Article by Amanda Tully – Lawyer & Director
It has been a quiet week at work, and you are starting to get that worried feeling where you think you’ll never have another client for the rest of your working life.
A couple of weeks ago you were flat out and felt secure in the work flowing through. But as happens, it had slowed down.
You were grateful then for a late Monday afternoon enquiry that arrives in your in-box from a new client, Fred Smith (Fred Snr), who has been referred by one of your long-standing and loyal clients. Fred Snr requests an urgent appointment to discuss his will, as he is heading overseas that Friday and currently has nothing in place.
You promptly reply, offering him an appointment the following day, which Fred Snr gratefully accepts.
Fred Snr arrives the next day, arms full of documents. He assures you that his affairs are straightforward: he wishes to leave everything to his son, Fred Jnr. He mentions he has a daughter, Freida, from whom he is estranged, and expresses a strong desire to exclude her from his will. “She never talks to me,” he says, “and has always been a difficult child.”
As you discuss the potential risk of a claim, Fred Snr has a bit of a change of heart. “I was probably a bit hard on poor Freida when she was a kid” he admits.
Fred Snr explains that most of his assets are held by his company, Fred & Son Holdings Pty Ltd, of which he is the sole shareholder and director.
“I’ll give her one property,” he decides. “There’s a commercial building in Sydney worth a bit—she can have that one.”
Fred Snr asks for his will to be prepared by the next day, wanting to finalise matters before his trip. He leaves the property to Freida and the rest of his estate to Fred Jnr, subject to Fred Jnr ensuring the property is transferred to Freida first. Fred Snr attends the following day, signs the will and departs for his trip.
About a week later, you receive a call from Fred Jnr. Fred Snr died while overseas from an unexpected heart attack.
You tell Fred Jnr it shouldn’t be too complicated, “the shares just need to be transferred to you, but firstly we need to get the Sydney property to Freida”.
“But” you say to Fred Jnr “we can’t rush it through as we really should wait the required period – plus we need probate anyway to transfer the property and the shares”.
Fred Jnr says he isn’t too worried about the wait and is also confident Freida won’t make a claim – “ I don’t think she’ll want the old bugger’s money anyway..”
After probate is granted, you arrange to transfer the property to Freida and the shares to Fred.
The Stings – Transfer of Property
Although the will says the Property is to go to Freida, the property was not an asset of Fred Snr, it was an asset of Fred & Son Holdings Pty Ltd, so:
- Section 128-10 of the Income Tax Assessment Act 1997 (“ITAA 1997”) which allows any capital gain or loss to be disregarded when an asset passes to a beneficiary, does not apply because Fred did not own the property himself. Because the company and Freida are not dealing at arm’s length, the market value substitution rule applies so the company is treated as having received the market value of the Property at the time of transfer. The property was acquired by the company in 1999 for $850,000 and has since almost tripled in value to $2,400,000, so the capital gain is $1,550,000.
- Section 63 of the Duties Act 1997 (“Duties Act”) does not apply to the transfer to Freida either, therefore duty on the market value of the Property is payable, being $114,012.
- The transfer of the Property to Freida is also treated as a payment under Division 7A of the Income Tax Assessment Act 1936 (section 109C(3)(c)), so the company is taken to have paid a deemed dividend to Freida of $2,400,000 on which Freida will have to add to her assessable income for the year and pay income tax.
The Sting – Transfer of Shares
Although the ASIC search indicated that the shares in Fred & Son Holdings were held in Fred Snr’s name, you later discover from the accountant that Fred Snr held the shares as trustee for the Fred and Freida Family Trust.
So, when the shares were transferred to Fred Jnr, they were not shares being transferred pursuant to the terms of the will. It was instead a transfer of shares from the Fred and Freida Family Trust to Fred Jnr.
The land holdings of Fred & Son Holdings has an unencumbered value of $20,000,000 and it is considered a landholder under section 146 of the Duties Act.
Because the Fred and Freida Family Trust disposed of the shares it owned in Fred & Son Holdings Pty Ltd, and the transfer resulted in Fred Jnr acquiring 100% of the shares, amounting to a relevant acquisition (section 149) giving Fred Jnr a significant interest (section 150) in the company, landholder duty is payable.
Capital gains tax will also be payable…..
Is there a way out? Perhaps, maybe a Division 7A Loan Agreement can help with the dividend issue for Freida, BUT it will mean Freida will have to eventually make payments of principal and interest back to Fred & Son Holdings. Also, the ATO might be feeling charitable and give a break under s 109R of the ITAA 1936…