The curious cases of SMSF estate planning
Australian state Supreme Court decisions on SMSF estate planning cases have resulted in a new body of law, which show the risks of SMSF estate planning, David Barrett writes.
Self-managed superannuation funds (SMSFs) offer a number of estate planning features which are generally not available in larger Australian Prudential Regulation Authority (APRA) regulated funds.
However, SMSF estate planning also presents a number of risks, which should not be overlooked.
Over the last decade, various Australian state Supreme Courts have handed down decisions which involve SMSF estate planning, including two decisions in 2015. These cases now form a body of law which, for financial services professionals, is both interesting and noteworthy, and highlights some of the key risks of SMSF estate planning.
Trustees thwart deceased's apparent intentions - Katz v Grossman
Katz v Grossman1 involved a two person (husband and wife) fund with individual trustees.
After his wife passed away in 1999, Ervin Katz appointed his daughter, Linda Grossman, as an additional trustee.
After her father's death, Linda Grossman appointed her husband as an additional trustee. Together they determined that Mr Katz's death benefits (which exceeded $1 million) be paid solely to Linda Grossman, despite the deceased's non-binding nomination to pay the benefit equally between his daughter and son (Daniel Katz).
Daniel Katz contested in the Court the technicalities of the appointment of Linda and her husband as trustees. Those arguments ultimately failed and the trustees' decision remained effective.
What can we learn from Katz v Grossman?
Control of the fund had been seized by Linda Grossman and her husband.
As trustees, they were able to pay the benefit without necessarily following the non-binding nomination, which was no more than a consideration for the trustee to take into account.
The Superannuation Complaints Tribunal (SCT) has no basis for reviewing an SMSF trustee discretion decision. Raising a dispute through the court system can be costly and may be ineffective in terms of resolving a key issue to the satisfaction of the aggrieved party.
A binding death benefit nomination (BDBN) may have been more effective, but the following cases illustrate some of the pitfalls encountered with SMSF BDBNs.
Binding death benefit nominations — Donovan v Donovan
In Donovan v Donovan2 the deceased, Ronald Donovan, was the sole member of an SMSF with a corporate trustee.
The fund's trust deed allowed both non-binding and BDBNs. Mr Donovan had made a death benefit nomination, requesting payment to his legal personal representative.
As the nomination did not state that it was binding, the Court determined it was non-binding.
A death benefit payment was made to the deceased's second wife, Helga Donovan, effectively disentitling Ronald's daughter from a previous marriage.
What can we learn from Donovan v Donovan?
A BDBN must clearly state that it is binding on the trustee.
A key issue in Donovan is whether the BDBN requirements described in Superannuation Industry (Supervision) Regulations 1994 (SISR) regulation 6.17A, stemming from Superannuation Industry (Supervision) Act 1993 (SIS Act) subsection 59(1A), must be met by a SMSF.
Those requirements include, for example, that the nomination:
• Must be in writing;
• Must be signed and dated by the member in the presence of two witnesses who are:
- Over the age of 18; and
- Not nominated to receive a benefit in the notice.
• Must contain a declaration signed and dated by the witnesses stating that the notice was signed by the member in their presence; and
• Will lapse after three years.
The Commissioner of Taxation has stated in SMSFD 2008/3 that the rules in SIS Act subsection 59(1A) and SISR regulation 6.17A have ‘…no application to SMSFs…'3
However, an SMSF trust deed may specifically incorporate the requirements of SISR regulation 6.17A into its particular BDBN requirements.
This was the conclusion drawn in Donovan v Donovan. The Court determined that the deed was drafted in a manner that imported the requirements that ‘a superannuation fund' must meet ‘in order to qualify for income tax concessions', including the requirements in reg. 6.17A.
However, that result may not necessarily apply to all SMSFs, which became more apparent when the decision in Munro v Munro4 was handed down.
Non-lapsing BDBNs okay, but take care with wording — Munro v Munro
Munro and his second wife, Patricia Suzanne Munro (Suzie), were the only members and individual trustees of an SMSF.
On 22 September 2009, Munro signed a BDBN form, nominating his beneficiary as ‘Trustee of Deceased Estate'.
Munro passed away in August 2011, survived by Suzie and two daughters from his previous marriage. His will left the residue of the estate to his two daughters (via testamentary trusts).
Suzie's daughter was appointed as replacement trustee for Munro. The trustees announced their intention to exercise their discretion to pay the death benefit, on the basis the BDBN was invalid.
The Court found that the BDBN was invalid, that the term ‘trustee of deceased estate' was not another way of referring to the legal personal representative, nor did it refer to the trustees of the testamentary trusts.
So the SMSF trustees were free to make a discretionary death benefit payment decision.
What can we learn from Munro v Munro?
Where the intention is for payment to the member's estate, use of the term legal personal representative will avoid the unintended consequences which arose in Munro v Munro.
Further to Donovan v Donovan, and consistent with SMSFD 2008/3, this case is authority that an SMSF, via an appropriately worded trust deed, may offer BDBNs which don't conform with SISR regulation 6.17A, including that an SMSF BDBN can be non-lapsing.
More generally, SMSF trustees should ensure that the BDBN forms link appropriately with the trust deed provisions, and that these links, the intended nominations and the conditions relating to them are clear.
