Not all trust, company and self-managed superannuation fund (SMSF) documents are identical. It is important to make sure that you use the correct documents for your legal situation, and ensure that these legal documents are of high-quality, compliant with the law and prepared and regularly updated by lawyers to reflect changes in the law and best practice.
Why all the fuss? Poorly prepared legal documents can lead to uncertainties and cause all sorts of problems including incurring significant legal costs if interpretation issues result in legal action.
This article outlines some of the key areas to consider before using a legal document template.
Making variations to trust deeds
Whether you are varying the clauses of a trust deed, changing a trustee of a trust or changing the powers of trustee, it is critical to follow the correct procedure set out in the governing trust deed. This equally applies to all common legal documents such as those which relate to SMSFs, discretionary trusts, hybrid trusts etc.
When proposing to make a variation to a trust deed, it is important that this be done via a deed in preference to minutes of a meeting with parties resolving to make the change: and this is essential where the trust’s deed requires an amendment to be by deed. In Batmor Mortgages Pty Ltd v Arcuri [2017] NSWSC 84 the Court was required to consider the validity of a resolution which changed the trustee of a trust.
Should the parties have changed the trustee by way of deed, as was the case for a separate occasion in the same matter, it may have eliminated the need for litigation arising from ambiguities in relation to the variation.
Cleardocs products use deeds to effect changes to the terms of a deed, powers of the parties and when changing the trustee of a trust.
Trust documents
Distribution clauses
It is important that trust deeds are updated frequently to account for changes in the law and to prevent unfavourable outcomes which could have been avoided. One example is in the decision in BRK (Bris) Pty Ltd v Commissioner of Taxation [2001] ATC 4111 (BRK), which deals with distribution of trust income as further highlighted by an ATO publication on trust income distribution arrangements (Taxpayer Alert TA 2016/12)
An invalid distribution from a trust can have several negative consequences, including that the income could be taxed at the highest marginal rate in the hands of the trustee, or in the hands of one or more beneficiaries who receive the distribution under a default distribution clause in the trust deed.
In BRK, the trustee nominated two companies as general beneficiaries under provisions of the trust deed and made several trust distributions to those companies. The ATO argued that the distributions were invalid on the basis that the trustee did not have the power under the deed to make such a nomination. The Federal Court agreed with the ATO and decided that the trustee could not make the relevant distribution. Upon interpretation of the relevant clauses in the trust deed, the Court ruled that all undistributed income would be assessed against the trustee at the highest marginal rate.
The issue in BRK is addressed in the Cleardocs deed, and state that if the trustee fails to exercise its discretion to accumulate income by 30 June, then the income will be held in trust for the persons and subject to the rules in the default distribution clause. The Cleardocs default distribution clause sets out the default position for 30 June income distributions, which eliminates the possibility for income to be taxed at the highest marginal rate should a distribution fail.
Taking advantage of applicable tax laws and the Bamford decision
The Bamford decision allows a trustee to adopt a different definition of income in the trust’s deed, either by stating that definition in the deed, or by the deed granting the trustee an express power to adopt a different definition in respect of different periods.
Trust deeds which confer power on the trustee to adopt a different definition should also pay attention to the decision of Forrest v Commissioner of Taxation [2010] FCAFC 6 (Forrest), which read down the trustee’s powers in a clause designed to utilise the Bamford reasoning. In Forrest, the court held that such a power was a power to make an administrative determination only, and that it was not an unconfined discretion to determine whether a receipt represents realised or unrealised capital gains.
Several clauses in the Cleardocs deed have been redrafted with Bamford and Forrest in mind, granting the trustee the flexibility to determine whether receipts are to be treated as capital or income.
The Cleardocs discretionary trust deed grants the trustee the power to determine whether to adopt an alternative definition in respect of a particular income year, which is unconfined and not merely an administrative power. The document package allows you to choose whether you wish to limit distributions of income and capital, by excluding foreign persons as beneficiaries.
Plain language and Mercanti case
The decision of the Western Australian Court of Appeal in Mercanti v Mercanti (2016) WASCA 206 (Mercanti) confirms the importance of having a trust deed which uses plain language.
In Mercanti, the Court was required to consider the validity of the variation of the schedule to the trust deed (which changed the trust’s appointor) and whether the trustee was allowed to make such a variation in the first place. Ultimately the decision turned on the wording of the trust deed and the Court’s interpretation of the word “hereinbefore”. The wording of clause 28, the clause in dispute, allowed the trustee to revoke, add to or vary ‘all or any of the trusts terms and conditions hereinbefore contained’.
The argument was whether “hereinbefore” meant:
- The trustee could only vary terms and conditions appearing before that clause (meaning the trustee could not vary the schedule); or
- Whether “hereinbefore” was not intended to operate as a word of limitation.
It was argued that because the schedule appeared after this clause, it was not a term or condition “hereinbefore” contained. The trial judge concluded that the variation of the appointor in the schedule was valid and the change was within the trustee’s power.
On appeal, the Court held that the wording of the empowering clause did not restrict the trustee’s ability to vary the Appointor in the deed. In particular:
- The majority of judges pointed out that the Appointor was defined in the beginning of the deed as including the person named in the schedule. This clause precedes the empowering clause and is therefore “hereinbefore” contained.
- The President of the Court of Appeal made a similar finding but found that the word “hereinbefore” was in fact a word of limitation and did mean that the trustee could not amend those clauses appearing after clause 28. However, because the definition of the Appointor included the person in the schedule – the trustee could still vary the Appointor.
The use of plain language is designed to avoid matters of interpretation needing to be determined by successive judicial decisions at great cost to the parties. The Cleardocs deeds are constructed using plain English and clear language therefore avoiding issues such as those raised by Mercanti.
SMSF Documents
Wording in Death Benefit Nominations or Death Benefit Agreements
If the intention of the documents is to distribute the member’s death benefits to the member’s ‘legal personal representative’ – then using the words ‘executors and estate, ‘trustee of the deceased estate’ etc in the clause which makes the distribution would render the document invalid.
The law requires, and the Queensland Supreme Court has confirmed in Munro & Anor v Munro & Anor [2015] QSC 61, that the document must refer to a ‘legal personal representative’ in the relevant clause and not anything else: ss 55A(1) and 31 of the Superannuation Industry (Supervision) Act 1993 (Cth), reg 6.22 of the Superannuation Industry (Supervision) Regulations 1994 (Cth).
The Cleardocs Death Benefit Nomination (DBN) and Death Benefit Agreement (DBA) use the words ‘legal personal representative’.
Beneficiary predeceasing a member
Some DBN’s and DBA’s do not allow for different tiers of distributions – for example – where a first level beneficiary predeceased the member, then it is prudent for a DBN/DBA to allow for distributions to be made to a second level beneficiary. If a DBN/DBA does not allow for this contingency, then it would render the entire document of no effect and a waste of time and money.
The Cleardocs DBN and DBA use a two tier distribution mechanism.
Company documents
Documents which are not updated can impose unnecessary restrictions on a company. For example, the sections of a company’s constitution which deals with the ability to declare and pay dividends are informed by section 254T of the Corporations Act 2001 (Cth). Section 254T was last changed in 2022 to:
- remove the requirement for a company to pay dividends only out of its ‘profits’;
- and allow a company to pay dividends out of net assets, provided the interests of creditors and shareholders are protected.
The Cleardocs Constitution was updated when this change was first introduced. However, companies which have not updated their constitutions since 2010 may have an unnecessary restriction on the declaration of dividends in place.
This article was first published as part of ClearLaw on www.cleardocs.com. You can read more ClearLaw articles on related topics here.
