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The nuts and bolts of family trusts

According to the Australian Financial Review:

“…the Australian Taxation Office estimates that there are well over 800,000 Family Trusts in Australia, controlling more than $3 trillion of assets.”

The term ‘family trust’ can be somewhat loosely used at times. Strictly speaking, family trusts are a subset of the wider class of ‘discretionary trusts’ being trusts in which the trust administrator, the trustee, generally has a wide discretion to distribute trust income and capital amongst a wide class of beneficiaries.

This article explores some aspects of the legal effect, and consequent commercial benefits that family trusts can offer. Given the scope of the subject matter:

  • this article is a ‘grab bag’ of considerations that readers may find useful when considering whether family trusts might have a place in their individual investment strategies; and
  • it is recommended that any decision to use family trusts be accompanied with bespoke legal, accounting and financial advice.

Why are family trusts so popular?

John D. Rockefeller, the American businessman and philanthropist is quoted as saying:

“own nothing, but control everything”.

That sentiment is at the heart of the structure of most family trusts and one of the reasons that they are so widely used. Trusts create an opportunity to separate legal control and beneficial ownership - so that effectively one entity or person can control an asset for the benefit of another entity, person or class.

Legal framework of trusts

A trust is not a legal person like a company or an incorporated association.[1] Trusts can be understood in terms of the relationships that they create between the legal owner of assets and the beneficial owner of assets:

“…a trust exists when the owner of a legal or equitable interest in property is bound by an obligation recognised by and enforced in equity to hold that interest for the benefit of others. or for some object or purpose permitted by law.”[2]

Independent of the legalese, family trusts effectively split ownership and control in property between trustee and beneficiaries.

An interest in property has been described as consisting of a “bundle of rights”.[3] Family trusts effectively split that bundle and divide those rights between a trustee on the one hand and beneficiaries on the other. The way that the split occurs in a particular case will depend on the terms of the trust in question.

The nuts and bolts of family trusts

Trustee

The trustee is a person or company who administers the family trust on a day-to-day basis in accordance with the terms of the relevant trust deed. The trustee is responsible for the trust assets, and generally has broad powers to conduct the trust and manage its assets.

Family trusts are also known as ‘discretionary’ trusts which means that the trustee will be generally given choices about some aspects of the administration of the trust such as:

  • who the income is distributed to
  • whether any capital distributions are to be made
  • how the trust funds are to be invested
  • whether the trust should borrow or lend funds and on what terms
  • when the trust will end

The Appointor/Principal/Guardian

This person or entity has the ultimate power to control a family trust because they have the power to remove the trustee and appoint a replacement trustee. Sometimes, depending on the terms of the trust, their consent is also required before the trustee may take certain actions in respect to the trust.

Beneficiaries

The beneficiaries of a family trust can be persons, companies, other trusts or charities. They are usually the wider family of the ultimate trust controller. The relevant trust deed will define the class of possible beneficiaries who may benefit from the family trust from time to time.

Trust assets

Family trust assets may include personal property, real property or both.

Advantages of family trusts

Taxation benefits of using trusts

The flexibility of trusts may allow a trustee to allocate future income between a class of beneficiaries in a flexible and tax effective manner.

Trusts are taxed pursuant to Division 6 of Part III of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).

As a general proposition and ignoring beneficiaries that may be under a legal disability, it is a basic premise of trust taxation that a beneficiary presently entitled to a share of trust income is responsible to pay tax on that income to the extent of that entitlement.

In each financial year tax will be payable by each of the beneficiaries presently entitled to a share of the trust income during that financial year, on those respective shares, at their relevant marginal tax-rates. Any undistributed income will generally be taxed:

  • In the hands of a trustee at ordinary progressive marginal tax-rates after the tax-free threshold (for testamentary trusts if the Commissioner’s discretion is exercised), or
  • At the highest marginal tax rates applicable to trustees generally.

Accordingly, trusts provide an ability to split income between several beneficiaries, and the consequent opportunities for family trust controllers to potentially achieve beneficial tax outcomes depending on the circumstances.

Asset protection benefits of using trusts

Family trusts can offer protection against insolvency of a trustee, beneficiary, or appointor.

