Wednesday 15 July 2015
Supreme challenges in SMSF estate planning
Self managed super funds (SMSFs) are often heralded as offering estate planning opportunities not available in other types of super funds. While that might be true, SMSFs also present estate planning risks that may not arise in funds that are regulated by the Australian Prudential Regulation Authority (APRA), where the trustee is generally at arms-length to the funds’ members.
Case law in relation to SMSF estate planning dates back at least to 2005, so we now have a body of law covering a decade or more. A number of the State Supreme Court decisions highlight the problems that can be encountered in the SMSF estate planning context. This article covers the key aspects of these cases and what we can learn.
Being aware of both the advantages and the potential problems with SMSF estate planning may help financial services professionals when assessing the suitability of an SMSF to specific clients’ circumstances.
Note that the cases referred to below are decisions of the Supreme Courts in a number of different Australian states. Those decisions are not strictly binding on the courts in other Australian states and territories, but are considered to be highly influential on subsequent decisions by those other courts.
Trustees thwart deceased’s apparent intentions - Katz v Grossman
Although the decision in Katz v Grossman1 has been well documented since being handed down in September 2005, it is worth briefly recapping.
A long standing (established in 1965) employer superannuation fund became a two person (husband and wife) fund with individual trustees. After his wife passed away in 1999, the husband (Ervin Katz) subsequently appointed his daughter (Linda Grossman) as an additional trustee. Linda Grossman admitted herself as a member in 2003, just prior to her father’s death (although that admission was later found to be ineffective by the Court).
After her father’s death, Linda Grossman appointed her husband as an additional trustee. Together they determined that Ervin Katz’s death benefits (which exceeded $1 million) be paid solely to Linda Grossman, despite the deceased’s non-binding nomination that his benefits should be paid equally between his daughter and son (Daniel Katz).
What can we learn from Katz v Grossman?
Firstly, Ervin Katz’s apparent intentions for the distribution of his superannuation benefits did not eventuate because control of the fund was seized by Linda Grossman and her husband. The non-binding nomination was ineffective and failed both the deceased’s apparent intentions and his son.
Secondly, given that the Superannuation Complaints Tribunal (SCT) has no jurisdiction over SMSFs, aggrieved potential beneficiaries must resort to seeking remedies via the court system, if at all. Daniel Katz contested the technicalities of the appointment of Linda and her husband as trustees - those arguments ultimately failed. Raising a dispute through the court system can be costly (especially in comparison to SCT proceedings) and, as was the case here, ineffective in terms of resolving the key issue to the satisfaction of the aggrieved party. In Katz v Grossman the Court ordered costs to be paid by the fund, so the final benefit paid by the fund was presumably significantly reduced.
The ‘legendary oomidoodle bird’ – Donovan v Donovan
Donovan v Donovan2 is another case where the apparent wishes of the deceased did not eventuate.
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 binding death benefit nominations (BDBNs). Prior to his death, Ronald made a death benefit nomination requesting payment to his legal personal representative. The Court determined that the nomination was non-binding on the trustee, and the death benefit payment was ultimately made in favour of the surviving spouse, Helga Donovan. This effectively disinherited Ronald’s daughter from a previous marriage (Lynda), as she would have partially benefited if the payment had been made to the deceased’s estate, as nominated.
What can we learn from Donovan v Donovan?
As Mr Donovan’s nomination did not indicate whether it was intended to be binding on the trustee, the Court concluded that it was not binding. It follows that, as a generalisation, clarity of intention that a nomination is to be binding is paramount.
It follows that, as a generalisation, clarity of intention that a nomination is to be binding is paramount.
The trust deed in Donovan required that a BDBN be ‘in the form required to satisfy the Statutory Requirements’ and defined ‘Statutory Requirements’ to mean ‘…the requirements imposed under any law or by any Statutory Authority which must be satisfied by a superannuation fund in order to qualify for income tax concessions…’3
Interestingly, the Court suggested that the approach of referencing the legislation in a super fund trust deed makes sense because the ‘legislation governing superannuation in Australia is notoriously convoluted and is reminiscent of the legendary oomidoodle bird’!4
The Court determined that the trust deed was drafted to broadly import the requirements that a superannuation fund must meet in order to qualify for income tax concessions, including the BDBN requirements described in Superannuation Industry (Supervision) Regulations 1994 (SISR) regulation 6.17A.
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
- will lapse after three years.
The fact that the nomination didn’t meet some of these requirements added further weight to the Court’s conclusion that the nomination was not binding.
The learning from Donovan is that the courts may construe certain SMSF deeds to incorporate the requirements of SISR regulation 6.17A, despite the apparent exception for SMSFs from those requirements in Superannuation Industry (Supervision) Act 1993 (SIS Act) subsection 59(1). Note that the Commissioner of Taxation has stated in Self Managed Superannuation Funds Determination SMSFD 2008/3 that the rules in SIS Act subsection 59(1A) and SISR regulation 6.17A have ‘…no application to SMSFs…’5
…it is possible for the governing rules of an SMSF to permit a member to make a binding death benefit nomination whether or not in the manner and form set down in regulation 6.17A of the SISR.6
So it appears that the conclusion reached by the Court in Donovan is dependent on the wording in the fund’s trust deed. The view expressed in SMSFD 2008/3 indicates that an SMSF can offer BDBNs without the formalities in SISR regulation 6.17A necessarily applying if the deed is worded appropriately.
