What is a trust?
Trusts are not separate legal entities but is a relationship where a person or company known as the Trustee has the legal obligation to handle property owned by the Trust for the benefit of persons known as the Beneficiaries. The requirements for a Trust involve intention to create a Trust which is defined in specific terms, the subject matter set out which can be established with a settlement sum and the objects being the beneficiaries are established. The document which governs the Trust is defined in a Deed of Settlement or a Trust Deed.
Discretionary or Family Trusts?
Discretionary Trusts are Trusts where beneficiaries do not have a fixed entitlement or interest (only a mere expectancy) which means the Trustee has the decision to decide which beneficiaries will receive trust income and capital distributions. The main benefits or advantages of a family trust is it is flexible with its income streams, beneficiaries have asset protection and limited liability, less regulation than a company and there being tax advantages. In this respect, income can be distributed to the lowest income earner, with assets protected and wealth being able to pass onto the next generation. However, disadvantages of family trusts include less certainty than unit trusts or companies, capital gains tax implications, inability to distribute tax losses, establishment costs, ongoing costs of administration and borrowing costs.
Unit Trusts?
A Unit Trust has trust property which is divided into units that represent capital or income which the beneficiaries receive a fixed interest in the trust property. Initial unitholders subscribe for units by paying money to the trustee. The Unit Trust is useful in commercial matters as units can be transferred and redeemed. The unitholder will be given fixed share of the income. However, a unitholder is not entitled to a distribution of capital unless the trustee makes an interim distribution or winds up the unit trust. It is also easier to wind up than a company and can have taxation advantages over a company and have less regulations. However, there can be CGT implications on distribution of trust property and there is less asset protection and tax advantages compared to discretionary trusts.
Hybrid Trusts
Hybrid Trusts are various combinations of fixed and discretionary trusts. There are usually different unit holders and classes of beneficiaries. There may sometimes be an income unit holder. Hybrid trust distributions are made proportionately to the interests of each class. The major advantage in adding a unitised structure to a discretionary trust will avoid there being a resettlement of the trust if a new beneficiary is appointed which has resulting capital gains tax and stamp duty liabilities. In this respect, individuals or corporate entities that are beneficiaries of a discretionary trust are separated into classes of beneficiary and may also be a unitholder for other parts of the trust. This means that class beneficiaries can receive distributions from the trust in addition to the unitholders, which the trustee decides how much based on their discretion. This is useful where there are two or more sets of families which creates multiple classes of beneficiaries and the distribution is made in accordance with the fixed proportionate entitlements for each class of beneficiaries as set out in the trust deed. The trustee then decides how much income or capital to distribute to each member of a beneficiary class.
The Trustee then decides to distribute based on their sole discretion an amount to the holders of the income units so that the distribution does not need to be in proportion to the income units held, thereby excluding some unit holders. In general, the income units are often held by class beneficiaries and are distributed to incentivise key employees of a business. In this respect, income unitholders are not provided with a fixed right to a proportion of income and have no voting rights.
The Trustee then decides how much to distribute to ordinary unit holders in income and capital with distributions being made based on their proportion of their unit holding. As the last line of distribution, any income from hybrid trusts not previously distributed will be distributed to ordinary unitholders in their proportion of units held.
Setting up a family trust
The settlor pays an amount called the settled sum to Trustee to hold on behalf of the beneficiaries, the Settlor and Trustee execute a Trust Deed and the Trustee deposits the settled sum in a bank account in the name of the Trust.
Role of the Trustee
The Trustee is the legal owner of the Trust Property but has no beneficial interest. The Trustee adds to the Trust Property by borrowing, receiving gifts or acquiring other assets. They determine who and how much of the income and capital of the trust is distributed. However, they may be personally liable for debts of the trust but generally entitled to be indemnified from trust assets where liabilities incurred in good faith and in proper performance of duties. In this respect, a corporate trustee provides asset protection and limited liability where a company has no assets. For example, if a trustee incurs a liability, the trustee can be indemnified from the trust assets if they acted honestly, but the trustee will be liable for any shortfall and have their personal assets exposed to meet any shortfall. This allows clients to control the trust without acting as a trustee by being the sole director of a corporate trustee. The Appointor has the ability to appoint a new Trustee.
A corporate trustee can have its directors and ultimately its shareholders, that appoint and remove directors, who control the company.
Role of the Settlor
The Settlor creates the trust by paying or gifting the settled sum to the trustee and must not be reimbursed for it. This is done when the trust deed is executed. Beneficiaries must not be the settlor. It is important lawyers and accountants are not acting as a settlor to avoid the risk to appear to be reimbursed through being paid their fees and it is better to use an independent person who is unrelated to the trustee and beneficiaries such as a family friend.
Role of the Beneficiaries
The beneficiaries are persons for whom the Trust Property is held. The definition of the beneficiaries are important as there are primary beneficiaries who are usually named family members (e.g. parents, children, grandchildren and future descendants) and general beneficiaries who are usually relatives of the named beneficiaries but can also be charitable institutions or any company in which a beneficiary holds an interest or another trust where they area also a beneficiary. In a visual sense, beneficiaries are in a defined cloud as a class and individual beneficiaries stay within the class. For most discretionary trusts, there are a wide range of beneficiaries.
Role of the Appointor
The Appointor has powers to remove and appoint Trustees, in this respect they have the ability to indirectly control the Trust. It is important to include a provision for future control of the trust following the death of the appointor. They are usually a primary beneficiary and have the ability to approve any distribution of income or capital of the Trust to the beneficiaries and appoint or remove beneficiaries of the Trust.
What is the Trust Deed?
The Trust Deed defines the relationship between the Trustee and the beneficiaries. It defines the powers and limitations of the Trustee as well as provide a process for amending the Trust Deed.
Ways of setting up a Family Trust
A Trust Deed can be drafted by a lawyer. If a client has an existing family trust, it can be cloned whereby a new Trust is set up with the same terms and beneficiaries then assets of the existing trust are then transferred to the clone trust.
Cloning a Trust
This cloning of a trust might be useful if you want different Trustees dealing independently with assets of their Trust. There is an ability to avoid capital gains tax and stamp duty on transfer of trust property. There is also asset protection reasons for cloning trust and can be useful in succession planning. However, to avoid capital gains tax the clone trust must have the same beneficiaries and terms as the original trust, but not necessarily the same trustee and trust property. Please note that there are usually stamp duty implications of trust cloning.
It is important to note that the clone Trust must benefit the same beneficiaries as the original trust. This includes beneficiaries defined by their membership of a class such as lineal descendants, the default beneficiaries and superannuation fund members. The beneficiaries must also be acting in the same capacity, i.e. individual, corporate or trustee capacity. This applies even where there are multiple tiers of trusts that ultimately benefit specific beneficiaries of the original trust.
It is important to note that a cloned trust does not need the exact same terms of the original trust. But it needs to create a trust relationship that is identical to that created by the original trust including the rights of the beneficiaries. The appointor, settlor or trustee do not need to be the same as well as the trust property which can be carved out of the original trust. But the dates which the trust is established or commences as well as the vests or terminates needs to be identical with the original trust. In this respect, elections of a family trust or interposed entity by the original trust needs to be applied to the cloned trust for there to not trigger liability for family trust distribution tax.
Trust splitting
Trust splitting is not trust cloning as trust splitting occurs when a new trustee or an additional trustee is appointed over part or all of a trust fund, which can carry stamp duty liabilities.
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