Tax Files: Taxation considerations as to the manner of compromising deceased estate litigation By Bernie Walrut

Some taxation considerations as to the manner of Compromising Deceased Estate Litigation

BERNIE WALRUT, MURRAY CHAMBERS

It is now commonly suggested that deceased estate litigation is a growth area and that much of that litigation is settled before trial or in the course of the trial. This may lead to terms of compromise, that whilst seeking to allocate responsibility for the payment of the various taxes that may be involved, does not adequately consider the possible relief available, and how the form the compromise takes may affect the availability of some of that relief.

CAPITAL GAINS TAX

In an article in this column in late 2012 the requirements for disregarding any capital gain or loss from a capital gains tax (CGT) event arising on death in respect of a CGT asset1 owned by the deceased2 under Division 128 of the Income Tax Assessment Act 1997 (Cth) (ITAA97) were described. In effect the CGT asset must pass to the legal personal representative or benefi ciary in one of a number of specifi ed ways. Firstly, under the taxpayer’s will, including under a will as varied by a court order.3 Secondly, by operation of the laws of intestacy, including the application of those laws as varied by a court order.

Thirdly where the legal personal representative satisfi es a pecuniary legacy or some other interest or share in the estate by appropriating an asset of the estate to the benefi ciary in satisfaction of such legacy, interest or share.4 Finally, a distribution of property of the deceased at the death of the death pursuant to a deed of arrangement will pass for these purposes, if it is entered into by the benefi ciary to settle a claim to participate in the distribution of the estate where the consideration given by the benefi ciary for the asset consists only of the variation or waiver of a claim to other capital gains tax assets that form part of the estate.5 STAMP DUTY

Whilst stamp duty under the Stamp Duties Act 1923 (SA) (SDA) is now limited to interests in residential land and primary production land6 (qualifying land),7 much of the current deceased estate litigation includes interests in such land. One of the exemptions from stamp duty for conveyances of such land is to be found in section 71(5)(h). It applies to a transfer by a legal personal representative of a deceased or the trustee of the estate of a deceased, being a transfer made in pursuance of the provisions of the will of the deceased or the laws of intestacy and not being a transfer in pursuance of a sale.

Section 10 of the Inheritance (Family Provision) Act 1972 (SA) (IFPA) provides that every provision made by an order under the IFPA shall, subject to the Act, operate and take effect as a codicil where the deceased died testate and a will where the deceased died intestate. In practice this has meant that where there is a conveyance pursuant to an order under the IFPA of qualifying land the exemption in section 71(5)(h) applied, unless it constituted a sale.

COMPROMISING ESTATE LITIGATION

Some Methods of Compromising Litigation

Any litigation, including estate litigation may be compromised in one of many ways.8 In Green v Rozen9 Slade J said that there are various ways an action can be disposed of where there are terms of settlement and the action comes on for hearing or is settled during the course of a trial. Slade J says that in his experience there are at least fi ve methods and they are not exhaustive. They are then described as: make the terms of compromise a rule of court, provided the terms provide for that; secure an order of the court by consent; obtain a Tomlin Order; obtain an order of the court by consent staying all further proceedings in the action on the terms agreed and endorsed on counsel’s brief; the fi fth method, is where there is no order of the Court at all, the Court merely being told by counsel that the case has been settled on agreed terms,10 and often the matter is then discontinued.

Foskett describes in chapter 9 the methods of compromising an action in much more detail.11 Foskett’s list includes an exchange of letters, particularly where the proceedings have not been commenced; a deed or memorandum; a consent order; where the terms of compromise go beyond the court’s normal jurisdiction and the parties desire the agreement to be readily enforceable, it is suggested the terms be made a rule of court; a consent judgment for the payment of money; a Tomlin Order; an adjournment to enable the parties to carry out terms of the compromise and the discontinuance either on terms or unconditionally of the proceedings.

