The “gift and loan back” strategy essentially provides an opportunity for some protection of assets, otherwise vulnerable to bankruptcy, occupational and estate challenge risks, by transferring the value of those assets (not the assets themselves) to a structure with lower risk (typically a discretionary trust).
An example of how this can be done is an individual gifting cash equivalent to the value of the asset they intend to protect to a trust, then the trust loaning the cash back to the individual for their personal use. Often there’s a mortgage involved, to provide security against the individual’s real property. Without transferring the assets themselves, capital gains tax and stamp duty implications can typically be avoided.
In the context of estate planning, a “gift and loan back” arrangement may be implemented to add a hurdle to any potential claimant to the estate. Essentially, the arrangement may succeed in acting as a deterrent to claimants, who will need to work harder to access the estate assets.
A recent Queensland Supreme Court case of Re Permewan [2021] QSC 151 provides valuable insight into a “gift and loan back” strategy and its application in the context of an estate challenge.
In this case, Prudence Permewan died in 2019, and was survived by three adult children, whose relationship was fairly strained. The deceased’s only son was appointed as executor of the estate, which had a value of approximately $3M comprising the deceased’s home and some share holdings.
The deceased’s Will gifted the entirety of the estate to her existing family discretionary trust, and also appointed the deceased’s son as the controller of the trust. The effect of this was that the son was in control of all the deceased’s assets.
The case also examined a number of transactions the deceased undertook in 2018. In summary:
- The deceased gifted $3M to the family trust via a promissory note (which represented her approximate net worth at the time); and
- The family trust then loaned the $3M back to the deceased, which was documented via a loan agreement, and the family trust registered a mortgage over the deceased’s home and also registered security over her shares.
Importantly, in these transactions the deceased did not have sufficient liquidity to gift cash to the trust, and no money ‘changed hands’ for either of the two transactions.
The effect of the transactions was that all of the deceased’s ‘worth’ was shifted into the trust, leaving the estate with little value for the deceased’s other two children to claim against.
Unsurprisingly, one of the deceased’s other children brought an application for the removal of her brother as executor of their late mother’s estate, given his reluctance (despite his role as executor) to investigate the “gift and loan back” transactions, and whether they were actually binding on her estate. Such unwillingness was criticised by the Court, with Justice Davis confirming “it’s at least arguable he should be considering setting aside the $3 million transaction”. Ultimately it was decided that the son was in a “hopeless position of conflict” given he would essentially need to sue himself as controller of the trust to test the enforceability of those transactions.
The Court ordered to remove the deceased’s son as executor, and appoint an independent legal practitioner as administrator of the estate, who will now have the role of determining what to do about the deceased’s 2018 transactions.
Key Lesson
The key lesson from this case is that if you want to implement a “gift and loan back” arrangement, the money needs to actually change hands. It’s all well and good for the transactions to be documented, but unless the transactions are actually taking place, it’s far more likely that they will be challenged.
Consideration should also be given to an executor’s duty to enlarge the estate, and whether it is appropriate to deal with this duty in the Will.
How we can help
Individuals and their advisors should be very careful in seeking to implement any “gift and loan back” arrangement and should consider whether more effective options may be undertaken. For expert advice or guidance regarding Estate Planning, please do not hesitate to contact us.