  • Property held by a bankrupt as trustee of a trust is not property “divisible amongst creditors”.
  • The power of an Appointor of a trust to appoint or remove trustees has been held to not be property that vests in the trustee in bankruptcy, and it has been held that the power of appointment is not one contemplated under section 116 of the Bankruptcy Act 1966 (Cth).
  • The trustee in bankruptcy is in no different position than the bankrupt beneficiary, insofar as trust entitlements are concerned, and would not be able to require the trustee to distribute trust assets unless a beneficiary has a fixed entitlement to trust assets or income. This proposition is confirmed in case law.

Assets held by a family trust may not be susceptible to a claim made against an insolvent family trust controller depending on the circumstances.

Disadvantages of using Family trusts

Some disadvantages of family trusts include:

  • ongoing administrative costs, which need to be justified relative to the benefits that are likely to be achieved
  • increased complexity in financial structure
  • notwithstanding the articulated tax benefits, the taxation of trusts is complicated, and some aspects are, to a degree, uncertain[4]

Family trusts and estate planning

The death or incapacity of family trust controllers changes a family dynamic and may change a family trust power division dynamic but will often not bring a family trust to an end.

The ability of trusts to be able survive the passing of (or loss of capacity of) a trust controller creates both opportunities and complexities when addressing succession of control issues that arise in estate planning.

When estate planning, family trust controllers need, in addition to executing a will to deal with estate assets, to make provision for the succession of family trust control.

Case study

The following case study demonstrates one way in which a family trust can create a bespoke estate planning outcome.

Simone needs to update her Will. She is married to Leonard. It is a second marriage for each of them - Simone has three adult children from an earlier relationship, and Leonard has no children - and whilst Simone and Leonard are close, Leonard and her children don’t get on.

Simone has about $1 million in assets in a family trust, a home that she owns jointly with Leonard and various bank accounts of minimal value.

She desires Leonard to inherit the home and bank accounts and her children to inherit the trust assets.

Simone executes documents appointing her children as successor controllers of the Trust and executes a Will appointing Leonard as executor and distributing her bank accounts to him.

On her death, after the funeral, there is no necessity for Leonard and the children to interact.

Conclusion

Family trusts can offer many commercial benefits and are therefore attractive financial entities to many investors. An assessment of those benefits, however, must be tempered with an appreciation of the complexity of family trust administration and the challenges associated with succession of trust control when estate planning.

As with other aspects of commercial life, specific and expert legal, accounting, and financial advice is recommended when considering using family trusts within a financial structure, so that benefits can be maximised and pitfalls avoided.

 

Greg Russo is a succession law specialist and principal of Greg Russo Law.

Disclaimer

The information given by Greg Russo and Greg Russo Law in this article is given in good faith but is of a general nature only and it is not intended that this article will be acted or relied upon in the absence of individual legal, advice. Each person's requirements and circumstances will be different and accordingly, each person should engage professional assistance according to their own particular needs. Copyright in this document is owned by Greg Russo Law.

 

[1] Although for some purposes a trust is “deemed” to be a legal entity – e.g., for taxation purposes in Division 6 of the Income Tax Assessment Act 1936 (Cth).
[2] Jacobs” Law of Trusts in Australia, 8th Edition, LexisNexis, page 1.
[3] See for example Yanner v Eaton (1999) 201 CLR 351, and  Brendan Edgeworth, Chris Rossiter, Pamela O'Connor, Andrew Godwin, Leon Terrill, Sackville and Neave Australian Property Law, 11th Edition, LexisNexis.
[4] See for example the ATO’s preparedness to address the administration of testamentary trusts in accordance with the practices set out in PSLA 2003/12.  Ultimately however that practice statement does not have the force of legislation but is an administrative statement to provide guidance to ATO staff.

 

24 Comments
Derek R
October 30, 2024

I'm amazed there hasn't been a class action against Centrelink's interpretation of Trust Law. How can the ATO have a different interpretation to beneficial ownership to that of Centrelink. Another Robodebt debacle, or the fraud of using deeming interest rate higher than the official cash rate. Pension aged people are transferring, spending up or using trusts to minimise wealth, in order to get the MASSIVE pensioner benefits. To get interest equivalent to the $25,000 pa pension I'd need over $1m in cash. NO life long tax paying middle class Australian senior has that. The Government is encouraging us to become loser in order to win.

Greg Russo
October 20, 2024

Hi everyone

Thank you for all of the comments and for the interesting discussion so far...
I am currently working on new trust articles for Firstlinks.
Please let me know if any areas are of particular interest.

