The recent Administrative Appeals Tribunal decision of Alderton and Commissioner of Taxation [2015] AATA 807 serves as an important reminder on the law of disclaimer, which in turn can have important implications for SMSF succession planning. Although the decision does not expressly consider superannuation, the principle that it relies upon can be critical.
Facts of the decision
In 2000, when Ms Lisa Alderton was 18 years old, she commenced a relationship with a medical professional, Mr Trapperton, who was then aged about 42 or 43 years.
Deputy President Hack of the AAT, who decided the matter, noted that at the time Ms Alderton was ‘considerably less sophisticated than she now appears to be’.
Throughout the relationship Ms Alderton was entirely financially dependent on Mr Trapperton. Originally, Mr Trapperton provided financial support by transferring money from his bank account to Ms Alderton’s bank account. However, in 2006 a discretionary trust was set up where Mr Trapperton was the trustee. Ms Alderton was able to access funds in that the discretionary trust’s bank account using a debit card in the name of the trust and by internet banking.
By May 2010 the relationship with Ms Alderton had come to an end. The trust lodged a trust return with the ATO disclosing net income of $79,880 in the 2009 income year, said to have been distributed to Ms Alderton. (The bank statements of the trust demonstrate that amounts in excess of $80,000 were transferred into the trust’s bank account to which Ms Alderton had access and that she withdrew those amounts.)
In June 2014 the commissioner made a default assessment of Ms Alderton’s taxable income for the 2009 income year. The distribution from the trust was the major component of the assessment. Without the distribution Ms Alderton would have been well below the taxable threshold.
Ms Alderton said, and the AAT accepted, that although she was aware of the creation of the trust she knew nothing of its a airs and, so far as she was concerned, its purpose was to save Mr Trapperton tax. She was not involved in its financial a airs nor was she aware of its dealings beyond using a debit card in the trust’s name to access the funds provided to her by Mr Trapperton.
Several months later, Ms Alderton, through her solicitors, wrote to Mr Trapperton disclaiming any interest in the trust.
Ms Alderton then asserted to the AAT that she had disclaimed the income and should not be assessed on the income.
Relevant law
The AAT noted the relevant law is that:
… to be e ffective, a disclaimer must constitute an absolute rejection of the gift. Here, Ms Alderton did not reject the gift because, having accepted the benefit of it, it was no longer able to be disclaimed. She had the use and benefit of the distribution.
The findings
The AAT appears to have great sympathy for Ms Alderton, however, ultimately the law is the law. Accordingly, it was held that the objection decision was correct.
Deputy President Hack observed:
It is most unfortunate that Ms Alderton is in the predicament that she now finds herself. But … the Income Tax Assessment Act 1936 makes taxable in the hands of a beneficiary of a trust monies that would not have been taxable but for the trust. On the face of it, the conduct of Mr Trapperton is quite discreditable. He has, at least in this respect, taken advantage of Ms Alderton’s naivety in a way that has burdened her with a significant tax debt for primary tax, penalty and general interest charge. Moreover, her solicitors did not seek remission of the administrative penalty when it seems obvious that they should have done so. … [T]he Commissioner … accepted that it was still open to Ms Alderton to now seek remission of that penalty. I urge her to do so … On the face of it she presents a case with considerable merit.
Relevance to SMSF succession planning
There are SMSF members who wish that, upon death, their superannuation benefits are paid to their grandchildren. Naturally, this can be extremely tax effective. More specifically, if the SMSF member dies after he or she has attained age 60 and benefits are paid to the grandchild as a pension, the SMSF doesn’t pay income tax and the grandchild doesn’t pay income tax. Furthermore, this arrangement can go broadly forever (or at least until the capital supporting the pension is exhausted).
Of course there is a big catch. Superannuation death benefits typically can’t be paid to the deceased’s grandchildren. Subject to various exceptions, superannuation death benefits can generally only be paid to a grandchild where the grandchild was financially dependent upon the grandparent.
It is somewhat common for grandparents to pay the school fees of grandchildren. The question is often then raised whether this constitutes financial dependency. Based on various private binding rulings, I suspect the ATO will not view this as financial dependency. However, based on various testators’ family maintenance claim court decisions, I think there is an argument that it can constitute at least partial financial dependency. That being said, the scope of financial dependency in this superannuation/taxation context is yet to be tested.
Accordingly, SMSF members who want their superannuation death benefits to be paid to their grandchildren might make a binding death benefit nomination in favour of their legal personal representative (executor) and then ensure that the terms of their will require that superannuation death benefits received by the executor then be paid to the grandchildren.
I have seen this happen frequently. However, it raises the question: what happens if upon the grandparent’s death it is determined that the grandchild was in fact financially dependent and thus could receive the death benefits directly and in an extremely tax efficient fashion?
Alderton and Commissioner of Taxation suggests that — under the law of disclaimer — if the executor of the estate acts promptly before using any superannuation death benefits the executor could invoke the law of disclaimer. More specifically, the case suggests an executor could disclaim the superannuation
death benefits under the binding death benefit nomination thus allowing the trustee of the SMSF to pay the benefits directly to the grandchild.
However, all is not as it seems. Recall that executors are under very strict fiduciary duties. An executor should think very carefully before disclaiming a superannuation death benefit as to do so may well constitute a breach of the executor’s fiduciary duties.
Some possible solutions are as follows.
Possible solution 1: The will expressly authorises the executor to disclaim. However, this is still novel and not without risk.
Possible solution 2: The binding death benefit nomination is drafted on the basis that death benefits are to be paid to grandchildren if this is allowed under superannuation law (eg, if the grandchildren are financially dependent upon death).
Possible solution 3: Discretion is left with whoever is going to be running the SMSF upon death. Great care should then be taken to ensure that this person is someone who is completely trustworthy.
Conclusion
The law of disclaimer can operate in respect of superannuation death benefits. However, do not expect an executor to be able to use it. Instead, alternate solutions should be sought.
Bryce Figot is a Director of DBA Lawyers.
