This is another area of law which is connected with almost all parts of our practice. The simplest form of a trust is perhaps a bank trust account which a parent holds for a child. Such a trust is a fixed trust because the child is the only beneficiary. It is also probably a bare trust, meaning that the parent has little or no obligations other than to hold and operate the account.
Family (Discretionary) Trusts
This is perhaps the most overt aspect of practical trust law. A family trust is not a fixed trust. The trust deed specifies a range of beneficiaries.
It gives the trustee the discretion to distribute capital and income between those beneficiaries from time to time as the trustee thinks fit. The trustee might be an individual or individuals – such as Mum and Dad. Or it might be a company of which one or both of them are the directors and shareholders. A significant role in a trust is that of the Appointor.
This is the person – again usually Mum or Dad or both – who has the power to dismiss and appoint trustees of the trust. This reserve power is analogous to (but different from) the ultimate power of the Governor General to dismiss a government. Significantly, the listed beneficiaries have no right to demand a distribution at any time. They have little or no other rights, other than the right to be considered for a distribution, and, sometimes, the right to trust documentation.
These features give rise to the following advantages of a discretionary trust:
- Taxation – where the trustee on behalf of the trust receives income, and distributes that income to a beneficiary or beneficiaries, taxation is not paid by the trustee, but by the beneficiary to the extent they receive the income. This gives for example a family the ability to reduce tax by distributing income to those beneficiaries who are subject to a lower marginal rate of tax. An exception is where the income is derived from the personal services of an individual;
- Asset protection – unallocated assets in a discretionary trust do not ‘belong’ to any of the beneficiaries. They do not belong to the Appointor. Nor do they belong to the trustee – the trustee only being the legal holder of trust assets, with no equitable rights to them. It follows that if an individual who happens to be a beneficiary, trustee or appointor suffers a bankruptcy, neither the Trustee in Bankruptcy nor creditors have access to trust assets. In other words a family trust can be used as a legitimate device to protect family assets. An exception is a loan account – that is, monies which are owed by the trust to the bankrupt. Another exception is the clawback provisions in the Bankruptcy Act. The main such provision is an automatic clawback with respect to assets transferred to a trust for inadequate consideration during the previous five years. Another is a transfer effected with an intent to defraud creditors. Yet another is the provision of the Bankruptcy Act which entitles a Trustee in Bankruptcy to recover the value of personal services provided by an individual to a Family Trust.
- Avoiding estate claims – where a deceased Will-maker, in the eyes of the Court, fails to comply with their moral obligation to provide financially for a particular person, the Court has the power to award an increased amount to that person. This is pursuant to the Testator’s Family Maintenance provisions of the Administration and Probate Act. That jurisdiction applies to assets owned by the deceased at the time of their death. It does not extend to assets held in a discretionary trust controlled by that person when they died. In New South Wales legislation has been introduced to catch such assets. But that has not occurred in Victoria. This raises the opportunity of transferring assets prior to death to a discretionary trust, which trust would be taken over by the desired beneficiary following death. Care of course needs to be taken in relation to capital gains tax, stamp duty and, potentially, GST.
Also see comments in above section under “Wills” in relation to Testamentary Trusts, which are a form of discretionary trust within a Will.
A unit trust is often used either as a vehicle to conduct the business, or to hold assets. It is a fixed trust – that is, with set entitlements, unlike that of a discretionary trust. Equity in such a trust is held in the form of allocated units.
A unit trust may be established, for example, when two families wish to operate a business together.
The trustee will be a company in which members of both families will be appointed directors and shareholders. Each family will hold 50% (or some other percentage) of the units – often via a discretionary trust.
An alternative to this structure, often favoured nowadays by accountants, is to operate a business with a trading company, of which the shareholders are the trustees of a discretionary trust of each family.
To avoid such exposure to other assets, the notion of a bare trust was introduced. A simple trust is created, to hold the property on behalf of the trustee of the superannuation fund. Because the trustee has no obligations other than to hold the property, the trust is a “bare” trust The lender agrees that the only recourse it has following a default is to the security property provided by the bare trustee.