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.