Compromise Arrangement without Orders

Where the estate litigation is compromised without an order of the Court, Division 128 of ITAA97 will only apply to the passing of the property under that compromise if section 128-20(1) (d) is satisfi ed, namely there is a deed of arrangement, it is entered into by the benefi ciary to settle a claim to participate in the distribution of the estate, and the consideration given by the benefi ciary for the CGT asset consists only of the variation or waiver of a claim to other CGT assets that form part of the estate.12 From a stamp duty perspective, if the property involved in the deceased estate includes qualifying land, in many situations

the document evidencing the terms will be liable as a conveyance of a benefi cial interest in such qualifying property or as a assignment or disclaimer of an interest in a deceased estate.13 Occasionally, the compromise agreement may constitute an agreement to which section 31 applies, namely an agreement the property subject thereof which cannot vest except upon registration of a transfer.14

Orders of the Court

If the terms of the compromise give effect to or are embodied in an order of the Court15 then for the purposes of Division 128 the property the subject of the order will pass for the purposes of Division 128 under the will or intestacy as varied by the order of the Court. Also, for stamp duty purposes, any qualifying land passing pursuant to the order should be exempt from stamp duty under the exemption in section 71(5)(h).

Tomlin Order

Foskett describes the use and the form of a Tomlin Order as follows:16

The method most commonly adopted to effectuate a compromise involving terms going beyond the court’s normal jurisdiction is to incorporate the agreement into a “Tomlin Order”. This provides for a consensual stay of the proceedings on the agreed terms save for the purpose of carrying the agreed terms into effect, permission to apply to the court for this purpose being reserved. The terms are usually incorporated into a schedule to the order or are recorded in a separate document’ which is identifi ed clearly on the face of the order. The great advantage of this procedure is that it enables the enforcement of the terms of the settlement within the existing action by a summary procedure.

In Thomas v Cummins17 Beech J said of a Tomlin Order:

By its nature, a Tomlin order is an order giving effect to settlement terms agreed between the parties. The terms of the settlement are a schedule to the orders but are not orders of the court. The compromise agreement in the schedule supersedes the parties’ previous rights and obligations which had been in dispute:

It would therefore appear, that the compromise terms scheduled under a Tomlin Order remain simply the agreement of the parties and that Division 128 of ITAA97 will only apply to the passing of the property under that compromise if the requirements of section 128-20(1)(d) are satisfi ed, as already described. From a stamp duty perspective, if the property involved in the deceased estate includes qualifying land then the position will also be the same as described in respect of a compromise agreement.

Rule of Court

Another of the methods already mentioned is to compromise a matter by making the compromise terms a rule of Court. Mortimer in his The Law and Practice of the Probate Division of the High Court of Justice describes at some length the use of a rule of Court in compromising a probate action.18 In an article in June 2008 entitled “Making terms of compromise a Rule of Court”19 the then Registrar of Probates described using a rule of Court where part of the order cannot be made an order in the IFPA proceedings, in the following terms:

You settle an inheritance Act claim, but part of the settlement can’t be made by way of court order because it isn’t-technically “provision out of the estate”, Or, you settle a contested - probate action and want to have an order embodying the terms of settlement. What do you do?

Record the terms to writing and ask the Judge or Master to make them a rule of court in the action.

An old text entitled The Practice of the Courts of King’s Bench and Common Please in Personal Actions describes what is a Rule,

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likely in this context, in the following terms:20

Rules, it has been said, are not records; but only remembrances, not entered on the rolls of the court. And if a rule of court be produced under the hand of the proper officer, there is no need to prove it to be a true copy, because it is as an original. But the allegations in a rule of court, do not prove the facts alledged.

Foskett also contains a discussion of the concept and describes it, inter alia, in the following terms:21

Where the agreement as a whole has been filed and made a rule of court the enforcement process will depend on the provision sought to be enforced. Where a particular provision has been made an order, then the enforcement process applicable to that order will be appropriate. Where a particular provision has not been made an order, but nonetheless remains part of the agreement, it is submitted that the approach will be similar to that which is appropriate to the enforcement of provisions in the schedule to a Tomlin order: subject to one possible exception, a further order of the court, converting the contractual obligation into an enforceable order, will be needed before enforcement steps can be taken.

Foskett relies on Re Shaw,22 for this view, where Swinfen Eady LJ said, “[b] ut there is here only an order making the terms a rule of Court…Here there is merely a contract which is none the less a contract because it is made enforceable in a summary manner”.23 There is then a brief discussion of a couple of decisions24 that appear to suggest a rule of Court has the effect of converting the compromise agreement into an order.25 Foskett then says, referring to the concepts of a rule of Court and order of Court:26

Despite the apparent interchangeability of the two expressions, the case of Smythe v. Smythe, it is submitted, supports the view that a further order is required before a provision in an agreement made a rule of court becomes an order.