Greg Russo

Sanjiv Jain
October 21, 2024

Hi Greg

Thanks for the very clear explanations. Would you be doing a separate article on Testamentary trusts that are included in the Wills and to avoid any pitfalls.

Greg Russo
October 22, 2024

Hi Sanjiv

Thank you for your comments.
Yes, I can do a separate article on testamentay trusts.
Watch this space!

Justin Hockley
November 04, 2024

Hi Greg
Some words around what S100a actually means in terms of normal family dealings and is there a generic financial limit that might be applied go this type of motherhood statement. And dome working examples would be a real plus

Wildcat
October 20, 2024

One thing not mentioned in the article that is also relevant is the law of perpetuities.

South Australia aside which has yet to be tested by a court, a trust cannot exist for more than 80 years unless it is a Charitable trust (I think the exemption exists but not 100%).

Once you hit 80 years (which probably won't be your problem) the trust will vest. This will cause an effective liquidation of all assets with the requisite CGT implications of disposal in one year. Therefore older trusts approaching 80 years need a lot of work done on them. You also need to wary of wacky deeds, eg 10 years after the death of King George's last issue or other such nonsense. This can bring the vesting date inside the 80years and if you aren't careful have a massive tax problem that you haven't properly planned for.

Lastly the $3T value must be understated. Almost every trust accounts I have ever seen hold everything at book value. Especially businesses can be worth x10 - x100 or more than the book value.

Greg Russo
October 20, 2024

Hi Wildcat
Thank you for your comments - all very valid points!
You’re correct – I didn’t mention the perpetuity period in my article or its relevance to trust administration. In South Australia Trusts can exist in perpetuity. In other States, Trusts can exist for the "perpetuity period" - generally for up to 80 years – and now 125 years in Queensland – or for the relevant common law (your wacky deed) period.

However, the provisions of the relevant trust deed may nominate an earlier vesting date. One of the first things that I do as an advisor is to identify the maximum ending date of the trust - as the lifespan of a particular trust is one of the critical factors that needs to be taken into account when making decisions regarding trust administration.

You also correctly point out that the vesting of a trust has consequences - although the extent of those consequences (including taxation consequences) will depend upon the specific circumstances.

...and finally, a careful scrutiny of trust financials with the trust accountant is often warranted.

Trusts remain extremely useful, but the complexity that they invite needs to be managed.

Thanks again for your comments
All the best,
Greg Russo



SMSF Trustee
October 18, 2024

And of course everyone should realise that it's the law of Trusts that enables and dictates the operation of all superannuation funds, including self-managed super funds. The assets are held in a Trust that is to be managed in accordance with the Trust deed for the purposes of the Trust (in super this is for retirement income and capital preservation beyond the payment of income).
In the light of which, all that 'purpose of superannuation' stuff a couple of years ago never made any sense to me. The purpose has always been pretty clear under Trust law!

Greg Russo
October 20, 2024

Hi SMSF Trustee,

Thank you for your comments.

You are 100% correct - SMSFs are really just discretionary trusts with legislative (and trust deed) imposed limitations (on trust purpose, trust administration, and beneficial entitlement) - but they are governed, fiundamentally by trust law.

SMSF succession is also governed by trust law, and even though there are "standard" pathways for succession (binding nominations etc...) any anomalies will be dealt with using trust law.

The requirment of a strict and clearly articulated "trust purpose" is partly to attract the preferential tax treatment that SMSF compliance generates.

Thanks again for your comments

Greg Russo

Disgruntled
October 18, 2024

A guy I work with says his grandfather set up a blind trust and he has money coming to him.

He will be 58 next year and it has been over 25 years since his grandfather died.

There is either no money or the controller of the trust has stolen the money.

Greg Russo
October 20, 2024

Hi Disgruntled

Thank you for your comments.

A blind trust is a type of trust in which the person who sets up the trust and the beneficiary have no control over, involvement in the administration of, or knowledge of the assets in the trust once it is set up.

Blind trusts are designed to eliminate conflicts of interest...but in my experience they are not common - your colleague's experience is an example of why.

If your colleagie hasn't done so already, obtaining bespoke legal advice may assist.

