More and more clients are coming to Shire Legal to set up a family trust, usually on the advice of their accountant or financial adviser. But this begs the questions – what is a trust? And why is it recommended that you set up a company to run the trust?
What is a trust?
A trust is a relationship where the trustee carries on business and/or holds assets on behalf of the beneficiaries of the trust.
A trust set up for the benefit of family members is typically set up as a discretionary trust, meaning that the distribution of income earned from the assets is distributed each year at the discretion of the trustee. Otherwise, the trust would be set up as a fixed trust, where each beneficiary has a fixed interest to the distribution of income.
Who are the parties to a trust?
When establishing a trust, there are a number of appointments that you need to decide upon:
- the Settlor is the person who initially “owns” the assets and property, and effectively “settles” the establishment of the trust, by transferring those assets and property to the ultimate holder of the assets, being the trustee;
- the Appointer is the person who appoints, changes, removes and replaces the trustee;
- the Trustee is the person in whose name the assets are held, on behalf of the beneficiaries, pursuant to the terms and rules set out in the Trust Deed;
- the Beneficiaries are those named persons and/or legal entities, or classes of persons and/or legal entities, who receive income from the trust. For a family trust, the beneficiaries are typically spouses, children, grandchildren, siblings, any company in which any of these individuals hold any interest, and even charities.
Why have a trust?
One of the main reasons that families establish a trust is because of the flexible options available to distribute income to minimise tax payable. By way of example, if you are considering the purchase of an investment property, one option is to purchase it in your own name, then any income earned from the investment property would be treated as taxable income in your own name. Combined with the regular income you earn from your main employment, this may or may not have the effect of essentially pushing you into a higher tax bracket. On the other hand, if the property is held by a family trust, then the income from the investment property may be distributed to a lower income earner (such as your spouse), thereby minimising the total tax paid by the family for that particular year.
Other advantages of holding assets in the name of a trust are:
- discounted capital gains tax for beneficiaries;
- protecting the assets of any “high risk” family members (e.g. trading company directors and professionals, or family members with hostile family situations of their own);
Why should I have a corporate trustee instead of a personal trustee?
The trustee is the legal owner of the property. The trustee therefore has the ultimate control over the assets of the trust. The trustee can either a company, or one or more individuals. With a corporate trustee, the directors of the corporation will have the day-to-day control of the trust (although the shareholders have ultimate control, as they are able to appoint/remove directors as required). Arguably, the appointer has the highest power, because they are able to appoint/remove the trustee at any time.
Clarity of ownership – because a trust is not a separate legal entity, the assets of the trust need to be held in the name of the trustee. A person acting as a trustee would thus hold assets both in their own individual capacity (that is, their personal assets), and also in their capacity as trustee (that is, the trust assets). There is therefore a risk that personal assets will become intermingled with trust assets. Whereas confusion as to what are the trust assets is minimised when held in the name of the corporate trustee.
Protection of personal assets – Trustees may become liable for any losses incurred as a result of a breach of trust. So persons acting as trustees place their own personal assets at risk. Whereas corporate trustees are generally “shell corporations” with no, if any, assets. If there is any liability attributed to the trustee, then the liability doesn’t go any further than the corporation’s assets.
Indefinite existence – if a personal trustee passes away (or indeed becomes mentally incapacitated and is no longer able to act), then the ownership of any assets held in the person’s name on behalf of the trust would need to be transferred to the new trustee. This can be a time consuming and expensive exercise. Whereas with a corporate trustee, where the persons effectively controlling the trust are mere directors and/or shareholders of the corporation, then the ownership would not need to be changed in the event of anyone’s death. Instead, a new director may need to be appointed, and the shares allocated in accordance with the Will.
Are there any disadvantages to a corporate trustee?
As a corporation, there are additional costs involved in establishing and running the corporation, although the main cost is only incurred at the time of registering the corporation with ASIC, otherwise the annual running costs are limited to the cost of the annual review.
- under the “law of perpetuities”, all trusts have a vesting day of 80 years, which means that 80 years after its creation, a trust will automatically cease to operate, at which point the assets of the trust must be distributed to the beneficiaries.
- some trusts include a corporation as a potential beneficiary of the trust, which has tax advantages, as corporations typically have a lower tax rate than individuals.
- if the trustee does not exercise its power to distribute income, then the Trustee Deed may set out who the default beneficiaries are.
Thinking of setting up a family trust? Contact Shire Legal to ask any questions you may have about the process and/or the costs.