So, it would appear that for Division 128 purposes and stamp duty purposes in respect of interests in qualifying land, where there is a rule of Court, the position is the same as a Tomlin Order. SUMMARY

In summary, where the actual terms of compromise are made an order of the Court Division 128 of the ITAA97 will apply to the property passing under such order and where the matter is an IFPA matter any qualifying land passing under the Order is likely to be exempt from stamp duty under section 71(5)(h).

In any other situation involving a compromise, including where the terms are the subject of a rule of Court or a Tomlin Order, the compromise will need to comply with section 128-10(1)(d) if the property of the estate is to pass with the benefit of that Division. Any such terms, to the extent they involve interests in qualifying land, are likely to be dutiable or at least any conveyance required to give effect to those terms is likely to be dutiable under the SDA if the compromise arrangement is not.

Tax Files is contributed on behalf of the South Australian based members of the Taxation Committee of the Business Law Section of the Law Council of Australia. B

Endnotes 1 A CGT asset is defined in section 108-5 more broadly than simply property. 2 Section 128-10. 3 This will clearly apply to the IFPA and like enactments. 4 This possibility is not adequately dealt with in TR 2006/14 and provided there is power in the instrument to do so would appear to provide opportunities to facilitate arrangements without the constraints imposed by the family arrangement exception. There may be an issue as to whether the person is still acting as the legal personal representative in some situations. 5 Section 128-20(1)(d). See discussion in Taxation

Ruling TR 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests (TR 2006/14) [33]-[37]. 6 This article does not consider the possibility that under some arrangements section 71CC of the

SDA may be available where the land is primary production land. 7 Section 105A SDA. Some transactions that involve interests in companies and unit trusts that own qualifying land are also dutiable under Part 4 of the SDA. The exemption from duty under section 71(5)(h) may also apply to such interests on a look through basis, by virtue of section 102F. Some may be within further exemptions in section 71CC. 8 See D Foskett The Law and Practice of Compromise (5th ed 2002) (Foskett) [9-05] – [9-38]. 9 [1955] 2 All ER 797, 798-800. 10 In that decision it is described as being endorsed on counsel’s brief. 11 Foskett [9-05] – [9-38]. 12 Other relief may be available in respect of residences where the main residence relief provisions of Subdivision 118-B apply (they may even apply to non main residences that are pre

CGT assets, in some situations) or in the case of primary production land used in a primary production business where the small business relief provisions are available under Division 152. It may also be possible in some situations to take advantage of the appropriation provision in section 128-10(1)(c), but this must satisfy the requirements for an effective appropriation to be within that provision. 13 Sections 71(3)(a) and 71AA. In some situations, if the land is primary production land and the requirements of section 71CC are satisfied, then there may be relief available under that provision.

It may also be possible in some situations to take advantage of the appropriation provision in a will, if there is one, if the appropriation satisfies the requirements for an effective appropriation. The current practice of the Commissioner of State

Taxation appears to be to accept that a conveyance by way of appropriation authorised by a Will, will be within the exemption in section 71(5)(h). 14 See 695113 Ontario Ltd. v CS (SA) (1990) 20 ATR 1807 15 Not in a rule of Court or Tomlin Order, as will be discussed. 16 Foskett 9-19. 17 [2009] WASC 228 [24], also see Forrester v Clarke [2012] WASC 3. 18 H Mortimer The Law and Practice of the Probate

Division of the High Court of Justice (2nd ed 1911) 670-673. 19 S Roder “Making terms of compromise a rule of

Court” The Last Testament June 2008. 20 W Tidd The Practice of the Courts of King’s Bench and

Common Please in Personal Actions (1821) 512. So far

I have found little other guidance on this concept. 21 [11-06] - [11-09]. In the 5th edition at [9-07] he notes that there is a division of judicial opinion about the manner of achieving enforcement. In his 9th edition (2020) at [9-09] he adds that it is an old and rarely used procedure and later at [1106] it is rarely if ever used in contemporary times in main stream litigation. 22 [1918] P 47. He also refers to Croft v Croft (1922) 38 TLR 648 and Aspden (Inspector of Taxes) v

Hildesley [1982] WLR 264. 23 [1918] P 47, 53. Warrington J agreed as did

Scrutton LJ. 24 Royal Society of Literature v Lowenthal (1978) C A T 182 and Herbert v Herbert (1978) 122 S J 826. It is noted that Foskett highlights that in both matters it appears the earlier authority was not cited. 25 [11-12] - [11-13]. 26 [11-14] - [11-16].