The why & how of personal asset protection

I have had the unfortunate experience of having to represent the director of a small enterprise whose business had gone into liquidation through a series of unfortunate events including litigation, bankruptcy of a supplier and machinery failure.

None of these events on their own, or even 2 simultaneously would have led our experienced director to my office, but four major events within a six-week period left him with insufficient cash flow to meet his debts as and when they became due. He was legally insolvent.

Our director believed that the company assets would be more than enough to meet its debts, but due to the age of the machinery and a decrease in its value, the valuation was less than anticipated and the company was unable to be sold as a going concern. The bank moved in quickly and repossessed his family home along with an investment property that was intended to be his retirement fund.

It is easy enough to think, ‘this would never happen to me’, but the truth is many of us are at risk. It happens very fast, and at that point it is too late to think about personal asset protection.

There are a variety of ways to isolate assets depending on the nature of the asset and the potential tax implications.

The following are 3 of the most popular methods of asset protection:

1. Majority ownership – family home

   One of the most popular options for small business owners and sole traders is to transfer the family home, or the majority ownership, to your spouse. The advantage of this is that it is quick and easy and, because it does not attract Stamp Duty or Capital Gains Tax (CGT), it is also one of the most inexpensive options.

   It is however not without some risk. It is crucial that the spouse is not a guarantor to any business loans. A default in guarantee will result in the same outcome – loss of your home.

   It is also essential that the spouse does not participate in the day-to-day management of the company and does not engage in decision-making regarding the company or its finances. If it can be at all inferred that the spouse participates in the management or decisions of the company, they can be deemed to be a ‘de-facto’ director and therefore liable for the debts of the company.

2. SMSF – Superannuation

   Superannuation is not only one of the most tax effective methods for growth of assets, but also has statutory protection from creditors, making it one of the securest options to preserve retirement assets.

   An industry or corporate superannuation fund can be used as a vehicle to preserve cash, but if you wish to have more control and flexibility over investment assets, then a Self-Managed Superannuation Fund (SMSF) is an extremely effective and secure and way build a superannuation portfolio that is safeguarded against bankruptcy, litigation and the litany of things that can go wrong.

   SMSFs are subject to CGT when transferring assets, and can be complicated to set up, particularly if you wish to offset CGT against charitable donations. They are also subject to strict regulatory supervision and it is highly advisable to seek professional advice to make sure you understand what your specific SMSF responsibilities are.

3. Discretionary Trust

   Trusts are used heavily not only in asset protection, but also in succession planning, ensuring that assets are preserved for their ultimate beneficiary – you, your children and/or grandchildren.

   The safest and most flexible trust structure is a fully discretionary trust. In this structure, the trustee maintains absolute control as to who, when and how beneficiaries may receive a distribution. Because beneficiaries do not own or have any interest in the property, it cannot be accessed by creditors or any other party seeking assets.

   While discretionary trusts, when used properly, can be effective tax vehicles, transferring an asset into the trust is a CGT event, making it very costly to establish. Transferring real property, such as the family home, will trigger both Stamp Duty on the transfer as well as CGT.

There are additional arrangements that can overcome some of the tax burdens of transferring assets to a trust but we highly recommended seeking professional advice to ensure you don’t trigger the tax avoidance provisions in the monolith that is Australian tax law.

Remember, asset protection is not about hiding assets, avoiding responsibility or giving you an opportunity to act unethically, it is about preserving assets in the event something goes wrong.