Binding nomination upheld, but… – Wooster v Morris
Wooster v Morris7 involved Maxwell Morris and his second wife, Patricia Morris, who were the only members and individual trustees of an SMSF. Maxwell Morris passed away in February 2010, having made a BDBN (in respect of all his interests in the fund) in March 2008 in favour of his two daughters from his first marriage.
Specialist legal advice (sought by Patricia Morris and others) indicated that the BDBN was ineffective as it did not meet all of the requirements in the fund’s trust deed. Accordingly the SMSF trustee (by this time a corporate trustee with Patricia Morris as the sole director) exercised its purported discretion to pay all of the deceased’s benefits to Patricia Morris.
The daughters objected, seeking declarations that the BDBN was valid and binding on the trustee, ultimately culminating in the Supreme Court of Victoria decision. The Court found that the BDBN was valid and binding, ordered finalisation of benefit payments to the daughters, and the daughters’ costs to be paid by the SMSF trustee and Patricia Morris personally.
Patricia Morris passed away in September 2013, prior to the date of judgement, 1 November 2013.
What can we learn from Wooster v Morris?
From the perspectives of both the deceased’s apparent intentions and the nominated beneficiaries, Wooster v Morris initially appears as a good news story – the deceased’s BDBN in favour of the daughters was ultimately effective.
Nonetheless it is unclear just how much of the deceased’s account balance was ultimately paid to the daughters. Although an account balance of approximately $924,000 was shown in financial statements as at 30 June 2010, there was little more than $75,000 attributable to Maxwell Morris’ account as at the date of judgement (1 November 2013).
An amount of approximately $600,000 had been paid by the fund to the daughters prior to the Supreme Court hearing as a result of a Special Referee’s report (a Court ratified dispute resolution process consented to and binding on both parties). But a substantial shortfall still existed – the large accounting and legal advice fees paid from the fund after Maxwell Morris’ death at least partially contributed to that shortfall.
The Court ordered that the SMSF trustee, and Patricia Morris personally, pay the balance of approximately $324,000, plus interest, plus the costs and incidentals to the proceedings and of the Special Referee process.
As noted above, Patricia Morris passed away prior to the judgement, leaving her estate with net debts of approximately $100,000, so it is unlikely that any of the shortfall was recovered from Patricia Morris (or her estate) in her personal capacity.
This case highlights the potential vulnerability of SMSF estate planning. It is vulnerable because potentially self-interested parties are involved in the death benefit decision and payment process, and those same parties may also decide whether or not to engage the fund in costly legal defences of their actions as trustees.
Although Patricia Morris’s actions were based on specialist legal advice, that advice was ultimately inconsistent with the Court’s decision. As part of that decision, the Court made general comments regarding the risk ‘inherent’ in SMSFs and the ‘substantial conflict of interest’ that may exist. In this case, Patricia 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 beneficiaries,8 despite the duty of a trustee to act impartially and in the absence of a conflict of interest.9
In addition, the estate of Maxwell Morris was also the subject of protracted litigation between the same parties. The financial impact of this litigation contributed to the diminution of the estate after death – it was valued at approximately $1.8 million at the time of death, but had reduced to less than $200,000 by the date of hearing of Patricia Morris v Smoel10 (11 November 2013). Patricia Morris was consistently unsuccessful in this litigation process.
Wooster v Morris (and the several other related court cases11) 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 that legal challenge process.
Non-lapsing BDBNs okay, but take care with wording – Munro v Munro
In another second marriage scenario, the March 2015 decision in Munro v Munro12 illustrates that attention to detail can be critical to the success of an SMSF estate planning intention.
Barrie John Munro and his second wife, Patricia Suzanne Munro (Suzie), were the only members and individual trustees of an SMSF. On 22 September 2009, Mr Munro signed a BDBN form. He nominated his beneficiary as ‘Trustee of Deceased Estate’, despite instructions on the form which insisted that the term ‘Legal Personal Representative’ be used if payment to the member’s executor was intended.
Mr Munro passed away in August 2011, survived by Suzie and two daughters from his previous marriage. His will provided Suzie with a gift of $350,000 (less certain debts, if any, owed to the deceased), with the residue of the estate to be divided into two testamentary trusts, one trust for each daughter as trustee and beneficiary. So, had the deceased’s SMSF death benefits exceeded $350,000 and his BDBN been effective, the daughters would have benefitted from their father’s estate.