Thanks again for your comments

Greg Russo

Jon Kalkman
October 17, 2024

A trust’s facility of splitting ownership from control, used to make trusts very popular with retirees as a way of masking asset ownership when it came to the assets test for Centrelink benefits.
Since 2002, the law gives Centrelink the power to look into a trust and if you are either the donor of the trust assets or the trust controller or a beneficiary of the trust income, ALL the assets in the trust are assessed as yours for the assets test.
That makes estate planning for an adult disabled son or daughter much more complicated, if they are in receipt of a disability support pension.

William
October 17, 2024

Hi Jon (and any others that may wish to comment)
I am looking into setting up a testamentary trust as part of my estate planning, and am very concerned about how centrelink may treat the assets in the hands of the beneficiaries of my estate

I am thinking of making a condition of the trust deed that the "principle beneficiary" (or indeed any beneficiary) of the trust I create is made an "ineligible person" to get any benefit from the trust or control any trust (eg make them ineligible to be the trustee or the appointor of a trust) if they are completing any government form. In that way, they can honestly answer a question on any such form such as "are you a beneficiary or controller of any trust?" with a NO.

My alternative approach would be to set them up with two trusts as part of my will. The first trust has almost all of the wealth they inherit, but has a condition that the maximum that they can obtain by distribution from the trust is $1000pa. The second trust would have (say) $10000 of assets. I would be setting up sets of two trusts for each of my children and adult grandchildren. Then a clause slipped into the trust somewhere that says "any trust created by this will is a beneficiary of any other trust created by this will" - in so doing, two possible ways of letting the beneficiaries have access to the assets would arise - firstly, by distributing from the large trust to the small trust just enough for them to live on, or alternatively getting the kids to co-operate - one kid gives their sibling (say) $100000 distribution and the first kid distributes $100k to the other back. Then, using the discretionary powers, the kid wanting centrelink can honestly say that the distribution from the sibling last year doesn't mean they are going to get anything this year

Would either of these work????

Jon Kalkman
October 18, 2024

William, I suggest you seek your own legal advice, but from first principles, a discretionary trust means that the beneficiaries have no control over what happens. The trustee has absolute discretion to pay all of the income to one beneficiary or none at. So you can’t place restrictions on beneficiaries. And because a beneficiary is able to receive all the trust income, Centrelink can assume they are no longer eligible for a pension.
If you place restrictions on the trustee, the trust is no longer a discretionary trust.
The only way to avoid this complication is to completely exclude the adult son or daughter with a disability from the family trust and make separate arrangements for them. One alternative worthy of serious consideration is a Special Disability Trust which has special conditions but also generous concessions.

Rob
October 20, 2024

William - clearly take your own advice but facing the same issue of Testamentary Trusts the decision was to make them "optional" rather than "compulsory" to give Trustees and Beneficiaries as much flexibility as possible. [With an overseas based son, it would give him time to relocate back to Australia and avoid Inheritance tax!] The specific clause reads:

"...Rather than holding the interests and/or shares of any beneficiary on one separate trust as hereinbefore provided, my Trustees may with the consent of that beneficiary transfer any part or the whole of any interest or share of that beneficiary to him or her absolutely and where a beneficiary is not sui juris in the opinion of my Trustees then they may in their absolute discretion transfer any part or the whole of the interest or share of that beneficiary to any person or persons who are in the opinion of my Trustees the guardians (whether formally appointed or not) of that beneficiary......"

Being too prescriptive can be a mistake. In an ideal world families are all close and trust each other but money and blended families can test that theory!

Greg Russo
October 20, 2024

Hi William,

Thank you for your comment - and Jon and Rob thank you for your responses

Underover of endosing the recommendation that you obtain individual advice....

Testamentary trusts are trusts created by a Will – but otherwise have a lot in common with family trusts insofar as Centrelink’s treatment, and the beneficial entitlements they provide, are concerned.

A focus at the trust drafting stage on the specifics of your situation is likely to be the most effective approach to address future Centrelink assessment.

Depending on your circumstances the drafting of your testamentary trust may include:

• Providing the trustee with the power to exclude beneficiaries - so that particular beneficiaries won't need to disclose the existence of the trust to Centrelink in the future;
• Incorporating limitations on trustee discretions and beneficiary entitlements in the trust provisions (in the Will). Family trusts are not “one size fits all” and this is particularly true when it comes to trustee power and beneficial entitlements.
• The incorporation of a process where the use of the trust is optional is fairly common in testamentary trusts and depending on the circumstances may be an additional tool to address future Centrelink scrutiny
• As has been mentioned in this in earlier posts the availability of special disability trusts should also be considered

Good luck and thank you again for your comments

All the best

Greg Russo

John B
October 18, 2024

Hi Jon if you have a disabled child you could consider a special disability trust. Get advice specific to youe circumstances. John B

Greg Russo
October 20, 2024

Hi Jon

Thank you for your comments.

