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Asset protection strategies feature at Terrigal conference

Friday, 30 August 2002
By Print 21 Online Article

Printing Industries NSW Manager, Darren Jensen warns anyone intending to take advantage of the advantageous rates at the Terrigal conference to confirm their bookings ASAP. “Many delegates have registered their interest in attending but have yet to confirm. Unless they do so quickly they may find themselves out in the cold as far as conference rates go,” he said.

The Printing Industries conference (register online at left) features a quality line-up of industry management and financial speakers. David Brown, a financial strategist, is one who will present his findings on what steps printers should take to protect their business, or even the family home from commercial misadventure.

“In an increasingly litigious society it is not only the imprudent entrepreneur who is at risk. Personal finance disaster may be precipitated by unforeseen claims against a family company for negligence or product liability or through failure of a few large debtors. In an environment where financiers are extremely cautious and directors are often personally liable, it is only prudent to plan one’s affairs so that core assets are protected,” said Mr Brown. “This is especially the case for business people with dependent families.”

The key asset protection is to ensure that core assets are held by a person or entity, which is totally insulated from all possible third party claims. An operating company, or indeed its directors should not hold such assets. A passive shareholder (e.g. a spouse) may be the appropriate party to own core assets provided that they have not given personal guarantees in respect of the family company.

The courts have held that a spouse who merely signs documents as a passive director may be liable for company debts. Consider replacing family members who are non-executive directors with reputable third parties. This improves skills available at board level as well as reducing financial exposure. Alternatively, the Corporations Law now permits companies to operate with a single director so spouses may retire as director’s altogether.

Asset Protection Trusts

An asset protection trust (APT) is one of the most popular vehicles for integrating asset protection with tax and estate planning. An APT is essentially a discretionary trust structured so as to ensure that creditors of the persons who have donated assets to the trust cannot pursue trust assets. For example persons such as directors or guarantors who may be embroiled in claims against the family business should not act as trustees of an APT or be in a position to control the actions of the trustee or appoint a new trustee.

Frequently an APT has a private company as trustee with trusted third parties acting as shareholders and directors of the Trustee Company. Pursuant to the Trust Deed the person behind the trust may have the power to appoint new trustees (thereby reasserting direct control) but this power ceases or reverts to someone if the appointer becomes bankrupt or mentally unsound. Whilst this model for an APT is one of many it is popular because it does not necessitate finding a totally trustworthy and risk free family member to act as an asset owner or trustee.

However an APT is not usually the best vehicle for acquiring assets that are negatively geared. Such a strategy would involve the making of continuous donations to the APT to meet its cash flow needs whilst tax losses would be a ‘structure’ in the APT and could not be used by its beneficiaries. On the other hand, the APT is the ideal vehicle for sheltering assets, which produce assessable income and/or capital gains. The income of an APT can be distributed annually on a discretionary basis among a wide class of beneficiaries to minimise tax.

Becoming your own creditor

The proprietors of a private company are frequently its largest or second largest creditors. They often advance start-up capital to the company then reinvest profits as further advances year after year to help the company grow. Indeed, it is common to find the most valuable asset in the shareholder’s estate is not his shareholding but the debt owed to him by the company.
Against this background it is curious why shareholders so rarely take security over advances to their own companies. Even when taking security requires the consent of financiers it is a simple legal procedure involving only minor transaction and stamp duty costs. It is true the shareholders security will almost invariably rank after the security taken by the company’s financiers.

However it will rank ahead of unsecured creditors e.g. trade creditors. This can be particularly important if the company suffers some large unexpected claim such as negligence or product liability. If such a claim is upheld against a successful company it is common to find the secured creditors are fully protected while unsecured creditors including the shareholders and plaintiffs receive only a few cents in the dollar.

Practical Tip

It is important to recognize debts, whether secured or unsecured, as an asset separate to shareholding in a family company. A separate assets debt should be protected by being held through a party insulated from creditor risking (such as an APT). Unsecured debts can normally be translated without attracting any tax or stamp duty costs if appropriate steps are adopted. Secured debts can be similarly transferred but may give rise to loan security duty.

Creating debt to shareholders

In addition to the asset protection advantages of separating debt from shareholding in a private company there are frequently other benefits. For example, if an APT holds the debt, paying interest to the APT may reduce the profit of the company. This can be distributed on a discretionary basis by the APT to persons who are not shareholders. From an estate-planning viewpoint it may be convenient to leave the company debt to a family member not involved in running the company whilst leaving the shares to the family member who will inherit the business.

If the above objectives are to be met in the case of a company not having significant debt to its shareholders then various strategies exist for creating such debt. For example, if the company has significant retained profits it may be able to pay a large franked dividend, which is then reinvested in the company as debt by the shareholder or an associate. It may be necessary to simultaneously undertake some tax planning for the shareholder to minimise the potential tax consequences of such an extraordinary franked dividend.

Alternatively more complex debt creation strategies are available where the above strategy is inappropriate. For example, the operating company may acquire a shelf company subsidiary and sell some or all of its business assets to that new company.
Thereafter the new company will take over trading operations and will have debt, which may be secured, to its parent company. Complex stamp duty and tax issues arise in connection with such restructures making it difficult to generalise. The existence of the rollover provisions in the tax legislation frequently makes such restructuring a viable option.

Protecting geared investments

The Australian taxation system encourages negative gearing as a technique for converting current taxable income into capital gains, which are tax deferred and sheltered by indexation to the consumer price index. It can be difficult to reconcile a wealth creation strategy (which involves acquiring negatively geared assets) with an asset protection strategy, which involves the ownership of assets outside the business vehicle, which generates the cash flow to finance their acquisition.

Conclusion

“Why do business people so often neglect asset protection strategies until it is too late? It is foolhardy to say, It can’t happen to me or to be too busy to protect one’s family. Asset protection strategies must be planned and implemented in conjunction with wealth creation, tax planning and estate planning strategies. With adequate forward planning core assets can be protected,” concluded David Brown.

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