When you have to be right.

Honey, I forgot to do my gifting

It is a common misconception that gifting was abolished along with gift duty. Ironically, now that people can gift without limit, increasingly gifting programmes are not being maintained.

Vicki Ammundsen explores the consequences of abandoning gifting programmes and how this can be addressed.

Prior to the abolition of gift duty, gifting programmes were common. When assets were sold to a trust the mechanism was a deed of sale and an acknowledgment of the debt back, which was then progressively forgiven. Annual trustee meetings commonly occurred at the same time as gifting was carried out. This served the dual purpose of ensuring that gifting was attended to and allowing dialogue around trust management so that, among other things, any further advances were identified and recorded.

All that changed in 2011 when gift duty was abolished. The Government’s decision to abolish gift duty was based on the high cost of retaining a tax on gifting that no longer generated significant revenue. However, this decision was a governmental policy decision and was not based on consideration of the consequences for private individuals of not maintaining a gifting programme.

Four years later these consequences are already becoming apparent.

So why is it still important to gift?

The house ma’am, nothing but the houseOne premise behind the abolition of gift duty is that there is only a single type of gifting programme. Para 25 of the Inland Revenue “Regulatory Impact Statement: Gift Duty Repeal” notes:

“Gift duty is easy to avoid through the use of gifting programmes. Under a gifting programme, an asset is sold at market-value in exchange for an interest-free, on-demand loan for the value of the asset. Legal title to the asset instantly transfers, but no payment is made. The interest-free, on demand debt that the recipient of the asset owes to the donor is then progressively forgiven by the donor at a rate of $27,000 every twelve months. The forgiveness of the debt constitutes annual gifts; however

they are within the accepted level so as not to attract gift duty. Until it is completely forgiven, the debt owed is legally an asset of the donor and the donor can demand that it be repaid.”

Is this correct, however, given that the family home is the sole asset for many discretionary family trusts? The transfer of the family home may represent the most significant gift to a trust but, if a trust has no other assets, the settlors or other beneficiaries must necessarily continue to advance funds to meet the costs incidental to home ownership (eg rates, insurance and maintenance). While these expenses may not be significant individually, an accurate record is extremely important in ensuring the proper management and administration of any trust.

Indeed, from little advances mighty debts grow. Where the habit of regular gifting is lost, it is easy to lose sight of how much has been advanced to the trustees.

The loan–gift tug of war Where advances are not documented, questions can be raised as to whether the advance is a loan or a gift. The wider issues that can flow from this are illustrated by the case of Peters v Peters (2013) 3 NZTR ¶23-004.

In this case, after it was accepted that the advance was not a gift, the trustees who had tried to retain the loan advance sued the lawyers who acted on the matter. The Court found the lawyers guilty of negligence for failing to accurately determine (and document) the nature of the advance.

The decision also highlighted the risks of undocumented advances to trustees who, in the absence of a formal agreement, are unable to limit their liability to the assets of the trust as is normally the case. As noted in Peters v Peters at [93]:

“… That conclusion accords with evidence given by both Mr Graham and Mrs Edna Peters. Each said that if they had been informed that the $800,000 represented a loan for which they would have a liability to repay, they would not have committed to borrowing those moneys.”

Honey, I forgot to do my gifting

Creditor windfallIf gifting falls into arrears, unforeseen creditors may receive a windfall. Consider the possibility of selling a house to trustees and gifting the full purchase price immediately. Each year after the sale, advances are made to meet insurance, rates, maintenance and the occasional renovation. Without anyone noticing, over the period of 10 years $200,000 of undocumented loans accrues. When the settlor’s business fails, he and his wife are grateful that the trust was settled and the house was sold to it long before the business venture commenced. However, if the set-tlor is successfully sued by a creditor and bankruptcy ensues, there is a possibility that the Official Assignee will call up the advances made by the settlor.

Till divorce us do part …Sometimes debts owing by trustees are called up by someone closer to home.

There can be good reasons to leave a debt owing so that the lender retains the ability to call up the debt. However, this can also be an unintended end result. The recent case of Shailer v Shailer [2015] NZHC 250 provides a practical example of the consequences of incomplete gifting. In this case Mr and Mrs Shailer sold their farm to trustees of a trust they had settled for $1m in 2001. The initial $500,000 debt owing back to each of them was reduced by four annual gifts of $27,000. The gifting programme then stopped and when Mr and Mrs Shailer separated the debt owing to each of them was still $419,000.

Unhappy differences continued and ultimately resulted in a High Court judgment in Mrs Shailer’s favour. The question of how the liability should be divided between the trustees (including Mrs Shailer) remained to be determined.

I know I had a gifting programme — I just don’t remember whyThere are, of course, valid reasons not to gift. However, it is important that the decision not to gift results from a positive choice rather than simply the failure to gift.

One reason not to gift (or at least to exercise caution) is where future prospects of a residential care subsidy (RCS) are entertained. The possibility of qualifying for a long-term RCS has been a motivating factor behind the settlement of many trusts. However, it is important to appreciate that the abolition of gift duty

had no impact on the levels of permissible gifting for RCS purposes. Before a person goes into care, it is still permissable to gift:

• $27,000 per annum outside the five-year gifting period, and

• $6,000 per annum within the five-year gifting period.

However, following the Court of Appeal decision in Bridgford v Chief Executive of the Ministry of Social Development (2013) 3 NZTR ¶23-011 the question of whether gifts made by couples are aggregated for RCS purposes has been decided in the Ministry’s favour, meaning that the permissible limits are generally aggregated.

For some people, a practical response may be to limit annual gifting to $13,500 each for a couple. However, note that for the last five years before a person goes into care, the annual limit is $6,000. For this period, a cautious response would be to limit gifting to $3,000 each.

It is also important to note that $27,000 gifts cannot be spread. Therefore, a single gift of $270,000 counts as $243,000 over the threshold and cannot be discounted over time.

More than just a piece of paperGifting is more than just keeping track of the numbers and filing the correct documents. Careful attention to how a trust is funded can have a positive impact on the overall trust governance and avoid prolonged unhappy litigation if disputes arise over who paid for what and who was repaid and who was not.

In the initial case of Spence v Lynch [2013] NZHC 1478 (at least eight more proceedings followed), the scene is set succinctly in para [3] of the decision where the judge notes that “despite the initial orthodox and sensible arrangements evinced by the trust and s 21 agreement, carelessness, confusion, and chaos rode in behind the couple.”

The judge later notes:

“I find it remarkable that a professional trustee … did not inquire or insist that some documentation was in place … to record the large advance made on 11 October 2006 and the terms on which such an advance was made. This was a year before Mr Lynch retired as trustee. Doubtless in some measure that oversight on his part lies behind the $155,000 settlement payment he has made to Mr Spence.”

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Some structure around documenting advances, whether or not any of these were forgiven, might have enabled the parties to avoid the serial litigation that followed as the result of the financial chaos the trust accounts represented.

Set and forget?Trusts can provide excellent long-term asset protection. However, they need time, attention and a firm hand to ensure a robust asset and estate

planning structure. Very few trustees have the skills and resources to manage a trust without expert guidance. The use of professionally drafted, maintained and updated gifting precedents can help ensure that trust management is appropriate and nasty surprises are avoided.

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