A trust is a relationship where a person (the trustee) is under an obligation to hold property for the benefit of other persons (the beneficiaries).
EXAMPLE
Rob is an accountant in practice and has a risk of being sued for negligence. Rob is also a single parent and has two children, Jack and Jill, aged 10 and 12. Rob wishes to provide for his children if anything ever happened to him.
Rob asks his brother Tom, to “hold” certain income producing assets on behalf of Jack and Jill.
Rob instructs Tom in writing that he (Tom) will be the legal owner of the property, but any income flowing from the assets will only accrue to Jack and Jill.
The above arrangement is a form of trust relationship as follows:
– Trustee – Tom;
– Beneficiaries – Jack and Jill;
– Trust deed – Rob’s instructions to Tom
A trust is not a separate legal entity, even though, for tax law purposes, a trust return is required to be lodged.
A trust cannot exist forever. The trust comes to an end on the “Vesting Day”, and for most trusts (except those in South Australia) this day must generally occur within 80 years of the establishment date.
A discretionary trust is generally a trust under which the distribution of income or capital to beneficiaries is made at the discretion of the trustee. Until the trustee exercises its discretion, the beneficiaries generally have no interest in the property of the trust. A discretionary trust is sometimes called a “family trust” (however, for tax purposes, a “family trust” is defined to mean a trust that has made a “family trust election”).
EXAMPLE
Discretionary trust
The trust deed of the XYZ Family Trust provides that the income and capital of the trust can be distributed to the beneficiaries of the trust as determined by the trustee each year. This is a discretionary trust.
Not a discretionary trust
Jack and Diane own half of the units each in The ABC Unit Trust. This is not a discretionary trust.
Strictly speaking, a person to whom the trustee can distribute income or capital is only a potential beneficiary and not an actual beneficiary until the trustee exercises their discretion and actually makes them entitled to income or capital. Until this time, the beneficiary has no rights except to be considered as a potential candidate for a distribution of income or capital.
Nonetheless, in practice, people generally refer to a “potential beneficiary” as a “beneficiary”.
EXAMPLE
The XYZ trust is set up with a wide range of beneficiaries, including Mr A and all of his family. Mr A and his family are merely only potential beneficiaries at this time. At the end of the trust’s first year of operation, the trustee resolves to distribute the trust income to Hank, a child of Mr A. Hank is now a beneficiary under the trust with a recognisable interest in the income of the trust, whereas the rest of the family are still only potential beneficiaries.
This is one name given to a type of discretionary trust that endeavours to ensure that the property of the trust will remain within a particular family, perhaps as defined by direct (i.e., blood) relationship to a particular individual. Although such trusts are often set up in an attempt to protect the trust assets in the case of marriage breakdown, they can also be useful in other situations where the principal setting up the trust wants to ensure that the benefit of the trust property will remain with his or her immediate family.
EXAMPLE – Ordinary discretionary trust vs. Pedigree Trust
Mork has set up a discretionary trust – The Mork Family Trust – which includes standard terms for such discretionary trusts, and includes a broad range of beneficiaries. It also states that, on the death of a trustee or an appointor, the trustee’s/appointor’s legal personal representative will take over that position.
Mork is both the trustee and appointor of the Mork Family Trust. Over the years he works hard, building up many assets in the trust, but unfortunately not having time to have children.
One day, Mork and his younger wife Mindy sadly perish in a car accident. Although they are both killed at the same time, the law in Mork’s State assumes that the older person dies first. Therefore, on Mork’s death, his wife Mindy (his legal personal representative under his will) became, very briefly, the trustee and appointor of the Mork Family Trust. Then, on her death (which, in the eyes of the law, took place a split second after Mork’s), her legal personal representative, in this case her father, became the trustee and appointor of the Mork Family Trust.
Mindy’s father, as trustee, then promptly distributed all of the income and assets of the Mork Family Trust to himself and his wife (Mindy’s mother), both of whom are included in the broad class of beneficiaries, much to the surprise and indignation of Mork’s parents and siblings, who then contemplate launching legal action against the trustee of the Mork Family Trust.
