Trusts can be very powerful tools, but their creation and structure need to be considered carefully.
A trust is essentially a structure in which a person or a company agrees to hold an asset for the benefit of others. This means that the legal and beneficial owners are separated, that is, someone (the “trustee)” is responsible for managing assets and distributing income to others (the “beneficiaries”). The concept of trusts has a very long history, originating in 12th century English law.
They are many types of trusts, used for a variety of reasons, from domestic to commercial contexts.
A discretionary trust is a type of trust where the beneficiaries have no fixed interest in the assets. Whether or not a particular person can benefit under the trust is entirely discretionary to the trustee.
Trusts that are created during a person’s lifetime are known as inter-vivos trusts, whereas those that are created through a Will are called testamentary trusts. There are not many differences between the two in practical terms, but there are some differences in taxation of beneficiaries.
Family trusts set up as discretionary trusts for holding a family’s assets or to conduct a family business are popular in Australia. Generally, they are established for asset protection or income tax planning purposes. In a family trust, the beneficiaries are linked via family relationships. The law defines what constitutes a family relationship.
A legal document called a ‘trust deed’ will formally set up the family trust. It will name the trustees, list the beneficiaries, and state various rules for the administration and management of the trust. The trust deed needs to be very carefully written, preferably by a lawyer.
Income tax planning
Generally, the net income of a trust is taxed in the hands of the beneficiaries. Distributions received from a trust are not a special form of income, but instead form part of a beneficiary’s assessable income. If the beneficiary receives income from other sources in addition to distributions from the trust (eg salary or wages), all of the income will be taxed together at the beneficiary’s marginal rate.
One advantage of a family trust is that income generated by the trust from investments (including capital gains) can be distributed to beneficiaries in lower tax brackets. This reduces tax liabilities. If the trust beneficiaries are in the highest tax bracket, there will be no tax advantage.
If income is not distributed fully, then it will accumulate in the trust, and be taxed at the top marginal rate. This provides a strong incentive for family trusts to fully distribute the trust’s income before the end of each financial year.
Taxation for minors
As mentioned above, adult beneficiaries pay tax on their share of the trust’s net income at the tax rates that apply to them.
Higher rates of tax apply to most trust distributions to minors. This is not the case for a testamentary trust, that is, one which is created through a Will. The current tax rates applying to a family trust beneficiary who is a minor are shown in the table below:
|Income||Tax rates for 2018-2019 income year|
|$0 – $416||Nil|
|$417 – $1,307||Nil plus 66% of the excess over $416|
|Over $1,307||45% of the total amount of income|
Whilst there is some opportunity to reduce tax liability through income splitting, the benefits of doing so are possibly not as great as many perceive them to be. Income splitting is most useful where the trust has low-income or adult beneficiaries who are in lower tax brackets, such as adult children who are studying or older parents who are retired.
Family trusts are popular structures for protecting assets from potential bankruptcy or business failure. Because the assets of the trust belong to the trustee, and not the individual beneficiaries, they cannot generally be used to pay the creditors of individual beneficiaries. An exception to this is if assets were contributed to the trust with the intention of defeating creditors.
They may also be used for protecting family assets from future marriage breakdowns. In the event of a family law property settlement, assets held in a family trust may have a higher likelihood of being excluded from a property settlement than assets held directly by an individual.
Holding assets in a family trust can also assist in avoiding challenges to a Will since any assets held in the family trust will not form part of a deceased estate. Retaining assets within a family group can also be a motivator for holding assets in a trust, for example, a family farm.
It is critical that the trust is structured correctly to maximise asset protection.
Protecting vulnerable family members
Family trusts can be beneficial for protecting vulnerable beneficiaries who may make unwise spending decisions if they controlled assets in their own name. For example, a family member with mental health issues, or a gambling/alcohol addiction can have access to income but no access to a large capital sum that could be quickly spent.
The Costs Associated with a Family Trust
The cost of establishing a family trust is generally $1,000 to $2,000 depending on the structure used. Costs include the cost of the deed, the cost of a corporate trustee and cost to obtain an ABN and tax file number. Maintaining a typical family trust may cost a further $1,500 to $2,500 in accountancy fees each year, plus a yearly filing fee and fees required for the preparation of an annual tax return for the trust.
Trusts are not simple instruments and there are many issues to be aware of in establishing one. Choosing an appropriate trustee/s is important and you should specify the powers that they have. You may want the trustees to have different areas of expertise.
In amongst all of this is also the consideration of ensuring any asset protection (including gifting property to a trust) is not done with the specific intention of defeating creditors, in which case it could be clawed back into your assets pool at any time.
We are not lawyers, but this area is an important part of your asset protection and structuring planning so we always take this into account when reviewing your affairs and involve lawyers if need be.
Trusts are very powerful tools, but their creation and structure need to be considered carefully. Professional advice is very important to ensure they are established and maintained in a way that serves the family’s needs.