A Matter of Trust: Do Gift and Loan Back Schemes Work?

Do Gift and Loan Back Schemes Work?

By Grahame Young FTI, TEP

Barrister, Francis Burt Chambers

In some quarters gift and loan back schemes have had some popularity.

The purpose of such schemes is to diminish the net value of the donor’s assets without affecting their use and enjoyment of those assets. One motive for entering into such a scheme can be to ensure there are no estate assets that may be available to satisfy an anticipated family provision claim.

The decision of the Queensland Supreme Court in Re Permewan1 may have cast some doubt as to the efficacy of one such scheme.

Mrs Prudence Permewan had assets being her principal residence and shares and loans in a private company, worth in total about $3 million. She wished to benefit her son who was to “do the right thing and look after everyone who deserves it.”

By her will she appointed her son as executor and left him the shares in the corporate trustee of a family discretionary trust and the residue of the estate to the trust. The beneficiaries of the trust included the son and her two daughters. As the son would control the trust and all assets would belong to the trust, the daughters were dependent for benefit on the decisions to be made by him. The daughters had made family provision claims, but were faced with the prospect that there may not be any available assets in the estate.

The scheme had been implemented by a series of transactions entered into by Mrs Permewan on the same day: she signed a bearer promissory note promising to pay the bearer the sum of $3 million; as sole director of the corporate trustee she signed a receipt that the trustee received the promissory note as a gift to the trust; she then resolved to loan the money gifted by the bearer promissory note to herself, repayable on demand and secured by a mortgage over her real property and shares; she then signed a loan agreement

between herself on behalf of the trustee as lender and herself as borrower and a security deed and real property mortgage. she then signed a further receipt for the promissory note stating that she received it as a loan and that it was cancelled by her because of the merger of the right to be paid and the obligation to pay; The judge found, at [24]:

By this series of extraordinary documents:

1. Prudence purports to gift, through the provision of the promissory note, $3 million to the Lotus

Trust. This is despite the fact that

Prudence clearly did not have $3 million in cash and would have to liquidate all of her assets to pay it. 2. The Lotus Trust has loaned $3 million to Prudence. This is despite the fact that the

Lotus Trust clearly did not have $3 million in cash to loan to

Prudence.

3. To secure the loan, so as to give effect to the gift evidenced by the promissory note, Prudence mortgaged or otherwise charged her assets.

4. The result of the transactions is that Prudence, who before these transactions had assets worth net $3 million, now has a debt of that amount to the Lotus Trust secured over her assets.

The transactions effectively obliterated the fund from which provision could be made for the daughters. The judgment contains excerpts from a transcript of a recorded conversation between the son and one of the daughters which the judge found to be significant and readers may find remarkable for the vituperative and colourful language. The judge found the conversation revealed a deep-seated animosity of the son to the other daughter and his intention to access the estate’s funds to fight any claim knowing she would have to fund any legal fees. The judge also drew an inference that the son as executor had no intention to consider, let alone act upon, any issue as to enforceability or otherwise of the transactions.

The judge made orders revoking the grant of probate to the son and appointing an independent solicitor as administrator.

The question of the invalidity of the scheme is yet to be determined and it is not suggested that the scheme, or any other gift and loan back scheme, will be found to be invalid or ineffective, but the entry into and implementation of such schemes is likely to be subject to intense scrutiny as to the legal effectiveness of the scheme, and issues such as incapacity, duress and undue influence. In this instance the implementation of the scheme relied upon creation of a liability by a promissory note, and the gift of that liability by delivery of the note and a loan back, again by delivery of the note. At a visceral level there appears to be an air of unreality of a person creating a liability by signing a bearer promissory note of which they are the initial bearer in another capacity or which only becomes a liability upon delivery to themselves in another capacity. A more straightforward implementation could have been the transfer by gift of the house, shares and loans. However, the transfers would have had capital gains tax implications and incurred liabilities for transfer duty and land tax in respect of the house. No doubt it was for that reason that a promissory note was used to create a liability equal to the value of the assets.

Any practitioner tasked with implementing a gift and loan back scheme should take great care not only as to the effective implementation of the scheme, but also to ensure that the client fully understands and voluntarily intends the consequences of the scheme and that one consequence may be litigation between family members.

End notes

1 Re Permewan, Frater v Permewan [2021] QSC 151

Grahame Young is a member of STEP, the Society of Trust and Estate Practitioners, a multi-disciplinary group with branches worldwide, including in Western Australia. For further information concerning STEP visit https://stepaustralia.com