Dusting Off The Old Trust Deed: Why Default Beneficiary Clauses Suddenly Matter In Queensland

The Federal Government’s proposed changes to the taxation of discretionary trusts may create one of the most significant small business restructuring opportunities seen in years. Assuming, of course, the legislation survives the usual process of political compromise and lobbying.

Under the proposal, retained income in discretionary trusts would effectively be taxed at 30%, significantly reducing one of the long-standing advantages of discretionary trust structures for business and investment groups.

At the same time, the Federal Government has proposed a 3-year CGT rollover relief period to facilitate the transfer of assets from trusts into companies.

The obvious policy intention is clear: encourage businesses and asset-holding groups to migrate from discretionary trusts into corporate structures.

In many states no or nominal duty is payable on the transfer of business assets, meaning that a CGT rollover can be undertaken with minimal tax consequences.  For Queensland taxpayers, however, a critical issue immediately arises.

Even if the Federal Government provides CGT rollover relief, a transfer of business assets or land from a trust into a company would ordinarily attract transfer duty in Queensland.

That is where section 413H of the Duties Act 2001 (Qld) becomes highly relevant.

Queensland already has an existing exemption for certain transfers of “small business property” from a discretionary trust to a company. Where the exemption applies, transfer duty may not be payable on the transfer.

Importantly, if both the proposed federal CGT rollover relief and the Queensland duty exemption are available, some business owners may potentially restructure from a trust into a company with little or no immediate tax or duty cost.

However, the Queensland exemption is narrower than many people initially assume.  The exemption sits within Part 1A of the Duties Act, which applies only to qualifying “small business restructures”.

The first major limitation is the turnover threshold.

To qualify as a “small business entity” under section 413A, the discretionary trust must carry on a relevant Queensland business with annual turnover of no more than $5 million.

That threshold is likely to exclude many otherwise legitimate restructuring candidates, particularly larger trading businesses, professional firms, pharmacy groups, wholesalers, construction businesses and multi-site businesses.

Ironically, some relatively asset-rich structures with modest turnover may qualify more easily than successful operating businesses with comparatively small profit margins but higher revenue.

The exemption also only applies to “small business property” as defined in section 413B.

Broadly, this requires the property to be:

• dutiable property;
• directly held; and
• used for carrying on the business.

The legislation specifically excludes property used as a personal residence, and investment property used to generate income to fund the business.

This distinction is important as many discretionary trusts accumulate a mix of:

• trading assets;
• business premises;
• passive investment properties;
• share portfolios; and
• other long-term investments.

Only some of those assets may qualify for relief.

Importantly, the legislation does not appear to require all trust assets to be transferred. Rather, the exemption can apply to qualifying “small business property” that is transferred to the company.

That creates planning flexibility, but also complexity. Advisers will need to carefully identify which assets qualify and whether partial transfers create unintended tax or commercial consequences.

The transferee company must also satisfy strict requirements.

Under section 413C, the company must effectively be a new shelf company that has:

• never held assets or liabilities;
• never entered into agreements;
• never acted as trustee or beneficiary; and
• never issued shares previously.

Accordingly, the exemption generally will not apply to transfers into existing corporate groups or long-standing companies.

Another key requirement relates to “default beneficiaries”.  Section 413H requires all default beneficiaries of the discretionary trust to become shareholders in the transferee corporation.

For many modern discretionary trusts, this may not be overly problematic. In practice, many trust deeds define the takers in default as the primary beneficiaries, often equally.

However, trust deed drafting becomes critically important.  Some trust deeds contain:

• broad family classes;
• cascading default provisions;
• corporate beneficiaries;
• different default entitlements for income and capital; or
• unclear vesting provisions.

In some cases, families may discover that the legal “default beneficiaries” are far broader than the commercially intended ownership group.

The exemption is also proportionate in operation.  Duty relief is available only to the extent of the lesser of the beneficiary’s trust interest in the discretionary trust and the beneficiary’s share interest in the transferee corporation.  Where trust interests and shareholdings do not align, partial duty may still arise, meaning that restructures will require careful modelling of:

• trust entitlements;
• proposed shareholdings;
• asset values; and
• future succession intentions.

Despite these limitations the combination of proposed federal CGT rollover relief and Queensland’s existing section 413H exemption creates potentially valuable planning opportunities for many Queensland business owners.

Potential advantages of moving from a discretionary trust into a company may include:

• access to the corporate tax rate for retained earnings;
• simpler reinvestment structures;
• improved succession planning;
• more certain ownership interests;
• simplified governance;
• greater investment flexibility; and
• avoidance of the proposed discretionary trust tax regime.

The reforms may also place renewed focus on trust deed drafting itself.

Clauses that many advisers historically treated as largely academic, particularly default beneficiary provisions, may suddenly become highly significant in determining whether duty relief is available.

The next few years are therefore likely to produce substantial restructuring activity, particularly for family businesses operating through discretionary trusts.

However, the interaction between:

• federal CGT rollover relief;
• Queensland transfer duty exemptions;
• trust deed terms;
• asset classifications; and
• ownership structures,

will require careful analysis before any restructure proceeds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.