Mobbs and Marr

Family Discretionary Trust Fact Sheet

Family Discretionary Trust Fact Sheet

This Fact Sheet has been prepared to be read in conjunction with your draft family discretionary trust deed.

The trust relationship

A discretionary trust in the nature of the draft provided allows for:

  1. Control of the trust property without beneficial ownership of it; and
  2. Provides a unique degree of flexibility in deciding who should benefit from income earned and from capital gains.

How is the trust defined?

The trust relationship comprises of:

  1. The settlor (this is the person responsible for establishing the trust. Once the trust has been established, the settlor does not have further involvement in the trust);
  2. The beneficiaries (these are the persons who might benefit (either from the income or capital or both income and capital of the trust fund) from time to time during the term of the trust;
  3. The appointor (this is the person who is responsible for overseeing trustees with power of consent and dismissal); and
  4. The trustee (this is the person who is responsible for overseeing the administration of the trust fund).

Persons who might benefit from time to time during the term of the trust (beneficiaries) should be determined at the time when the trust is created. While beneficiaries may be added or removed during the life of the trust, transfer duty considerations should be taken into account before the trustee uses the power to add or remove a beneficiary.

Together, the roles of the various parties form the trust relationship.

Why establish a discretionary trust?

A discretionary trust is most suited to a family situation. A business relationship will require a greater degree of certainty and security in financial dealings affecting trust property.

Discretionary trusts have commercial advantages not only in allowing for changes of, or choosing between, a range of beneficiaries, but in the provisions of the Corporations Act 2001 (Cth) generally not applying. However, s 197 of the Act makes directors of a trustee corporation liable for debts and other obligations incurred by the trustee in certain circumstances.

One of the benefits of the Corporations Act generally not applying to the operation of a discretionary trust is that persons entitled to receive moneys from the trust, and the financial affairs of the trust, need not be disclosed on public records. Whilst proper accounts must be kept, necessity for audit can be made optional and winding up the trust is a relatively simple procedure.

Taxation

A discretionary trust can result in taxation benefits and if properly implemented should not come within the general anti-avoidance provisions of the Income Tax Assessment Act 1936 (Cth). Distributions of income can be made to corporate beneficiaries or individuals on lower marginal tax rates although special provisions apply to distributions of income to minors. However, if there are tax losses or shares which have been acquired by the trustee of the family trust after 31 December 1997 carrying imputation credits, it may be necessary for the trustee of the family trust to make a “family trust election”. This election can be made notwithstanding the terms of the trust deed and, in particular, the definition of “beneficiaries”. The effect of making a family trust election may be to restrict the ability of the trustee of the trust to tax effectively distribute income to beneficiaries of the trust. In particular, if a “family trust election” is made by the trustee, income distributions are effectively restricted to a tightly defined family group of two generations with income distributions made to persons outside of that group being taxed at the top marginal rate of tax. Once made, the election is generally irrevocable. An election should not be made without first seeking professional taxation advice.

Discretionary trusts may have capital gains tax advantages over companies — especially in regard to individual beneficiaries being able to claim the general discount capital gain. The precedent trust deed contains provision to separate various kinds of income or capital to which special taxation treatment is attached. The separation also requires timely and appropriate resolutions to be made. As taxation laws and the Commissioner’s views are continually changing and individual circumstances may dictate special treatment, up to date and specific advice will need to be obtained in considering the taxation aspects of discretionary trusts.

Discretionary trusts (and many unit trusts) may be adversely treated for land tax purposes if the trust is proposed to hold land in New South Wales.

Asset protection

A discretionary trust may also play a significant part in an asset protection strategy. There are limitations arising under the Family Law Act 1975 (Cth) and from changes to bankruptcy laws as to the protection that is offered.  For this purpose, it would be unwise to have the person at risk being the trustee or able to control the corporate trustee or its identity (via shareholding or directorship or as sole or surviving appointer). However, such protective steps also raise risks of loss of control in other situations (eg divorce). In addition, once control is lost (eg the client only has a minority, if any, shares in the corporate trustee), it will be difficult to deal with this “asset” for estate planning purposes. Accordingly, the more control that the “at risk” individual has over the operation and management of the trust, the more risk there is of a dilution in the asset protection that the trust may afford the individual.

As proprietary companies may operate with a sole director, sole shareholder or both, the trust deed provides for the prospect of a trustee company that has a sole director who is also the sole shareholder and that person is a beneficiary of the trust.

Estate planning

Estate planning issues (including the identity of the appointor on death and ownership of the shares in a corporate trustee) should be considered prior to making the decision about the appointment to such roles.

If you have any questions about the terms of the trust, please contact us to discuss.

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