Had Mork used a Pedigree Trust, this situation may have been avoided. He could have limited the objects (i.e., potential beneficiaries) of the trust, as well as the potential trustees and appointors, to his blood relations, saving future angst for his family (although acknowledging that it would restrict the operation of the trust somewhat).
This Pedigree Trust has a very broad range of beneficiaries, including spouses of all relevant beneficiaries, in relation to the distribution of the income of the trust each year. However, spouses of capital beneficiaries are generally excluded from benefiting from the capital of the trust (i.e., they may be entitled to share in trust income, but are not entitled to the trust’s assets).
However, note that, as with ordinary discretionary trusts, the trustee has a broad power to determine the income of the trust from year to year and may, for example, determine that capital gains are in fact income. Although this may allow some capital receipts to be received by the income beneficiaries, removing this flexibility would greatly reduce the effectiveness of the discretionary trust and may result in adverse tax consequences.
In addition, the restrictions on the identities of the trustees and the appointors should ensure that this power is only exercised for the correct purposes and only in favour of beneficiaries the trustees intend should benefit. Nonetheless, trustees should be careful when exercising these powers for a Pedigree Trust.
TRUST WARNING – Family law
Although some people may want to set up a Pedigree Trust to ensure that their spouse (or a spouse of one of their relatives) never gains access to the trust assets, it should be noted that the Family Court has very broad powers to treat assets of trusts as those of any married, or formerly married, parties. Therefore, simply setting up a Pedigree Trust does not necessarily mean that the assets in that trust are safe from the Family Court.
There are a number of important issues to consider in relation to operating a trust.
After the deed is executed, the trustee should arrange for a bank account to be set up as soon as possible. The name on the bank account should be along the lines of the following:
EXAMPLE ONLY – ZBC Pty Ltd as Trustee for the FGH Discretionary Trust.
The bank can provide details of the information required to open up a new bank account.
Where a corporate trustee has just been set up as well, the company provider may provide a bank kit to assist with opening up a new bank account (we provide such a kit).
TAX WARNING – Trust bank account not for personal use
After the deed is executed, the trustee should arrange for a bank account to be set up as soon as possible. The name on the bank account should be along the lines of the following:
EXAMPLE ONLY – ZBC Pty Ltd as Trustee for the FGH Discretionary Trust.
The bank can provide details of the information required to open up a new bank account.
Where a corporate trustee has just been set up as well, the company provider may provide a bank kit to assist with opening up a new bank account (we provide such a kit).
As well as maintaining records it is important that the trustee holds a meeting (or otherwise resolves) on or before 30 June each year to allocate the income of the trust among the beneficiaries. Please contact your accountant for information on how the meeting should be documented.
Trustees often have unlimited powers in deciding in what to invest. The trustee’s powers are set out in the trust deed, but the trustee has a responsibility to exercise skill and care in making their investment decisions. This rule basically says that the trustee should ensure they take the same degree of care that a prudent person would take in making investment decisions, given their skills and knowledge.
There are a number of tax obligations that the trust may have to register for, including GST, PAYG withholding and so on. In this regard, advice should be obtained from your accountant.
The benefits of a discretionary trust include the following:
One of the main advantages of a discretionary trust is the ability to distribute income and capital tax-effectively. The trustee is able to either distribute income to the beneficiaries or accumulate it (although accumulating causes its own problems – i.e., the trustee may be taxed on such amounts at the top tax rate). None of the beneficiaries are able to force the trustee to distribute income in a particular way.
The principal benefit of using a trust to carry on a business or hold assets is that no single beneficiary has any claim to any assets of the trust (apart from any unpaid distributions they remain entitled to) and therefore a trust provides a good way to obtain asset protection.
EXAMPLE
Madison is listed as a beneficiary of the Plastics Family trust. Madison borrows to invest in speculative shares and encounters financial difficulties. The bank forecloses on Madison’s home to recoup some of the lost borrowings. As Madison has no claim on (and does not own) the trust property, the bank should not be able to force the Plastics Family Trust to sell its assets to pay Madison’s debt.
When considering asset protection issues, reference should also be made to page 6 of this Guide for a discussion about the role of an appointor in a trust.
