Gift and loan backs: Key issues in asset protection arrangements
4 mins reading time
Recently, concerns have arisen regarding the continuing viability of ‘gift and loan back’ arrangements. Such arrangements have historically been popular as a tool by which clients can seek to protect their personal assets from the risks of their business ventures or reduce the value of their estate now as part of a broader estate plan, in favour of intended recipients.
However, in the recent case of Re Permewan No. 2 [2022] QSC 114 (Re Permewan), the Queensland Supreme Court set aside a gift and loan back arrangement on the basis it was unenforceable.
What are gift and loan back arrangements?
A gift and loan back is an arrangement that allows an individual to protect their assets from risk and liabilities that may befall them personally. It involves the person making a gift of an amount reflecting the value of their equity in the assets to be protected to a lower risk entity that they also control (typically a discretionary trust). The gift and subsequent loan are often made using promissory notes in the absence of cash being readily available. With the agreements giving rise to the transactions usually recorded in a deed of gift and a loan agreement, it is common for security to be taken by the trust to secure the loan.
The leading case on gift and loan back arrangements is Atia v Nusbaum [2011] QSC044 (Atia). In short, the facts of Atia were as follows:
- Dr Atia entered into a gift and loan back arrangement with this mother.
- When Dr Atia’s mother subsequently called in the debt, Dr Atia argued that the loan and mortgage were not intended to be binding and were only a pretence to protect him in the event he was sued in his professional capacity as a surgeon.
- The Court found that all aspects of the legal documents, including the deed of gift, loan agreement and registered mortgage had been validly signed and confirmed that the legal effect of the documentation was exactly as the parties intended it to be. Therefore, there was no mistake or sham involved.
Overview of Re Permewan
In Re Permewan, the deceased, Prudence Permewan (Prudence), left behind three adult children. In her Will, she appointed her son, Scott, as executor and trustee, left him shares in her company, which controlled her family discretionary trust (Trust), and bequeathed the remainder of her estate to the trust.
Prior to her passing, Prudence had expressed her desire to exclude her two daughters from her estate. On this basis, Prudence – with assistance from Scott – entered into a gift and loan back arrangement whereby she gifted, through promissory note, $3 million to her trust. The trust then loaned the $3 million back to Prudence and took a mortgage over her property to secure the loan.
The intended effect of the arrangement was to move the entire value of Prudence’s assets from her estate to her trust, leaving no material value for her daughters and rendering any proceedings for family provision under the Succession Act 1981 (Qld) ineffective. As Scott controlled the trust, he was effectively bequeathed everything.
The daughters subsequently commenced proceedings on the grounds that their mother’s gift and loan back arrangement was unenforceable, because it frustrated the family provision proceedings.
Key issues arising in Re Permewan
The Supreme Court identified three key elements of the transaction in support of their finding that the arrangement was unenforceable:
- Firstly, the Court determined that it was ‘almost certain’ the transaction was a ‘sham’ in that Prudence never had any intention to pay back the $3 million loan to the Trust and the Trust never intended to call on payment of the loan.
- Secondly, the transaction was ‘contrary to public policy’ as it was an attempt by Prudence to circumvent the family provision proceedings under the Succession Act 1981 (Qld).
- There was no evidence that the promissory note had been delivered by the Trust to Prudence and, as a result, the transaction was technically never completed.
Interestingly, the reasoning of the Court in Re Permewan conflicts directly with that of the court in Atia – where the arrangement being void as a sham was expressly rejected. In particular, the Court in Re Permawan appears more interested in the intent of the parties, rather than the legal effect of the documentation implementing the arrangement which evidences a genuine agreement reached between the parties.
Under asset protection arrangements, the parties generally execute the documents with the genuine intention for them to operate according to their terms. That is, the Lender genuinely having the power to call on the loan and enforcing the security is the mechanism by which the protection is enlivened.
If the agreement is genuinely undertaken and the documents are, on their face, effective, one can argue that the court should not deem such transactions to be undone because of a speculated ulterior motive in undertaking it.
Takeaways when advising clients
The Supreme Court has made it clear in Re Permewan that it will not tolerate ‘illusory transactions’ that are implemented to circumvent legal rights and obligations created by legislation.
It is crucial to note that Re Permawan No.2 is focused on the determination of costs in respect of Re Permawan No. 1 [2021] QSC 151, which concerned Scott’s appointment as trustee and executor. As such, it is not a binding case on the validity of gift and loan back arrangements, but the reasoning creates a significant degree of uncertainty.
In our view, gift and loan back arrangements continue to be an effective tool for asset protection where the alternatives are ‘do nothing and hope for the best’ or incur the usual costs associated with an asset transfer.
However, it is now more important than ever to keep the following in mind for the arrangement to be viable:
- An asset transfer is always preferred.
- Where the gift and subsequent loan cannot be evidenced by cash and promissory notes are to be relied upon, it is advised that a contemporary letter of offer from a financier be obtained to evidence an ability to obtain funding.
- In determining the amount of equity, inherent liabilities such as tax and realisation costs should be taken into account.
