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12/02/2015 | Stephen Harvey risk, trust, deed

Exterminate! Exterminate!

The risks of letting robots run the show
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With respect to “Dr Who” – we’re really showing our age! – we could not go past this headline for our lead article this month. Whilst we’re not advocating wholesale destruction, the rallying cry of the daleks stands the test of time in an industry like ours where you’ll come across automated systems running the show, without the scrutiny they require.

Without wanting to state the bleeding obvious, risk comes in many forms. At worst, the realisation of some risks may threaten the very existence of your business. Our primary concern at Acis is to manage and mitigate legal risk and reputational risk. The first can be costly, and the second, not just costly, but fatal to an advisory business.

It’s important, therefore, to choose your business partners carefully, and build trust with each of them.

Trust comes through understanding the service guarantees provided by the partners who supply your business structures.

Do they commit to immediate, personal service from an in-house team of specialist practitioners? Do they commit to personal scrutiny of every product you order? Do they take full responsibility for the delivery of accurate documentation?

We are concerned that practitioners are potentially unaware of the adverse outcomes they face because they are concentrating on business survival, and not necessarily as focussed on the risks inherent in some of the most basic transactions they undertake.

What risk looks like

In this issue, we thought we’d share with you some real life examples of the risks we’ve seen materialise at the hands of some service providers, over some 30 years in the industry.

Settlor also the Primary Beneficiary

Some automated, robotic services permit the Settlor of a trust to also be named as a beneficiary. Of course, most modern trust deeds specifically exclude the Settlor from being a beneficiary, or obtaining any benefit from the trust. There are good reasons for this – if not excluded, the risk is that the trustee (not the beneficiary) will pay tax at the highest marginal rate. Not only that, the person who is primarily intended to benefit from the trust will be unable to receive distributions.

One recent instance we found resulted in amended returns being lodged and more tax being paid, plus penalties, because (ineffective) distributions had been made to a beneficiary who was also the Settlor.

Failure to review the Trust Deed

A review will highlight the need to read each trust deed, and that this obligation is ongoing. It is important that each trust deed be considered, each year, particularly in light of changing circumstances, and the need to make effective trust distributions.It will also highlight the benefits of having all trusts using similar or standardised terms, to help you to reduce the time taken on these tasks.

This is what can happen (real examples) if a regular review is not undertaken:

  • Distributions were not effective because the documentation to make the distributions didn’t follow the method laid down by the trust deed. This led to no effective distribution, and the trustee being assessed at the top rate;
  • Distributions were made to persons who were not beneficiaries, on the assumption they were. This led to no effective distribution, and the trustee being assessed at the top rate;
  • No income was available to distribute because the trust deed contained no power to carry forward losses. This meant that all of the trust income was applied to the loss, reducing the income to zero. The result – capital gains could not be distributed and the CGT discounts were lost.

No Tax-Effective Income Distribution

Trust deeds which do not contain modern income provisions will rob the trust of the ability to carry out critical tax planning and distribute income in a tax-effective way.

For example:

  • A trust deed which did not contain any definition of income prevented the trustee from treating capital gains as income and a distribution of the gain failed – tax was reassessed to the trustee and the CGT discounts were lost;
  • A trust deed which did not contain a power for the trustee to stream income – franked distributions could not be streamed to beneficiaries who were able to gain maximum benefit from the franking credits.
Incorrect trust

Using the wrong type of trust can have significant effects on the tax treatment of an entity, leading to higher than necessary tax liabilities.

For example:

  • A trust was assumed to be “fixed” because it was a unit trust. Not all unit trusts are fixed trusts, and a failure to appreciate the distinction between a fixed trust and a non-fixed trust meant the unit holders lost access to franking credits flowing through the trust;
  • A discretionary trust was used to acquire land in New South Wales. While this is not a failure in itself, it meant that the trust lost access to the land’s tax-free threshold in NSW that is available to “fixed” unit trusts.
  • A unit trust was assumed to be fixed, however, was treated as non-fixed due to some loose provisions. This meant a unit holder who had borrowed to acquire units was denied a deduction for the borrowing costs.

In all of these cases, the practitioner suffered reputational damage and, in some instances, was hit with an out-of-pocket payment they weren’t expecting or for which they had not budgeted.

So when we talk about the importance of risk management and mitigation, we’ve seen where it can go wrong. By placing your trust in people, not automated systems, you know you’re in good hands.

To review the Acis guarantee, please go to our guarantee page

To discuss risk in more detail, please contact Matt Neibling toll-free on 1800 773 477.