However, it appears that the estate had net debts of approximately $8,000, and the BDBN was found to be invalid by the Court. The Court did not agree that the term ‘Trustee of Deceased Estate’ is another way of referring to the executors of the estate, or the Legal Personal Representative. Nor did the Court agree that the term alternatively referred to the trustees (the daughters) of the two testamentary trusts, as this approach would require construing the deceased’s will to determine the death benefit nominee.
So the SMSF trustees, Suzie and the newly appointed co-trustee Angela Pooley (Suzie’s daughter), were free to make a discretionary death benefit payment decision, which was presumably not in the favour of Mr Munro’s daughters.
What can we learn from Munro v Munro?
This case provides judicial authority for the proposition that an SMSF, with appropriate deed clauses, may offer its members BDBNs which may not necessarily meet the formal requirements of SISR regulation 6.17A (see discussion above regarding Donovan v Donovan). This is consistent with the approach adopted by the Commissioner of Taxation in SMSFD 2008/3. One important consequence is that the SMSF BDBNs can be non-lapsing.
Secondly, SMSF and other superannuation fund members should take great care when completing BDBN forms. Where the intention is for a benefit to be paid to the member’s deceased estate, use of the term Legal Personal Representative should avoid the unintended consequences which arose in Munro v Munro.
Where the intention is for a benefit to be paid to the member’s deceased estate, use of the term Legal Personal Representative should avoid the unintended consequences which arose in Munro v Munro.
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.
Executor not automatically a trustee – Ioppolo v Conti
Also a second marriage scenario, the March 2015 WA Supreme Court decision in Ioppolo v Conti13 again highlights the need for clarity in SMSF estate planning.
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. In the absence of a valid BDBN, the fund’s trust deed provided the trustee with discretion to pay death benefits to Mrs Conti’s dependants. As sole remaining trustee, Mr Conti determined to pay the benefit to himself, as a superannuation pension from the fund.
Mrs Conti’s son and daughter (two of four children from a previous marriage), as executors of her estate, challenged the legality of the trustee’s decision. There were two key bases of that challenge. 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 his death. The son and daughter requested the Court appoint one of them as trustee. 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?
Importantly, this case affirms the position that the SIS Act does not cause the executor of the deceased estate to automatically become a trustee (or director of the body corporate) of an SMSF upon the death of the member, nor are the remaining trustee(s) obliged to appoint the executor as a trustee (or director of the body corporate).
Note that a specific SMSF deed may require such actions, but this clearly wasn’t the situation in this case.
Secondly, if trustee discretion does apply to the payment of death benefits, the burden of proof that the exercise of that discretion by the trustee lacked 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.
The essential risk with SMSF estate planning is that, after the death of a key SMSF member, control of the fund can be seized by an individual or individuals who stand to benefit personally by not following the wishes of the deceased in relation to the payment of the deceased member’s death benefits.
This conflict of interest appears to be overwhelming in some cases, and can lead to SMSF estate planning disasters. Note that the potential for this conflict is avoided in APRA-regulated superannuation funds, where the trustee is at arms-length to members and does not stand to benefit from any death benefit payment decision. Additionally, decisions of an APRA-regulated superannuation fund trustee may be subject to review by the SCT.
Katz v Grossman illustrates that this conflict can occur even in a first marriage, nuclear family scenario. There, the daughter/sister seized control and arranged to pay the benefits entirely to herself, despite the wishes of her father that his son and daughter should share the proceeds. The father’s non-binding nomination was ineffective.
Although a binding nomination is seemingly a step forward in terms of estate planning certainty, it is of no value if found to be ineffective by the Court. In both Donovan v Donovan and Munro v Munro BDBNs failed for lack of clarity or imprecise wording. Attention to detail when making a BDBN may be crucial for the success of an SMSF estate plan.
SMSFs may offer BDBNs which depart from the strict criteria imposed by SISR regulation 6.17A (which apply to the BDBNs offered by APRA-regulated superannuation funds). The decision in Munro v Munro supports the view of the Commissioner of Taxation in SMSFD 2008/3 on this point, and removes some (but arguably not all) of the previous doubt around this issue. One implication is that an SMSF BDBN does not need to lapse after three years.
Although the BDBNs of APRA-regulated funds must lapse after three years, some APRA-regulated funds offer their members non-lapsing nominations, to which the trustee may agree to be bound.
It was confirmed in Ioppolo v Conti that the SIS Act does not require the executor of a deceased member’s estate to automatically become a trustee (or director of a corporate trustee) of an SMSF in the member’s place. Whether or not an executor can replace a deceased member as a trustee of an SMSF is dependent on the terms of the governing rules facilitating that.
even if a BDBN is found to be valid and binding on an SMSF trustee(s), the accounting and legal process and associated costs to establish that validity may be disastrous in itself
Finally, even if a BDBN is found to be valid and binding on an SMSF trustee(s), the accounting and legal process and associated costs to establish that validity may be disastrous in itself. Wooster v Morris is an illustration of how SMSF assets can be dissipated by advice fees and extended litigation, simply because an aggrieved potential beneficiary has control over the operations of the SMSF.
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