Gift and loan back arrangements – are they still viable?

Gift and loan back arrangements are a popular strategy for a number of reasons, including for estate planning and asset protection. Many advisers have actively used this strategy as it does not trigger the same adverse tax or duty outcomes as when transferring the asset, but largely achieves the same economic outcome.

The recent case of Re Permewan (No 2) [2022] QSC 114, brings into question whether gift and loan back strategies can be effective. There is a real risk for clients with these strategies in place, and who are relying on them to achieve a particular outcome.

A gift and loan back arrangement is usually structured as follows:

• A high risk individual gifts an amount to a lower risk entity controlled by them, such as a discretionary trust. The amount gifted should reflect the value of the equity in the asset they are trying to protect. The gift should be made by cash.
• The lower risk entity then loans the gift amount back to the individual as a loan.
• The lower risk entity takes security over the asset (such as a mortgage).

The result of implementing this strategy is that the underlying ownership of the asset remains the same, but the value of the asset is shifted to another entity.

In Re Permewan (No 2), the background facts were as follows:

• Prue died in September 2019, with three adult children surviving her (Scott, Marla and Donna).
• It appeared that Prue’s estate had about $3 million worth of assets, including her home and a share portfolio.
• Prue’s Will named Scott as the sole executor and gave the whole estate to Prue’s family trust. Scott was also given control of the family trust.
• In April 2018, Prue had entered into a gift and loan back arrangement with the trust:
  • Prue gifted $3 million to her family trust by way of promissory note.
  • Prue then ‘borrowed’ $3 million from the family trust. This loan was implemented by endorsing the promissory note back to Prue.
  • Finally, as security for the loan from the family trust to Prue, the family trust registered securities over Prue’s home and share portfolio.
• Importantly, no cash changed hands at any point.
• These transactions effectively stripped all value out of the estate. This meant that any family provision claim made by Marla and Donna would be pointless as the estate was apparently worthless.

In Re Permewan (No 1) [2021] QSC 151, the Queensland Supreme Court removed Scott as the executor of Prue’s estate and an independent lawyer took his place on the basis that the proper administration of the estate would be frustrated by Scott if he continued to act as executor. As part of this decision, the Court also made some comments about the gift and loan arrangement, including that the transactions were ‘commercially insensible’.

Re Permewan (No 2) considered the validity and enforceability of the 2018 transactions between Prue and the family trust. During the course of proceedings, Scott conceded that the transactions were invalid and unenforceable because the Court could not find that the promissory note had been delivered. This meant that the transactions were technically incomplete.

Even though the gift and loan back documents were invalid due to a technicality, the Court made a number of comments on other reasons why the arrangement would not have been effective. In particular, the Court commented that the gift and loan documents would have been found invalid and unenforceable at law as they were both contrary to public policy and a sham.

The Court’s reasons for this stance were that the transactions were illusory, and that Prue only appeared to have parted with her property – there was no intention for the transactions to actually occur during her lifetime. The sole purpose of the transactions was to defeat a future family provision claim by Donna and Marla.

The Court’s comments in Re Permewan (No 2) are concerning for anyone with a gift and loan back arrangement, especially where no money has changed hands, or where there is any doubt over the validity of the documents implementing the arrangement.

This is an important reminder to clients and lawyers that:

• they need to ensure the paperwork for these strategies will hold up to scrutiny by the Court
• cash should change hands as part of a gift and loan back arrangement.

Following Re Permewan, if you have a gift and loan back arrangement in place, it is important that you seek legal advice on the validity of those arrangements .

Join our webinar discussing this decision and the future of gift and loan back arrangements on 4 August 2022, or contact a member of our team.