As always, our Tax team is able to assist advisers and clients requiring further assistance when considering suitable asset protection arrangements.
more
insights
stay up to date with our news & insights
Gift and loan backs: Key issues in asset protection arrangements
Recently, concerns have arisen regarding the continuing viability of ‘gift and loan back’ arrangements. Such arrangements have historically been popular as a tool by which clients can seek to protect their personal assets from the risks of their business ventures or reduce the value of their estate now as part of a broader estate plan, in favour of intended recipients.
However, in the recent case of Re Permewan No. 2 [2022] QSC 114 (Re Permewan), the Queensland Supreme Court set aside a gift and loan back arrangement on the basis it was unenforceable.
What are gift and loan back arrangements?
A gift and loan back is an arrangement that allows an individual to protect their assets from risk and liabilities that may befall them personally. It involves the person making a gift of an amount reflecting the value of their equity in the assets to be protected to a lower risk entity that they also control (typically a discretionary trust). The gift and subsequent loan are often made using promissory notes in the absence of cash being readily available. With the agreements giving rise to the transactions usually recorded in a deed of gift and a loan agreement, it is common for security to be taken by the trust to secure the loan.
The leading case on gift and loan back arrangements is Atia v Nusbaum [2011] QSC044 (Atia). In short, the facts of Atia were as follows:
- Dr Atia entered into a gift and loan back arrangement with this mother.
- When Dr Atia’s mother subsequently called in the debt, Dr Atia argued that the loan and mortgage were not intended to be binding and were only a pretence to protect him in the event he was sued in his professional capacity as a surgeon.
- The Court found that all aspects of the legal documents, including the deed of gift, loan agreement and registered mortgage had been validly signed and confirmed that the legal effect of the documentation was exactly as the parties intended it to be. Therefore, there was no mistake or sham involved.
Overview of Re Permewan
In Re Permewan, the deceased, Prudence Permewan (Prudence), left behind three adult children. In her Will, she appointed her son, Scott, as executor and trustee, left him shares in her company, which controlled her family discretionary trust (Trust), and bequeathed the remainder of her estate to the trust.
Prior to her passing, Prudence had expressed her desire to exclude her two daughters from her estate. On this basis, Prudence – with assistance from Scott – entered into a gift and loan back arrangement whereby she gifted, through promissory note, $3 million to her trust. The trust then loaned the $3 million back to Prudence and took a mortgage over her property to secure the loan.
The intended effect of the arrangement was to move the entire value of Prudence’s assets from her estate to her trust, leaving no material value for her daughters and rendering any proceedings for family provision under the Succession Act 1981 (Qld) ineffective. As Scott controlled the trust, he was effectively bequeathed everything.
The daughters subsequently commenced proceedings on the grounds that their mother’s gift and loan back arrangement was unenforceable, because it frustrated the family provision proceedings.
Key issues arising in Re Permewan
The Supreme Court identified three key elements of the transaction in support of their finding that the arrangement was unenforceable:
- Firstly, the Court determined that it was ‘almost certain’ the transaction was a ‘sham’ in that Prudence never had any intention to pay back the $3 million loan to the Trust and the Trust never intended to call on payment of the loan.
- Secondly, the transaction was ‘contrary to public policy’ as it was an attempt by Prudence to circumvent the family provision proceedings under the Succession Act 1981 (Qld).
- There was no evidence that the promissory note had been delivered by the Trust to Prudence and, as a result, the transaction was technically never completed.
Interestingly, the reasoning of the Court in Re Permewan conflicts directly with that of the court in Atia – where the arrangement being void as a sham was expressly rejected. In particular, the Court in Re Permawan appears more interested in the intent of the parties, rather than the legal effect of the documentation implementing the arrangement which evidences a genuine agreement reached between the parties.
Under asset protection arrangements, the parties generally execute the documents with the genuine intention for them to operate according to their terms. That is, the Lender genuinely having the power to call on the loan and enforcing the security is the mechanism by which the protection is enlivened.
If the agreement is genuinely undertaken and the documents are, on their face, effective, one can argue that the court should not deem such transactions to be undone because of a speculated ulterior motive in undertaking it.
Takeaways when advising clients
The Supreme Court has made it clear in Re Permewan that it will not tolerate ‘illusory transactions’ that are implemented to circumvent legal rights and obligations created by legislation.
It is crucial to note that Re Permawan No.2 is focused on the determination of costs in respect of Re Permawan No. 1 [2021] QSC 151, which concerned Scott’s appointment as trustee and executor. As such, it is not a binding case on the validity of gift and loan back arrangements, but the reasoning creates a significant degree of uncertainty.
In our view, gift and loan back arrangements continue to be an effective tool for asset protection where the alternatives are ‘do nothing and hope for the best’ or incur the usual costs associated with an asset transfer.
However, it is now more important than ever to keep the following in mind for the arrangement to be viable:
- An asset transfer is always preferred.
- Where the gift and subsequent loan cannot be evidenced by cash and promissory notes are to be relied upon, it is advised that a contemporary letter of offer from a financier be obtained to evidence an ability to obtain funding.
- In determining the amount of equity, inherent liabilities such as tax and realisation costs should be taken into account.
As always, our Tax team is able to assist advisers and clients requiring further assistance when considering suitable asset protection arrangements.