Questions and Answers about Family Trusts are now being featured on this site. Users are accordingly invited to send Nick Renton pertinent questions dealing with matters not currently analysed in his book Family Trusts (fourth edition) or dealt with on this page.
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THE RATIONALE FOR A FAMILY TRUST
Q. One of the main benefits of a family trust is the ability to pass wealth between generations. Given that this is not relevant in our particular case, is a discretionary trust the best way to hold our investments or would some other structure be more appropriate?
A. Consider the KISS ("keep it simple, stupid") principle. The simplest and cheapest way for you to hold investments would be in the name of the spouse with the lower taxable income. Do not forget to draw up wills.
OWNERSHIP OF PROPERTY
Q. I have been told by a number of people that I should not be buying property in my own name (currently $3.5 million), so am considering the benefits of a hybrid trust which seem many. I am using the basic principles of leverage to spread my risk as widely as possible as fast as I can.
Cash flow is important at this stage, so being able to claim the interest payments in my personal tax return is important. If this can't be done then I see no benefit in a trust structure at all, as not being able to claim this could prevent someone from buying more properties.
My accountant has suggested that at settlement we should execute a loan document for the trust to lend the money to me on similar terms to the agreement between the lender and the trust. I would then use this money to buy units in the trust. Would this be OK, given that my reason for doing this is to improve my cash flow position to allow me to hold more property?
A. If I have understood you correctly what you wish to do is as follows:
Provided that the rate of interest and the rent are both on a commercial basis these transactions should be perfectly acceptable to the taxation authorities.
TAX OFFICE VIEWS ON HYBRID TRUSTS
Q. What is the latest ATO view on the deductibility of interest by unit holders in hybrid trusts?
A. Two private rulings issued in 2006 deal with this matter.
Can a deduction be claimed for interest paid on a loan used to invest in a hybrid unit trust where there is income received in the form of a distribution from the hybrid trust?
1. Is interest payable by the taxpayer on a bank loan for the acquisition of income units in a hybrid discretionary unit trust deductible under section 8-1 of the Income Tax Assessment Act 1997?
2. Can interest payable by the taxpayer on a bank loan for the acquisition of income units in the trust be deducted under section 8-1 of the ITAA 1997 against the taxpayer's assessable income in the event of a negative return?
These rulings should be read in full. The Australian Taxation Office's Register of Binding Private Rulings is at http://www.ato.gov.au/rba/search.asp
Each is based on the facts of a specific situation as advised to the Tax Office and reflects its view of the law in force at the time the advice was issued. Such rulings cannot be relied upon as precedents or used for determining how the Tax Office will apply the law in other cases.
As always, taxpayers have the right to challenge assessments in court.
HYBRID TRUSTS (1)
Q. I am looking into setting up a trust to hold some investments, which will be negatively geared. I have become aware of a hybrid discretionary trust structure that some property investors are using to hold negatively geared property, which gives them the tax and non-tax advantages of family trusts.
A hybrid trust seems to be a combination of a discretionary and a unit trust. Have you any advice in regard to the advantages and disadvantages of using a hybrid trust in this context?
A. A hybrid trust is a trust which is non-discretionary for some or all capital and/or for some or all income and which is discretionary for the balance.
However, the tax features of negative gearing do not depend on the type of trust. They do depend on the total trust portfolio, as trust losses cannot be distributed to beneficiaries. Thus unless there are other trust assets generating sufficient profits the net losses can only be carried forward.
In regard to the more general matter: In the absence of special circumstances, a discretionary trust, with its complete flexibility, would normally be more useful than a wholly or partly unitised trust.
HYBRID TRUSTS (2)
Q. I read in the Money Section of a newspaper that "Through the use of a structure called a hybrid trust, investors can obtain the benefits of negative gearing, ensure appropriate asset protection and have the ability to structure things to obtain the maximum tax benefits. Not many accountants or lawyers are familiar with these structures, so it is important to find an accountant with experience in this area.
Are these claims valid in relation to hybrid trusts?
A. I suspect that the reason that not many accountants or lawyers are familiar with these structures is that the alleged advantages of hybrid trusts over discretionary trusts simply do not exist.
I gather from the various questions to me that some unlicensed persons mention them periodically in lectures as part of a sales spiel.
I have not found anything in the legislation to support the hybrid trust theory. Even if there is some unintended loophole then taxpayers using it would probably expose themselves to penalties under the general anti-avoidance provisions of the tax legislation (Part IVA), so investors contemplating using these devices should be very careful.
HYBRID TRUSTS AND PART IVA
Q. I notice that you seem to be of the opinion that an investor cannot obtain tax benefits using a hybrid trust. I recently came across this type of trust deed and have been doing some research into the area. This research included a search of the private binding rulings register on the ATO web site. Using the search facility and typing in "hybrid trust" I saw ten rulings.