TRUST WARNING – Trust assets may still be at risk
In a recent company law case called “Richstar”, the Federal Court held that, where a beneficiary of a discretionary trust effectively controls that trust (e.g., they are the trustee or the appointor), then “there is something which is akin to a proprietary interest in the beneficiary”. However, the Court only came to this conclusion in relation to a particularly broad section of the Corporations Act 2001 that allows the Court to freeze the assets of certain entities on the application of ASIC while other matters remain unresolved, and it has not been followed subsequently in relation to (for example) bankruptcy law.
Nonetheless, that case (and other similar cases, including Family Law cases), highlight that a potential beneficiary of a discretionary trust, particularly where they play other roles in relation to running the trust, may still be found to have an “interest” in the assets of the trust.
A discretionary trust is created when a person known as the “settlor” gives the trustee money or
property for the benefit of the beneficiaries. This “settled sum” is the original trust fund. The settlor is normally a family friend and should not be a beneficiary of the trust, nor should they be the client’s professional adviser or anyone similar if it could be argued that the settled sum has been refunded back to them. No other legal obligations arise for the settlor, who is not responsible in any way for the trustee’s actions.
TRUST TIP – Further evidence of trust being established
It is often a good idea for the trustee to open a bank account to deposit the settled sum shortly after the deed has been executed (if the trustee is a company set up by us, the included directors’ resolution assumes this will be done) – this can provide further evidence regarding the date the trust was settled. Some trustees prefer to staple the settled sum to the deed, so as to ensure it is not eroded by bank fees, but this can also be dangerous if the original deed is lost (meaning the settled sum is completely lost). However, if a corporate trustee would prefer to take this alternative option, they should amend the directors’ resolution accordingly
A trust deed may be subject to stamp duty. The stamp duty (if any) can vary from one State or Territory to another, and the deed normally needs to be stamped within a limited time period after being executed – contact the relevant State Revenue Office for more details.
The trustee is the legal owner of the trust property, although not the beneficial owner, and is responsible for managing the trust fund. Being the legal owner, all of the transactions of the trust are carried out in the name of the trustee. The trustee signs all documents for and on behalf of the trust, i.e., in its capacity as trustee of the trust.
As a trust is not a separate legal entity, the trustee bears the duties and responsibilities in relation to the trust. As such, the trustee is personally liable to creditors and accountable to beneficiaries.
TRUST TIP – Limitation of trustee’s liability
The trustee can limit their personal liability by making it clear that any contract or promise is supported by the trust’s assets only and not by the trustee’s own personal assets. In particular, special care should be taken when entering into finance arrangements, as many finance documents will have a clause stating that the trustee enters into the obligations in a personal capacity as well as their capacity as trustee.
The trustee should ideally make it clear that they are contracting in their capacity as trustee and not on their own behalf and should consider inserting a specific clause in every contract to limit liability.
If this is not possible, the trustee should at least insert the following words after their name “as trustee only but not otherwise”. The above procedures are recommended but cannot be relied upon to fully protect the trustee. Also refer to the Trust Warning on the next page.
The trustee’s overriding duty is to obey the terms of the trust deed. The trustee also has a duty to act in the best interests of the beneficiaries. There are many other duties imposed on the trustee by law. In summary, these are:
EXAMPLE – Trustee complies with duties
Donald is the trustee of the Duck Discretionary Trust. The beneficiaries of the Duck Discretionary Trust are Daisy, Huey, Duey and Looey.
On 29 June, Donald resolves to distribute the income of the Duck Discretionary Trust.
Provided Donald considers all four beneficiaries in light of his duties, he will not breach his duty if he then exercises his discretionary power and decides to distribute all of the income to Daisy.
TRUST WARNING – Trustee must act in beneficiaries’ best interests
Unless the trust deed specifically allows it, Donald, as trustee, cannot exercise his powers in his own favour. For example, he could not borrow money in his own capacity from the trust interest free and without security unless the trust specifically allowed it. Similarly, if Donald was also a beneficiary he must take care when exercising his discretion to distribute income to himself. An improper exercise of that discretion to advance his own interest will constitute a breach of trust.
The Australian Business Structures Trust Deed does allow a trustee to be a beneficiary of the trust and to act even if the trustee has a personal interest in the result of the decision/action, but the trustee must still act in good faith and in the interests of the beneficiaries.
