“A fiduciary relationship in which one person (the trustee) holds the title to property (the trust estate or trust property) for the benefit of another (the beneficiary)” – this is how trust is defined in the dictionary.
Reasons to set up a trust
To protect assets is one of the major reasons for creating a trust. A trust can protect assets and property from creditors, it can look after an estate until such time when a beneficiary reaches legal age to take ownership, or keep valuable assets separate from a trading company that may be exposed to risk, like litigation.
If set up properly, a trust can be used to lawfully reduce some tax obligations. However, this can be a delicate matter, as the taxman is constantly watching for individuals or corporations who are taking advantage of the loopholes or over-stretching the limits for lowering taxes. It is advised that you seek specialised advice on this matter.
The word “trust” is used inappropriately in these types of arrangements. A trust is an official entity overseeing a responsibility, where “beneficiaries” put their trust (or confidence) in the one who controls the assets (called trustee) for their benefit.
Another party in a trust structure is a “settlor,” the person who provides the initial trust asset (which can be money or property like a house) in order for the trust to be formed. There is also the “appointor,” the person with the power to appoint, replace or remove trustees.
Fiduciary duty of a trust
This relates to isolating control from beneficial ownership. The trust allows for a business or assets to be controlled by a third party (trustee) who has the legal control and has the responsibility to run that business or oversee the assets for the benefit of another party (beneficiaries).
Distributions and tax
The usual tax laws govern how a trust computes its taxable income for the year. The income is either distributed or kept by the trustee. Income received by beneficiaries will be taxable at their own marginal rate. On the other hand, the trustee, (on behalf of the trust), must pay tax on any taxable income that is retained by the trust. Top rate (including Medicare levy) is used to tax undistributed income.
When income is distributed to each beneficiary, the trust must consider the financial, taxation and personal situation of each beneficiary so that income is distributed in a manner that benefits everyone. Naturally, the terms of the trust deed bound the trustee.
Types of trust
A fixed trust is where the share that beneficiaries own in assets and income (which can be absolute or proportional) are fixed or pre-determined, giving no flexibility for the trustee to adjust income distribution. A typical fixed trust is a unit trust, as each unit owned in the trust entitles a beneficiary to a specific share of the income and/or capital.
A discretionary fund gives the trustee the discretion to choose which beneficiary receives income from the trust. This must be distributed based on the terms of the trust deed.
A hybrid trust has elements of both discretionary and fixed trusts. It can be a discretionary trust having some rights that are pre-determined by the trust deed, or a unit trust having discretionary distribution options. A hybrid trust is characterised as anything that is neither completely discretionary nor completely fixed.
A hybrid or discretionary trust can typically be a family trust to obtain tax breaks, if the trustee chooses to do so. However, distributions have to be limited to members of a certain family group. Only the income distributed outside of this group will be taxable at the highest marginal rate (plus Medicare levy).
There are various reasons to set up a family trust. First, a discretionary trust’s beneficiaries may otherwise be unable to benefit from franking credits ascribed to share dividends obtained by the trust and distributed to beneficiaries. Second, it would otherwise be more difficult for the trust to utilise previous tax losses versus the present year income.
Another reason to set up a trust is if means or assets tests for government benefits are a possibility in your financial future. A trust can help re-allocate legal ownership without fully sacrificing the benefits you get from the assets.
Consideration for inheritance is the other side of asset protection. If a major asset, a beachfront property for example, is owned by a trust, and there are conditions for the sale and/or maintenance of the property specific in the trust deed, family members born later will also be able to benefit from the property and not have some irresponsible cousin just sell it off.
Getting the trust structure right can be a challenge. There could be instances in which asset protection and taxation would be competing interests, and great consideration should be given to other trade-offs for taking advantage of the trust structure.
There are some areas of trust that are complex, so if you are considering setting up a trust it would be wise for you to seek expert advice from a lawyer and an accountant.
Are you considering setting up a trust? Ask your lawyer or accountant for guidance, or contact PJS Accountants. We offer accounting and other bookkeeping services to individuals and companies, big and small. Allow our team to evaluate your business and advise you on the right measures to create an excellent financial management strategy for you.