One discusses the deductibility of interest on money used to capitalise a hybrid trust so that the hybrid trust could buy property - Number 28993. The conclusion was that the interest would be deductible as long as the unit holder received income. Some commentators would even be prepared to extend this so far as to say, as long as there is an expectation that income will be received as a unit holder. Putting Part IVA to the side, it would seem in this instance, at least, that the tax benefits are available.
In later years when the asset is sold or becomes positively geared the suggestion is that the capital gain or income can flow to the discretionary beneficiaries who, presumably, are on a lower tax rate. I guess the question is would the tax office then go back and try and amend previous returns denying some or all of the interest claimed? Or would it apply Part IVA?
A. My point has always been that the deductibility of interest does not depend on the type of trust - a unitised discretionary trust serves as well as a hybrid trust.
As the ruling you found indicates, deductibility is dealt with on a year-by-year basis. Thus future scenarios cannot deny a past year deduction which was valid at the time.
If you owned a negatively geared property and sold it before the rent exceeded the interest there could not be a retrospective disallowance. Your scenario is similar.
The risk of Part IVA is greatest when a transaction is non-commercial. The ruling you quote does not even hint at Part IVA - it deals, quite reasonably, with the ordinary law:
"Therefore while you continue to hold all the issued units of the trust and all of the income derived by the trust is directed to you, you will be able to claim 100 per cent of the interest expense. If the income from the trust is directed to other taxpayers by way of the discretionary clauses in the trust or through the disposal of some of the units on issue then the interest will need to be apportioned to reflect the proportion of the total trust income received."
MORE ON HYBRID TRUSTS
Q. I am about to set up a hybrid discretionary trust. I have noted your concerns about this structure. I certainly do not want to get into something which will cause me to be penalised.
I have found a number of law firms that endorse the hybrid trust concept. In fact, a number of them set up the deed and lodge it with the Office of State Revenue. My accountant has advised me that he has personal rulings from the ATO to assure me that the benefits of the trust are genuine. What can I do to be careful?
A. Get your own private ruling from the ATO - those issued to other people do not count. As the ATO web site explains, you will need to get a fresh one each year.
In any case, any lurk that works for hybrid trusts would work equally well for any unitised family trust. The legislation does not mention hybrid trusts. Those drumming up business like to promote these as somehow special.
Acceptance by a State Revenue Office would carry no weight with the ATO. Mention of this would seem to be another smoke screen by those seeking to raise additional fee income from clients.
HOME EQUITY LOANS
Q. We are considering using a home equity loan to raise some money to invest. Our home is held outside our family trust. Could the loan be in the name of the trust or would it have to be in our own names? If the loan were to be in our names and we gave the money to the trust would the interest on this loan be tax deductible?
A. For interest to be deductible the loan must be in the name of the investor. The security can be in a different name.
Individuals can, of course, use borrowed funds to buy units in a unitised family trust which makes investments. Such interest would normally be deductible.
Furthermore, such a trust can be made to mimic a discretionary trust by having several different classes of units.
ADDING NEW BENEFICIARIES TO AN EXISTING TRUST
Q. I intend to form a family trust and have it distribute income to my wife, who is in a low tax bracket. If everything goes according to plan the portfolio will grow and the investment income will eventually push my wife into a higher tax bracket. At that point it would makes sense to distribute the income to a company beneficiary. Would such a company have to be named as a beneficiary when the trust was established or could it be added later on?
A. Adding beneficiaries later on would amount to a reconstitution of the trust, thus attracting stamp duty and potentially triggering off capital gains tax.
You could name "companies" as a class of beneficiaries or you could name a specific company. Depending on how things are structured this could make a family trust election impracticable.
INJECTING AN EXISTING BUSINESS INTO A NEW TRUST
Q. I already have a company with myself as sole shareholder and director. The company has considerable undistributed profits (fully franked). Through this company I employ staff and conduct a service business. I want to protect its non-trading assets. I propose to roll the company into a new family trust. Can such a trust become the sole shareholder in the company?
A. No problem, but, of course, the shares would be need to be registered in the name of the trustee.
Q. What are the tax implications of such a move?
A. Your disposal of the company, if at a profit, would trigger off capital gains tax for yourself.
The undistributed profits in the company and their associated imputation credits would not change. The company could pay dividends at any times of its choosing and these could then in turn be distributed by the trust as sole shareholder to its various beneficiaries.
Q. Can the company also act as the trustee?
A. Yes, subject to what the trust deed might say about such appointments.
Q. Can the company also be a beneficiary?
A. That would naturally depend on the precise beneficiary clause in the deed.
DUTIES OF A CO-TRUSTEE
Q. My daughter received a large amount of compensation after a car accident. We have agreed to have it put into a private discretionary trust fund so that she will have a protected income for life.