You’re absolutely correct. While it is still possible to utilise trusts to estate plan for disabled beneficiaries, the way that the Centrelink trust tests work create planning challenges.

The availability of special disability trusts can be a partial answer in some cases, and so too can focusing on the transfer and management of exempt assets such as principal places of residence.

I have found that in most cases a collaborative approach focusing on the legal, accounting, and financial aspects of a particular case can generally reap some positive outcomes.

Thanks again for your comments.

All the best,

Greg Russo

Jordan
October 17, 2024

Hi Greg,

Great overview. What are the risks from government changes to family trusts in future, and are there ways to mitigate these risks?

Graham W
October 18, 2024

Hi Jordan, the law around the validity of Trusts, including so called Family Trusts goes back many centuries. So, there is little that a government could do legislatively to make them invalid. In the early 1980"s they did reduce the amount a child could receive before paying tax to $416. This has not changed in the ensuing forty or so years. I would propose that no government has the will to change the validity of trusts, it would be a vote loser similar to the taxing of the family home.

Greg Russo
October 20, 2024

Hi Graham W

Thank you ofr your comments

It's worth noting that the restriction that you have highlighted in relation to distributions of income to minors from family trusts does not currently apply to distributions from testamentary trusts provided certain conditions are met.

Greg Russo

Wildcat
October 20, 2024

Anything is up for change, including trusts. The problem is multifold for the government to materially change trusts.

Firstly much of trust activities are controlled by the deed, these are all different. Legislating this is worse than herding cats due to inherent complexities and blunt legislation really hurting some people.

Secondly many, potentially most, small businesses that aren't sole traders are in trusts. It would be an assault on small business. When Shorten looked at this a few years ago his proposals would have killed mum and pop shops (increased taxation) in trusts but left the very wealthy unaffected. The opposite of what the outcome he said he was seeking.

Thirdly trust law is about is about 600 years old or so. They would leave this alone and just go for taxation matters only I would expect. If they did, can't imagine it would be worse than personal MTR's.

Lastly, almost all politicians have trusts and as they say, there's no interest like self interest. :-).

You can't really mitigate legislative risk unless you emigrate permanently and cease to be Australian Tax Resident.

Jon Kalkman
October 20, 2024

At present, a trust doesn’t pay any tax but beneficiaries pay tax on the any distribution they receive at their marginal tax rate. The Labor government keeps threatening to tax trusts like companies. That would mean requiring the trust to pay tax before any distribution.

But if we are to avoid double taxation on that trust income, those beneficiaries would need to be given a credit for that prepaid tax - just like with companies. Each beneficiary would need to add that tax credit to their taxable income and then claim that credit back from their own personal tax payable - just like with companies. That is how franking credits work. The result would be that beneficiaries pay tax on their original trust distribution at their marginal tax rate - just like they do now.

It is true that beneficiaries in foreign jurisdictions would have tax extracted before they receive their distribution, but that is not the problem they claim they are trying to solve. The problem is that a trust can have many beneficiaries, each able to claim a tax-free allowance, thereby minimising the total tax paid on the trust distribution, but taxing trusts like companies won’t change that.

Changing the tax arrangement for trusts seems like a high political cost for minuscule fiscal gain. Maybe that explains why the party that eschews shares thinks this is a good idea until it is explained to them.

Greg Russo
October 20, 2024

Hi Jordan

Thank you for your feedback and for your comment.

Great question!

There is always a risk that the legislative and policy environment within which a trust may operate in the future can change due to government intervention.

We have seen this a lot over the past few years in respect of SMSF's.

In my view, the best way to mitigate against the risks resulting from government changes to trust law is:

• to review your trust deeds regularly; and
• to incorporate at the drafting stage (or within an allowable variation) sufficiently broad trustee powers to enable the trustee to respond appropriately to changes that may occur in the future

Thank you again for your comment.

All the best,

Greg Russo

 

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