However, even an effective BDBN may not completely ensure that the deceased's intentions prevail, which was illustrated in Wooster v Morris.
Binding nomination upheld, but… — Wooster v Morris
Wooster v Morris5 involved Maxwell Morris and his second wife, Patricia Morris, the only members and individual trustees of an SMSF.
Mr Morris passed away in February 2010, having made a BDBN in favour of his two daughters from his first marriage.
Mrs Morris received specialist legal advice that the BDBN was ineffective, so the SMSF trustee, now a corporate trustee with Mrs Morris as the sole director, announced its intention to pay all of the deceased's benefits to Mrs Morris.
The daughters sought declarations from the Supreme Court of Victoria that the BDBN was valid and binding on the trustee. The Court found for the daughters, and ordered finalisation of benefit payments to the daughters and all costs to be paid by the SMSF trustee and Patricia Morris personally, on a joint and several liability basis.
Patricia Morris passed away in September 2013, prior to the date of judgement 1 November 2013.
What can we learn from Wooster v Morris?
The deceased's BDBN in favour of the daughters was ultimately effective. But it is unclear how much of the deceased's account balance was ultimately paid to the daughters.
The large accounting and legal fees paid from the fund after Maxwell Morris' death contributed to the diminution of assets.
As noted above, Mrs Morris passed away prior to the judgement. The executor of her estate filed for bankruptcy, so it is unlikely that any shortfall was recovered from assets outside of the SMSF.
The Court commented on the risk ‘inherent' in SMSFs and the ‘substantial conflict of interest' that may exist.
Mrs Morris, as both individual trustee and later as controller of the corporate trustee, made decisions which favoured her own interests over those of the other beneficiaries6, despite the duty of a trustee to act impartially and in the absence of a conflict of interest7.
The outcome of Wooster v Morris highlights a key risk of SMSF estate planning. Mr and Mr Morris controlled in excess of $3 million of superannuation and non-superannuation assets at the time of Mr Morris' death.
By the time Mrs Morris passed away, less than four years later, there was only a fraction of that amount remaining.
The case illustrates that even if the SMSF estate planning arrangements stand up to formal legal challenge, the intentions of the deceased may be, at least partially, frustrated by the costs associated with protracted litigation.
The BDBN nomination was not sufficient to ensure the benefits passed to the intended beneficiaries intact — some further controls on the decision-making processes of an SMSF are necessary to prevent this potential outcome.
Executor not automatically a trustee — Ioppolo v Conti
In Ioppolo v Conti8, Francesca and Augusto Conti were the only members and individual trustees of an SMSF. Mrs Conti passed away in August 2010, her BDBN having lapsed in April 2009.
As sole remaining trustee, Mr Conti exercised the trustee's discretion to pay the benefit to himself.
Mrs Conti's son and daughter, as executors of her estate, challenged the legality of the trustee's decision on two bases.
Firstly, that the trust deed in conjunction with section 17A of the SIS Act required the appointment of one of the deceased's legal personal representatives as a trustee following her death.
Secondly, that Mr Conti's decision to pay the benefit to himself was ‘in bad faith', preferring his own interests to those of the deceased's children.
The Court rejected both claims.
What can we learn from Ioppolo v Conti?
The SIS Act does not cause the executor of the deceased's estate to automatically become a trustee of an SMSF, replacing the deceased as trustee , nor is the remaining trustee(s) obliged to appoint the executor as a trustee.
Note however that an SMSF deed may include clauses which may cause this result.
Secondly, the onus of proof that the exercise of discretion by a trustee lacks bona fides, or was made ‘in bad faith', rests with the party asserting that issue.
In Ioppolo v Conti, the Court found no evidence that Mr Conti had not acted with bona fides and in good faith.
In summary
Effective BDBNs are a first step, but not the complete solution to the SMSF estate planning challenge.
Clearly worded BDBNs, obvious linking between the BDBN and the deed provisions, and an appropriately drafted trust deed will all help to ensure that BDBNs are effective.
SMSF BDBNs need not follow the requirements in SISR regulation 6.17A if the fund's trust deed is appropriately worded, so the BDBNs may be non-lapsing.
Most importantly, consideration should be given to who controls an SMSF after a member's death, and whether the controllers have and can manage potential conflicts of interest.
The SIS Act alone does not cause the executor of a deceased member's estate to automatically become a trustee in place of the deceased member.
But this may be a desirable outcome in terms of control of the SMSF and managing the interests of potential beneficiaries.
If so, consideration should be given to appropriate trust deed provisions which facilitate the executor automatically becoming a replacement trustee. Note that other SMSF control mechanisms may be employed also.
The goal of SMSF estate planning should be to achieve the member's death benefit distribution goals in an administratively effective and tax efficient manner, while avoiding potential disputes and the costs of specialist advice and litigation.
David Barrett is the division director at Macquarie Adviser Services.
Footnotes
1. [2005] NSWSC 934
2. [2009] QSC 26
3. Self Managed Superannuation Funds Determination SMSFD 2008/3, para 15
4. [2015] QSC 61
5. [2015] WASCA 45
6. [2013] VSC 594
7. [2013] VSC 594, para 93
8. [2013] VSC 594, para 94
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