As the co-trustee of the fund, I am consulted about the management of her investments. But what is expected of me?
Do we have the right to go back to the court if we feel that the fund at any time is not managing the investments properly?
Am I entitled to see a copy of the deed of trust?
A. Chapter 6 of Family Trusts spells out in some detail the duties of trustees. Trust assets require a higher standard of care than personal assets.
As regards going to the court "if we feel that the fund at any time is not managing the investments properly" it is necessary to distinguish between "improperly" in the sense of fraudulently or negligently (for example, not keeping proper records), as distinct from your co-trustee making investment decisions in good faith which with the benefit of hindsight are seen to have been inadvisable. The fact that you are being consulted suggests that your co-trustee has nothing to hide.
If you are unfamiliar with investment matters then talk to someone who is - for example a stockbroker, in the case of shares.
In regard to getting information to help protect your daughter, you could talk to the Office of the Public Advocate or its equivalent in your State.
In regard to your final question, a trustee can hardly act prudently without having a copy of the deed.
Q. I am involved in a family trust with my ex-husband. He is the trustee and I am a beneficiary. He wants me to be taken off the family trust and has given me a variation deed to sign. We were divorced some two-and-a-half years ago and the family trust was not put forward as an asset in the divorce settlement. I have never been told what is in the family trust or anything about it.
If the family trust has assets should not I have had a share of those in the divorce settlement?
What would the outcome be if I don't sign the deed of variation?
Can I ask my ex-husband's accountant to produce a report on the family trust, showing the value of the assets?
A. You would be well advised to consult a lawyer who is an expert in family law.
You did not indicate how amicable the settlement was. But signing a variation deed is unlikely to be to your advantage without some quid pro quo.
By all means ask questions of the accountant, but you will probably be refused any information. Under most trust deeds in most States beneficiaries have no right to receive information of the kind you seek.
ADULT CHILDREN UNDER A DISABILITY
Q. I have a brother who is 58 and who suffers from a mild form of autism (Asperger's syndrome, a disease which affects judgement). But normally the victims, as in my brother's case, are very intelligent.
Over a number of years my father, who is now 88, has bought property in my brother's name, as a security buffer and to limit income tax and land tax.
My brother wishes to give me power of attorney with the view of my acting in his interests. My concern is for my brother's well being. He could easily become involved with people who would try to swindle him out of his assets.
What steps should be taken in order to protect his interests?
A. Family Trusts includes Chapter 20 "Trusts for Children with a Disability" which deals specifically with the concerns you raise.
You should seek specific legal advice, but some general comments may assist your thinking.
There are two separate aspects to be considered:
You could be one of the initial trustees, but there should be co-trustees to cover the situation if you die or become unable to act. Explore these aspects with a lawyer.
You also need to address the question of what is to happen to the trust assets on your brother's death.
STARTING WITH A BANK ACCOUNT
Q. My family and I are wanting to set up an account, into which we are all to deposit monies to create a fund to eventually buy an asset of some type. Our first idea was to create a bank account somewhere; by doing that have all ten people of the family on the account.
My question to you is: would we be better off creating a family trust, having two of us as trustees of the trust and eight of us as beneficiaries?
What kind of complications would we have with taxes, fees, and so on?
A. While it would certainly be possible to set up a trust structure on the lines you indicate it is unlikely to be the best course of action.
You really need to work out:
and so on.
Certainly, if you are going to have a trust then it is much better to set it up sooner rather than later. As explained at length in Family Trusts, there can be tax advantages but there are also setting-up and ongoing costs.
After reading this book you really should talk your ideas through with a local solicitor.
FEE-FREE BANK ACCOUNTS
Q. Which of the banks in Australia offer fee-free accounts to family trusts?
A. Usually no distinction is made between trusts and other customers. If you want a fee-free transaction account then you might be better off with a cash management trust or some similar product.
You will need to look at the prospectus for each one to ascertain its specific requirements for minimum balances to open an account and after that. Most have fairly modest requirements.
CMTs are fine for short term cash handling (drawing and depositing cheques or equivalent electronic transactions), but not as long term investments.
The business pages of the daily papers show the current returns of a number of CMTs. But look carefully at several prospectuses, as the bells and whistles differ from fund to fund. Many prospectuses are available online.
TRUST BANK ACCOUNTS
Q. What is the correct name to be used for bank accounts associated with a family trust having a corporate trustee? Can the account name be simply "ABC Pty Ltd" or is it a requirement to use a style such as "ABC Pty Ltd as trustee for XYZ Trust"?
A. There is no legal requirement to mention the trust in the name of a trust bank account, but it certainly seems desirable in order to avoid confusion, especially if the same entity also has its own bank account.
The trust designation would also help to ensure that the Australian Taxation Office treats income as belonging to the trust and not the trustee - although the use of the trust's tax file number for the trust bank account would make that less critical.
