Discretionary (Family) Trusts
Discretionary Trusts have been in existence for hundreds of years. Until about 30 years ago their principal use was to hold property to ensure that probate and estate duties were not payable on such property in the event of the death of an individual family member.
However, Discretionary Trusts are now primarily used for the purpose of splitting family income, and for asset protection, to minimise the rates of income tax applicable to the family income. The income which a Trust earns is, like a partnership, not taxable in the hands of the Trustee. The income is taxed when it is distributed to the individual family members and it is taxed in each individual family member’s tax return along with any other income which that particular family member has from other sources. This is the current Tax Law. The Government may change the law relating to taxation of income distributed from a Trust.
The term Discretionary Trust is used because the Trust gives a discretion to the Trustees as to whom they will distribute the income earned by the Trust, and a discretion to distribute the capital, or assets of the Trust to any eligible capital beneficiary of the Trust.
A Discretionary Trust is established by a person called a “Settlor” signing a document called a Deed of Settlement, which is the basis of the Trust. The Deed of Settlement provides:
- Who will be the Trustees of the Trust – that is, who will be responsible for the administration of the Trust and any business the Trust may conduct. If a Trust is to conduct a trading business, it is generally recommended that a Company be formed to act as a Trustee of the Trust and in that case, decisions have to be taken as to who will hold the shares in the Company and act as the Directors.
- Who will be the Appointors of the Trust. The Appointors are given the power to change the Trustees at any time, so whoever has that power really holds effective control over the Trust and its assets. If a couple establishing a Trust wish to retain control of the Trust being established for Estate planning, then they are nominated as the Appointors jointly during their lifetimes, but a close relative or friend or professional adviser is also selected to act as their Co-Appointor. The Appointor has nothing whatsoever to do with the day to day running of the Trust, nor does the outsider have access to the Trust’s Financial Statements or any knowledge of the Trust’s assets or liabilities.
- The original Fund which will be $10.00 which a family member or professional advisor can provide.
- Who is eligible to share in the assets which the Trust may acquire if the Trustees ever wish to distribute the assets out of the Trust. However, merely being a member of the beneficiary class does not confer any right or entitlement on the beneficiaries to demand any share of the Trust assets.
- Who is eligible to share in the income of the Trust:
- There is no restriction on the range of beneficiaries who can receive income.
- Each year the Trustees decide how the income earned by the Trust will be distributed.
- Different decisions can be made from year to year, depending upon the incomes which various family members may have.
- No beneficiary has any right to demand any particular portion of the annual income which the Trust earns.
- Beneficiaries are merely entitled to share, if the Trustees resolve in their favour.
- The control of the Trust can effectively remain in your hands as long as you like, provided you control the Appointor position, because by so doing you also control the Trustee position. The Trustees are given the right to transfer any part of the capital – that is the assets of the Trust – to any beneficiary.
- Because the Trustees can distribute any part of the capital to any beneficiary at any time, you (through your control of the Trustee) have the right to take capital out of the Trust into your personal ownership at any time you choose.
- Empowers the Trustees to own or lease land, to mortgage land, to borrow money, to enter into partnerships, and broadly to conduct any possible type of business activity which anybody might be likely to engage in.
The greatest benefits which will flow from the use of the Trust are:
- The ability of the Trustees to allocate some of the income earned by the Trust between your children. Approximately $700.00 of Trust income can be paid to a child under 18 years of age and the Trustees pay the money to the parents of the child, who are entitled to use it for the child’s benefit. At the age of 18 any person is subject to the ordinary threshold limits for tax currently – that is – the first $6,000.00 of income is tax free. If there is a member of the family over 18 still undertaking education, then quite often very substantial tax savings can be made by the Trustees allotting income to that family member who will use the income to defray living and educational expenses. Where there is not a Discretionary Trust in operation, the parents assist their children through the education years out of their after tax income. By use of the Trust quite substantial moneys can be directed towards the child or children being educated and become tax free within the family unit.
- There is flexibility in increasing or decreasing income allocations to each family member in each year, whereas in a partnership the percentage of income is fixed and invariable. As a result, if in a partnership one partner has other income, that spouse’s taxable income may be substantially higher than the other’s, and therefore a greater amount of tax may be payable than if the two spouses’ incomes were equal. Because of the flexibility of a Trust, spouses’ income can be kept equal and tax minimised.
- If a family member happens to have an investment which derives income, which is then taxed in that family member’s name, it may be prudent to consider giving the asset to the Discretionary Trust or lending it to the Discretionary Trust free of interest, so that the income derived from the investment can be received by the Trust and perhaps distributed more widely amongst the family than if the income was just received by the one family member and taxed in his or her name.
- The Trust Deed can empower Trustees to allocate a specific source of income eg. a fully franked share dividend or a capital gain to any beneficiary. This is called “income streaming” and often very significant benefits from a tax aspect can be gained. For example, if a Trust has investments in shares which pay fully franked dividends, those dividends can be distributed to higher, rather than lower income earning family members, who can then claim the benefit of the tax credit applicable to the dividend, against the dividend income in their tax return.
- Discretionary Trusts can also protect assets from creditors and a Trustee in bankruptcy, because in certain circumstances assets held by a Discretionary Trust are not available to the creditors or the Trustee in bankruptcy of a beneficiary of the Trust.
Obviously the issues involved in setting up a discretionary trust can be quite complex and confusing. We are here to help you understand your options and answer any questions you may have.
