While it goes without saying that there are several options available for protecting assets, there is no one-size-fits-all solution, and individuals and entities seeking to adopt an asset protection strategy are advised to enlist the help of a professional.  For an optimal asset protection strategy, all the entity or individual’s circumstances need to be considered, by a qualified lawyer, who is certified to practise in the judicial jurisdiction that the asset protections strategy will be subject to.

The ‘gift and loan back’ asset protection strategy is widely considered as a viable option and this article will unpack it further.

Why do you need asset protection?

If you own something, you have an asset.  Naturally, some assets are more valuable than others and most people will take appropriate measures to protect their assets from common daily threats, like security measures and insurance.  However, some people engage in what are known as ‘high-risk’ activities and these could include:

1. Engaging in a professional occupation 
2. Operating a business 
3. Actively serving as an officer of an organisation 
4. Participating in even riskier activities like property development
5. Litigation targets – people who are considered wealthy or may be of public interest.
6. Those enjoying established wealth. 

Most people never even realise threats exist to their assets, until they land in a situation where they are exposed to potential loss through an unforeseen event or claim by an external claimant or creditor. Conversely, some people are aware of potential risks, however their counter-measures are often ill-advised or inadequate.  For instance, transferring ownership of an asset to a spouse, partner, or other entity may seem like a safe option, until it emerges that the new title-holder is legally exposed in ways of their own, or the transfer incurs extensive costs.

The Gift and Loan-back Strategy 

The gift and loan-back strategy is often seen as an effective plan because it allows the retention of asset ownership without compromising equity protection of an exposed asset. This is especially important in situations where transfer or ownership would be impractical, unsafe or subject to unwanted tax and duty liabilities.

How Does it Work? 

The gift and loan-back strategy usually follows this process: 

1. An individual or entity (the 'at-risk party’) owns an asset of significant value, which is subject to nil or minimal charges.
2. The at-risk party borrows an amount equal to the value of their equity in the exposed asset, from an external third party financier, like a bank. 
3. The loan proceeds are ‘gifted’ to a related individual or entity, preferably a discretionary trust not engaged in any 'risky’ activities (the 'related entity’). 
4. The related entity then extends a loan in the borrowed amount to the at-risk individual in exchange for control over the exposed asset as security for the loan. 
5. The at-risk party repays the loan directly to the external third party financier. 
6. The gift and loan-back strategy effectively enables the at-risk individual to safe-guard the value of the exposed asset to the value of the loan amount secured against the asset.  

Individuals and entities utilising the strategy are strongly urged to make sure that assets that are appreciating in value remain adequately protected.

When your discretionary trust is the related entity 

As a result of the flexibility and protection that an inter-vivos discretionary trust can provide (especially in case of bankruptcy), the related entity will usually be the trustee of such a trust.

In most cases, trust beneficiaries are precluded from having any vested entitlements to income or capital of the trust, by the discretionary trust deed. Usually, absolute discretion to apportion trust income and capital, will lie with the trustee, who will at their discretion decide if, when, and how much beneficiaries will receive. In the absence of such allocations by the trustee, beneficiaries have no rights other than the right to be considered by the trustee. For this reason, the trust assets are beyond the reach of a beneficiary’s creditors, unless these transactions are within the applicable time limits under the Bankruptcy Act 1996 (Cth), or were intentionally instituted to defraud a creditor). 

It is also important to note that the rights of a bankrupt as appointor of a discretionary trust do not accrue to their trustee in bankruptcy.  Also, it is possible for a trustee in bankruptcy to become, or to control, the trustee of the trust which was previously controlled by a bankrupt. In such cases, the trustee in bankruptcy may successfully attempt to appoint income and capital of the trust to the bankrupt, which effectively makes the property accessible to the creditors of the bankrupt. However, this would likely constitute a massive breach of conduct in terms of the objectives of the trust, as it would benefit the interests of one beneficiary at the expense of other beneficiaries.

Important factors to take into account

The 'claw-back’ provisions of the Bankruptcy Act 1966 (Cth) may successfully be applied to an earlier transfer of assets from the beneficiary to the trust, to satisfy the claims of a bankrupt beneficiary’s creditor(s). 

The claw-back provisions of sections 120 and 121 make provision for the trustee in bankruptcy to recover property disposed of at any time by a bankrupt with the intention of defeating their creditors, or to recover property transferred for less than market value. 

Further, asset protection strategies undertaken for the purpose of achieving certain Family Law outcomes will also generally be ineffective. 

Considering the above, it is imperative that a client’s personal and business circumstances are scrutinized and assessed prior to the contemplation and adoption of an asset protection strategy.

Other factors that should never be overlooked are the costs involved.  Not just the immediate costs, but potential ongoing costs of the strategy, which will not only complicate an individual’s affairs considerably, but may also be so excessive that they negate the efficiency of the strategy altogether. 

It is also of paramount importance to consider that revisions of legislation may occur during the term of the strategy, that may render it impractical or financially unfeasible.

Conclusion 

The gift and loan-back strategy should never be implemented in relation to affecting an outcome for Family Law purposes, or where concerns exist regarding an individual’s personal or business solvency. Nor should it be seen as a total asset protection solution.  An effective asset protection plan should be constructed to encompass estate planning eventualities and tax reduction principles, while significantly reducing the risk of exposure to assets.  It should be a tailor-made plan, purposed to the needs and specific situation of the individual or entity it will serve.