March 2014

Family trusts not bulletproof in a bankruptcy

The facts

Mr Bonnell was the appointor and a beneficiary of a discretionary family trust. 

The trustee of the family trust was Windoval.  Windoval was controlled by Mr Bonnell.

Mr Bonnell was also the sole beneficiary of a non-complying superannuation fund.  The Commissioner of Taxation had issued a private ruling that contributions made to the superannuation fund were tax deductible.  However, the Commissioner had issued a media release several months thereafter that schemes such as Mr Bonnell’s non-complying superannuation fund were arrangements intended to frustrate the tax legislation.

After the issue of the media release, Mr Bonnell made contributions to his superannuation fund in the financial year ended 30 June 1999 and claimed tax deductions for the contributions totalling $5m.  Mr Bonnell was aware of the media release before he made the contributions.

On 1 July 1999, the superannuation fund was wound up by Mr Bonnell and all the assets of the fund, being the contributions of $5m, were distributed to Mr Bonnell.  Immediately thereafter, Mr Bonnell gifted the sum of $5m to Windoval in its capacity as trustee of the discretionary family trust controlled by him.

Over nine years later, on 10 September 2008, Mr Bonnell became bankrupt upon the application of the Commissioner of Taxation.  Mr Donnelly was appointed the trustee of the bankrupt estate of Mr Bonnell.  Mr Donnelly had the responsibility of administering Mr Bonnell’s financial affairs including to ensure that all of the bankrupt's assets were available for distribution to his creditors.

Mr Donnelly alleged that:

  • the transfer of the $5m into the discretionary family trust was done at a time when Mr Bonnell was or was about to become insolvent; and

  • the transfer was done to defeat that sum from being divisible amongst Mr Bonnell’s creditors or to hinder or delay the process of making that sum available for distribution amongst his creditors.  

In support of the argument that Mr Bonnell was or was about to become insolvent, the trustee alleged that Mr Bonnell knew that there was a real possibility that the Commissioner of Taxation would disallow the contributions as tax deductions and Mr Bonnell would be liable for income tax of not less than $2,425,000 as a result. 

By gifting the $5m to Windoval, Mr Donnelly alleged that Mr Bonnell deprived himself of the funds with which to meet the additional tax liability that would be assessed if the contributions were determined not to be deductible.

The decision

The Court found that the main purpose of the transfer of the $5m into the discretionary family trust was to defeat or hinder Mr Bonnell’s creditors and that the transfer was void against Mr Donnelly pursuant to section 121 of the Bankruptcy Act.  The Court also found that pursuant to section 37A of the Conveyancing Act, Mr Bonnell intended to defraud the Commissioner of Taxation who was seen as a likely creditor as at that time.

Conclusion

The outcome of this case is an important reminder that a trustee in bankruptcy (or a liquidator in an insolvency) has wide ranging powers to seek orders to claw back assets, including those that might be seen as “safely” housed in a discretionary family trust, if the Court is of the view that the assets were received for the main purpose of placing those assets out of the reach of the bankrupt’s creditors - hindering the process of making those assets divisible amongst creditors or with intent to defraud creditors.  Significantly, these powers enable transactions that took place many years prior to be analysed for this purpose.

Author: Elias Yamine