cases, it is not always so. Even if assets have been transferred into the Trust well in advance of the relationship starting they are still not always safe.
There are a number of avenues by which Trusts can be attacked. If these attacks are successful the result is either that:
1. The assets are clawed back out of the Trust; or
2. The person's private assets are used to equalise matters.
In recent years the Family Court have shown an increased willingness to attack Trusts.
With the abolition of gift duty and the increased ability for individuals to transfer assets into a Trust in one go, it is likely that the Family Court will continue to attempt to widen its ability to attack Trusts to achieve a "fair" result.
Not all of the ways of attacking Trust will be affected by the abolition of gift duty.
However, claims under sections 44 and 44C of the Property Relationships Act and the so called "Bundle of Rights" will be affected.
We have considered these three areas below.
Section 44
Section 44 allows the Court to make an order forcing the Trust to transfer the property back to whoever has been defeated by the disposition.
This section requires that there be intent to deprive. In most cases this intent is hard to prove.
After gift duty is abolished people will be more likely to gift large amounts into a Trust with the intention to defeat RPA claims. While most people will be smart enough not to state this as being their intention, the Family Court will look to infer an intention where it can.
Section 44C
This section is probably affected the most by the abolishing of gifting.
This section applies where assets are transferred to the Trust during the relationship and this otherwise defeats the partner's claim.
The Family Court may make an order to compensate the partner, including requiring:
1. Payment of cash from amounts outside of the Trust; or
2. Transfer of specific property other than Trust property; or
3. The trustees of the Trust to pay out income of the Trust.
In the past there was often a debt back from the Trust to the individual. Section 44C was commonly used to compensate the spouse out of this debt back.
Once gift duty is abolished, there will be greater freedom to transfer assets into a Trust. Well advised parties will have little or no separate or relationship property outside of the Trust from which a compensatory order can be made.
While the Court can still award payment of the income of a Trust in most cases a Trust will only own non-income earning assets. There will be little or no Trust income for any compensation to be paid out of.
Bundle of Rights
The Court has increasingly attempted to value what has become known as the "bundle of rights" which a party may have in a Trust. This bundle of rights may come about when an individual is the settlor, trustee, appointer and beneficiary of a Trust.
Conceptually, the Family Court seems to be saying that a party’s interest in a Trust, whether as settlor, trustee, appointer or beneficiary, may have a value and that value may be considered relationship property.
The bundle of rights doctrine has not been fully accepted in New Zealand but it has the potential to undermine years of Trust law.
We believe after the abolition of gift duty there will be increased pressure on the Family Court to accept the bundle of rights argument.
Conclusion
As you can see there are already a number of ways for the Courts to attack Trusts and with the abolishment of gift duty it is likely that fewer assets will remain in an individual’s hands.
As a result Trusts will undoubtedly come under closer scrutiny by the Family Court when determining relationship property matters between ex partners.
For this reason we suggest that an agreement contracting out of the Property (Relationships) Act is a necessity in all but a few cases, regardless of whether you believe your assets are "safely" in a Trust or not.
Trusts and Residential Care Subsidies
Historically, one of the main motivating factors behind forming a Trust was that it sometimes enabled people to avoid having to pay for their own residential care later in life.
The reason for this is that if you own little or no assets in your own name, then the Government will pick up the bill for your residential care.
The transfer of assets to a Trust may not always save an individual from paying for their own care.
With the abolishment of gift duty, you can now transfer all your assets into a Trust or to a third party (such as a child) in one go without incurring any tax at the time of transfer. and it might appear that you can quite easily avoid having to pay for your own residential care while protecting your assets through your Trust.
For obvious reasons, the Government is not keen on this happening as this simply passes the costs onto the State.
The Ministry of Social Development ("MSD") administers the Government subsidies for Residential Care. They start with the premise that people should look to their own resources before calling on the state to pay. If they believe you have deprived yourself of income or assets to avoid having to pay for your own care they will not grant you a subsidy.
Current criteria
The MSD assesses a person’s financial means. In general terms it will require an individual to pay for their own care if their assets exceed the thresholds.
As at 1 July 2011, to qualify for the subsidy:
4. A single person in care must have less than $210,000 (increasing at $10,000 per year), including the value of their home and a car, or
5. A person in care who has a partner in the community must have combined total assets that value up at less than:
(a) $210,000 (increasing at $10,000 per year) in cash assets, or
(b) $115,000 (increasing at $10,000 per year) in cash plus a home* and a car.
*The exempt home only applies to a home owned by the applicant and not by a Trust.
In addition there are other assets that are exempt, such as:
1. Household furniture and personal belongings, eg. clothing and jewellery;
2. Up to $10,000 of pre-paid funeral expenses; and
3. The home and car if the circumstances discussed above apply.
Individuals must also contribute their income (including Trust income) towards the cost of their care.
Is it this simple?
At first glance it appears if you can get your assets below these thresholds you won't have to pay for your care.