In addition to a trustee’s duties, which the trustee must carry out, the trustee also has the choice to use “powers”. Powers under many trust deeds include the power to buy assets, dispose of them at any time, mortgage assets for the purposes of undertaking borrowings, and so on.
As the trustee is personally liable for the debts and transactions they undertake on behalf of the trust, best practice is to use a company as trustee, for the following reasons:
It can provide good asset protection, especially if the company has no other significant assets of its own (i.e., if its only role is to act as corporate trustee) which could be exposed to the creditors of the trust.
TRUST WARNING – Directors may still be liable
A corporate trustee will not provide total protection. Even with a corporate trustee, there may be circumstances in which a director of a trustee company is personally liable, including:
In addition, there is a risk in some circumstances that the “corporate veil” will not work before a court of law.
Although there are circumstances in which the corporate trustee can be personally liable, a corporate trustee still generally offers greater asset protection than an individual being the trustee. Therefore, it is recommended that, where possible, a company should be the trustee.
TRUST TIP – Pedigree Trust limitation on trustees
Spouses of most capital beneficiaries are precluded from being trustees of a Pedigree Trust.
It is generally preferable to have separate trustees for the following reasons:
If a trustee’s liability arose from the proper exercise of their powers and duties, the trustee can be ‘indemnified’ out of the trust assets. Broadly, this means the trustee can pay expenses from trust funds, instead of their own, or be reimbursed by the trust if they do personally pay for trust expenses (although, if the assets of the trust fund are insufficient to meet the expenses, the trustee may be personally liable for such expenses).
A trustee can lose their right of indemnity if, for example:
EXAMPLE – Trustee loses right of indemnity
Francis is the trustee of the Black Trust. As trustee, Francis purchases speculative share investments, which go bad. Francis has no experience in share trading and relies on tips from friends.
Francis may have to pay for the losses from his own personal funds as, arguably, he has not acted diligently in choosing an investment.
The appointors (or appointor) of a trust have the real power and control of the assets of a trust, since the appointors have the power to appoint and remove trustees. In many cases, the original appointors include the one or more of the parties for whose benefit the trust is established.
If there is no appointor named in the trust deed, then our deed allows the trustee to exercise the powers of the appointor (although for other deeds it may be necessary to refer to the Trustee Act of the State or Territory concerned to work out how a trustee can be removed/appointed).
As the real control of a trust lies with the appointor, extreme care should be taken in choosing the appointor. Generally, having a number of joint appointors, possibly including an independent appointor, provides greater asset protection and succession planning benefits, so it is preferable to avoid having a sole appointor.
EXAMPLE – Why a sole appointor should be avoided
Bill decides to establish a family discretionary trust with White Pty Ltd as trustee. Bill and his wife Pauline are the directors and shareholders of White Pty Ltd. The trust deed states that Bill is the sole appointor and on his death his wife becomes the appointor.
Scenario 1
Six years after the trust is established, the trust has significant assets, and Bill and Pauline separate. Bill, as appointor, removes White Pty Ltd as trustee and appoints his brother (Jed) as the new trustee. Jed distributes all income to Bill. Pauline no longer has any control over the income or capital of the trust.
Scenario 2
Six years after the trust is established, the trust has significant assets, and Bill and Pauline separate. Shortly after separating, Bill dies. Pauline is now the sole appointor and controls the trust.
TRUST TIP – Pedigree Trust limitation on appointors
Spouses of most capital beneficiaries are precluded from being appointors of a Pedigree Trust.
Consideration needs to be given to the following points when deciding on an appointor:
EXAMPLE – Bankruptcy and divorce
Scenario 3 – Bankruptcy
If a sole appointor, who was also a beneficiary of the trust, was made bankrupt, the trustee in bankruptcy may try to argue that the power of appointment is “property” which vests in him. If successful, the trustee in bankruptcy could then appropriate and exercise that power of appointment to replace the trustee of the trust with himself. Consequently, all the income and capital could be distributed to the bankrupt beneficiary to pay all his creditors. The current state of the law is that the power of appointment is not “property” and so does not vest in the trustee in bankruptcy, but this could change (and a trust may incur significant costs defending such a claim, even if it is not successful).
