Discretionary and Family Trusts
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). The terms of the obligation are defined by the terms of the relevant Trust Deed. A trust is not a separate legal entity even though a trust tax return will be required to be lodged with the Australian Taxation Office each year. The Trustee is the legal owner of the trust property and the beneficiaries hold the beneficial interest in the trust property.
A discretionary trust is a common form of trust, often used in tax and asset protection planning, in which Trustees can freely distribute trust income and assets to beneficiaries named in the Deed.
A discretionary trust is where the beneficiaries do not have a fixed entitlement or interest in the trust funds. The trustee has the discretion to determine which of the beneficiaries are to receive the capital and income of the trust and how much (if any) ach beneficiary is to receive. The trustee does not have a complete discretion. The trustee can only distribute to beneficiaries within a nominated class as set out in the terms of the trust deed.
A discretionary trust usually has a wide range of beneficiaries, including family members, companies and other trusts. The beneficiaries of a discretionary trust do not have an interest in the assets of the trust. They merely have a right to be considered when the trustee exercises its discretion to make a distribution.
The law imposes upon a Trustee a duty to act in good faith for the benefit of beneficiaries named in the Trust Deed establishing the trust. The Trustee must administer the trust in accordance with the terms, conditions and powers enumerated in the Trust Deed and implied by law. Provided that a Trustee acts in accordance with the terms, conditions and powers contained in the Trust Deed and any other laws, it will be protected from any liability in respect of those actions or any claim by any beneficiary, despite the result of those actions.
All decisions of the Trustee, if a company, in relation to the trust should be made at a meeting of the directors of the Trustee properly constituted in accordance with the provisions of the Trustee’s constitution. Proper minutes of each such meeting of the directors of the Trustee should be kept. Similarly, proper accounting records should be maintained by the Trustee.
The major advantage, particularly in the case of a discretionary trust, is the ability to split income amongst the pool of beneficiaries. A benefit can be obtained by directing income to members of the family with low marginal income tax rates. The Trust Deed allows the Trustee various alternatives in relation to the net trust income earned in each financial year. Some alternatives, and some of the taxation ramifications of each of them, are as follows:
The Trustee may distribute the net trust income amongst the beneficiaries or any one or more of them in such proportions as it determines at a meeting of the directors of the Trustee. All the trust income can be distributed to one beneficiary to the exclusion of others, the income can be distributed equally, or it can be distributed disproportionately. If the whole of the trust income is distributed to adult beneficiaries, the amount received by each beneficiary is taxable in the hands of the recipient as an addition to the total income of that recipient.
Tax on income held on trust for or applied for the benefit of beneficiaries under the age of 18 is in effect paid by the Trustee on behalf of the beneficiary as if it were the income of an individual. Special provisions apply where the infant beneficiary has income from other sources. Special rates of tax apply to income held, applied or distributed to beneficiaries under the age of 18.
The Trustee may determine in a particular year not to distribute any proportion of the net income of the trust but to accumulate that income as an addition to the Trust Fund. In these circumstances, the Trustee is liable to pay tax (from the trust fund) on the net income of the trust at the highest personal rate. In exceptional circumstances, the Commissioner has a discretion not to apply the highest rate to accumulated trust income.
The Trustee may decide to distribute part of the net trust income and to accumulate the balance of that income. In these circumstances, the amounts received by beneficiaries would be taxable in their hands in the manner set out in paragraph 1 or 2 above and the balance retained by the Trustee and accumulated would be taxable in the Trustee’s hands in the manner set out in paragraph 3 above.
In the absence of any written determination by the Trustee to distribute or accumulate the net trust income in a particular year, that income is accumulated automatically as an addition to the Trust Fund and the tax consequences outlined in paragraph 3 will apply.
With the introduction of capital gains tax, careful consideration will need to be given to the consequences for the trust of various types of transactions which may give rise to a taxable capital gain. If the Trustee sells a trust asset and realises a gain on the disposal, the gain will be included in the assessable income of the Trust to be distributed or accumulated as any other income. Capital losses may be subtracted from the gain before a net amount is included as assessable income of the Trust.
A distribution to a beneficiary need not entail a physical payment of the amount distributed to the beneficiary. If the Trustee wishes to retain the money which it has decided to distribute to a particular adult beneficiary it may, with the consent of the beneficiary, establish a loan account in the books of the trust in the name of that beneficiary and credit the amount of the distribution to that loan account.
Trusts can be very useful tools for asset protection and tax planning so the advice of a lawyer, accountant and/or financial planner should be sought before undertaking any dealings in relation to them.