However the MSD does not stop there. They have wide powers to look at what assets and income the person has deprived themselves of in the past and present. In reality the regulations list a number of instances which qualify as deprivation of assets according to section 147A of the Social Securities Act 1964. There is no time limit on the MSD’s discretion to consider adding back assets that applicants have divested prior to going into care.
What gifts are allowed?
The regulations and current MSD policy provides that the following gifts will be allowed:
1. Up to $6,000 in total per year in the five years prior to going into residential care; and
2. Up to $27,000 in total per year outside of that five year period.
Gifts above these limits may be classed as deprivation of assets. They will be counted back into the calculation when assessing an individual's means to pay for their own residential care.
Note that gifts are assessed on a per application basis, not per person.
The MSD also allows gifting to be made in recognition of care provided by family or friends in the five years prior to going into the rest home. The criteria for allowing such gifts is limited to where the care has been continuous and must involve the person living with the carer. There is also a limit of $30,000 on this.
Example
Below is an example that was common in years gone by.
Mr Smith lives alone. He transferred his home worth $500,000 into his Trust 15 years before he had to go into residential care. He has an additional $100,000 of investments in his own name. He then progressively gifts $27,000 per year for the 15 years until he has gone into care.
Mr Smith would have gifted a total of $405,000 to his Trust. However because only gifts of $6,000 are allowed in the five years prior to going into care, $21,000, times five years ($105,000) would be counted back. This leaves him with $100,000 of initial investments (assuming no increase in value of this asset) plus the $95,000 not yet gifted and the $105,000 counted back making a total of $300,000 of "assessable assets".
He will have to pay the first $90,000 towards his care.
However, if the Trust was only formed today and the threshold continues to increase at $10,000 per year, then in 15 years the threshold would be (based on current policy) $360,000. As a result Mr Smith would be under the threshold and the State would pay for this care from day one.
(This scenario does not take into account other deprivation or factors that the MSD consider, and is intended solely to illustrate the basic premise)
So how does the abolition of gift duty affect this?
While gift duty is to be abolished as at 1 October 2011, this is a change in duty law not social security law. The limits with respect to residential care subsidy assessments are not changing.
Of course, as a result of the abolishment of gift duty, more people may have gifted away all of their assets before they need to go into residential care. This will result in the MSD looking more closely into the gifts made by individuals and any other deprivation of assets (or income) in the years before an application for a subsidy is made.
In conjunction with this, it is likely that in years to come the Government will tighten its purse strings around residential care subsidies. Closer scrutiny of deprivation of assets is one way to ensure that the cost is placed back on the individual.
Income assessment
In addition to the value of a person's assets, the MSD takes into account a person's income. A person may earn income while in residential care and will be required to contribute that income towards their own costs of care.
Deprivation of income
While most people think of depriving themselves of capital, there is also the ability for the MSD to determine that a person has deprived themselves of income.
An example of this is where a Trust has been earning income for a number of years and the accountant has determined for tax efficiency reasons, that the income should be paid out to the beneficiaries. The beneficiary then needs to go into residential care and has no assets in the beneficiary's own name. The beneficiary asks the trustees to stop paying income to the beneficiary because it will only be spent on having to pay for their residential care. The MSD may assess this situation as being intentionally depriving the beneficiary of assets through the control or influence the beneficiary has over the Trust. It will then assess the amount that the beneficiary would have otherwise received as income when determining if the individual would receive a subsidy.
$27,000 threshold
There is a common misunderstanding that the allowable gift for residential care subsidy considerations is $27,000 per person.
However, the assessment is actually made on a per application basis. When only one person in a couple goes into care, the gifting of both is taken into consideration by the MSD. Therefore the MSD will consider the extra $27,000 as an assessable asset. However, if both are in care, the MSD's current practice is to allow $27,000 per person.
It is important to note that there is no time limit for adding back excess gifts made and how far back the MSD will look depends on their policy at the time.
So what may happen if I gift all of my assets to my Trust in one go?
We believe that if your primary consideration is to avoid paying for your residential care, then, based on current MSD policy you should continue gifting at no more than $27,000 per year. If you are married you should consider gifting this amount in total (ie. at $12,500 each).
This is because a large gift will not be averaged out over the years since the gift was made.
Using the example referred to above, if Mr Smith gifted his entire $500,000 house in year 1 and then required rest home care 15 years later, the MSD may go as far back as the initial gift and say that he was only entitled to have a gift of up to $27,000 excluded from his assessment. As a result he has deprived himself of $473,000 worth of assets, and Mr Smith will be required to pay for his own care.
Conclusion
Hopefully, this paper has given you a sufficient overview of how the abolition of gift duty will affect you.
The next step is to make an appointment with your solicitor to discuss your planning going forward. How you structure your planning will principally depend on your objective for having a trust.
Seminar presenters:
Bill Holland
Simon Collett
Luke Stewart