Scenario 4 – Divorce
It is possible the Family Court could order an appointor to replace the trustee with the Family Court Registrar. The Registrar could then distribute the assets to the husband or wife. Although it is not clear whether the Family Court could take such action (although it does have very broad powers), it is best not to provide it with such an opportunity.
Provided Donald considers all four beneficiaries in light of his duties, he will not breach his duty if he then exercises his discretionary power and decides to distribute all of the income to Daisy.
The trust fund is all the property of the trust including the settled sum, income accumulated and any other money and property held by the trustee pursuant to the terms of the trust
The beneficiaries are the people (including other entities, such as companies) for whose benefit the trustee holds the property. As mentioned previously, a person to whom the trustee can distribute income or corpus (capital) is a potential beneficiary. A potential beneficiary becomes a beneficiary on the distribution of (i.e., on the exercise of the trustee’s discretion to distribute) the income or capital of the trust.
There are different types of beneficiaries of a Pedigree Trust, including the:
TRUST WARNING – Resettlement risk
Care should be taken when a major restructure of the beneficiaries is proposed. The risk is that such a change could mean the trust becomes an entirely new trust – triggering capital gains tax (CGT) and/or stamp duty consequences.
Listed below are some common traps which may be exposed on an ATO audit (and other dangers):
EXAMPLE – Shares in ‘bucket company’ held by primary beneficiary
Jason owns shares in a corporate beneficiary that has received or is entitled to receive large distributions from a discretionary trust. Unexpectedly, Jason goes bankrupt. The trustee in bankruptcy calls in all of Jason’s assets – one of which is the shares he owns in the corporate beneficiary. This is not a good result.
Since the assets of a trust are not owned by any one beneficiary, the beneficiaries cannot deal with those assets or pass them on their descendants by their wills. However, if careful consideration is given to who is and will be the appointor(s) of the trust, control of the trust may be effectively passed to the next generation.
TRUST TIP – Succession planning
An obvious way to pass control of the trust to the next generation is for the trust deed to provide that, following the death of the original appointors of the trust, their children will become the appointors. This will mean that, upon their parents’ death, these children will obtain control of the trust (and the trust assets), in the same way that they could obtain other assets directly owned by their parents and passed by will.
The following are some of the features of the Pedigree Trust Deed. However, the deed should be read in full to fully ascertain the relationship between the trustee(s) and the beneficiaries.
These instructions should be followed in numerical order:
(a) if the trustee (or trustees) are natural persons (or any of them are), they should then sign each copy of the deed where indicated in the presence of an independent adult witness, who should then also sign the deeds; or
(b) if the trustee is a company (or any of them are, if there is more than one trustee), the company will need to resolve to accept appointment as trustee of the trust before executing the deed. Therefore, the resolution of the director or directors of the company accepting the appointment should be signed and dated and, once this is done, the company can then execute the deed according to its constitution (i.e., with the requisite number of directors and/or secretaries signing the deed, accompanied by an imprint of the common seal of the company, if the company has one and is required to execute documents with it).
This guide is intended to be a guide only. You should not act solely on the basis of the information contained in this Guide because many aspects of the material have been generalised and the tax laws apply differently to different people in different circumstances. Further, as tax and other laws change frequently, there may have been changes to the law since the Guide was written.
Australian Business Structures Pty Ltd, its directors, employees, consultants and author expressly disclaim any and all liability to any person, whether a purchaser or not, for the consequences of anything done or omitted to be done by any such person relying on a part or the whole of the contents of this publication.
None of the comments in this Guide are intended to be advice, whether legal, professional or financial. Do not act on the information contained in this Guide without first obtaining specific advice regarding your particular circumstances from a tax or legal professional.
© 2021 Australian Business Structures Pty Ltd.
All rights reserved. Except as permitted by the Copyright Act 1968, no part of this Guide may be reproduced or published in any form or by any means, electronic or mechanical (including photocopying, recording, or by information storage or retrieval system) without prior written permission from Australian Business Structures Pty Ltd.
The law is as stated 1 January 2018.
Because it’s a jungle out there