BANK ACCOUNTS IN LIEU OF TRUST DEEDS
Q. Can a bank account serve as a form of trusteeship arrangement without all the formalities of a trust deed? I would like to put all of my cash assets into a trust account at my bank in favour of my only son, aged nine years, and a similar account at my bank's stockbroking arm.
My purpose is to protect my assets for the use of my son at a later date, should I get married again and so forth. Would such a proposed arrangement give sufficient protection for my assets from any possible claimants?
A. A bank account can indeed be used in the circumstances you describe. However, while this can work in simple cases where only one child is the beneficiary and relatively small sums are involved, this is not as good as having a proper trust deed, although such trusts are acceptable for income tax purposes.
There are many additional aspects that should be dealt with in any formal trust deed. Such a deed allows all relevant conditions to be spelt out and it facilitate the use of the deed down the track for other purposes - for example, if it is desired to cater for grandchildren or if it is desired that the trust should hold property investments. The earlier such a formal trust is set up the better.
There can also be difficulties with a simple bank account - for example, on the death of the child or in the event of disputes between the child and its parent.
BANK ACCOUNTS FOR MINORS
Q. Currently, I have a bank account in trust for a child nine years of age. This also includes a stockbroker's account.
I am aware of the necessity to bear the tax responsibilities of the account myself. My question concerns the legality of the account from any possible claimant's perspective. Are the amounts and stock holdings in the account entirely free from any claim which might be made by a disgruntled wife or husband, for example?
I would much prefer to keep my affairs in as simple a state as possible and to obviate the need to appoint a trustee.
A. While banks accept designations such as "ABC in trust for XYZ" I do not think that listed companies do that. So the shares may not be safe.
You say: "I am aware of the necessity to bear the tax responsibilities of the account myself." If you have been paying tax in your capacity as trustee on a trust tax return and at trust rates then that would strengthen your case that a bona fide trust exists. But if you have been paying tax on your own tax return then that would completely undermine your case.
You would be safer with a proper trust deed which excludes you as a beneficiary. You could probably get a friend to act as trustee without fee.
MISSING TRUST DEED
Q. How can one replace a missing trust deed for a family trust? The original seems to have been lost between accountants.
A. Before attempting replacement of the trust deed a thorough search for copies of the original should be made. The solicitor who drew up the deed would almost certainly have at least an unsigned copy on file.
A signed copy might be in a safe deposit box, along with documents such as wills.
Copies might also be with:
The solicitor should also be able to reconstruct the deed, based on the standard wording he uses and the correspondence.
One or more statutory declarations should then be obtained from all persons who can attest that the reconstructed deed is to the best of their knowledge identical to the missing document.
HOW TO AVOID BEING SUED
Q. I am just about to start a management consulting company and I am still not clear on whether it would be better to have the company owned by a family trust in order to disseminate the income of the company to family members or to have it as a separate entity and hence have any legal obligations separated from any connection with the family. I hear lately that directors of companies are being sued for private assets if companies fail.
A. Even in the case of companies that do not fail the directors could always be sued for their negligence - quite apart from fraud, defamation, breaches of the Trade Practices Act or similar State legislation. They can also be prosecuted for offences under taxation statutes, employment laws, environmental regulations, copyright law, and so on (as is the case for individuals and trustees).
For these reasons directors attempt to get cover under directors' and officers' liability policies.
A company structure helps to limit the liability on shareholders for debts of the enterprise - but, of course, only where lenders have not obtained personal guarantees.
THE REGISTRATION OF TRUST ASSETS
Q. Seeing that the trustee of a family trust acts as the legal owner of its assets, does this mean that a property need not be bought in the name of the trust? Is it sufficient for it to be registered in the name of the person who i s the trustee?
A. Property cannot be registered in the name of a trust at all - it must be registered in the name of the trustee or trustees.
In the case of shares it is common to add something on the lines of <John Smith A/c>, using the name of the trust but without the actual word "trust".
Q. Can the name of the spouse of an individual who is the trustee of a family trust be included when registering the ownership of trust assets?
A. No, the name of the spouse does not come into the matter at all, unless the spouse is a co-trustee.
GOODS AND SERVICES TAX
Q. For legal and taxation purposes, what are the correct procedures for an investor who is exempt from the goods and services tax GST by virtue of that person's turnover being below the $50,000 threshold? What does a reference to "excluding input taxed supplies" in this context mean?
What taxes would one deduct from the maximum allowable $50,000?
A. Nothing at all is deducted from the $50,000 figure.
Turnover is measured on a GST-exclusive basis. Residential rents and dividends and interest are also disregarded, because these items are "input taxed supplies".
This term refers to goods and services which are only partly exempt from the goods and services tax because, while that tax is not payable directly by consumers, the suppliers of those goods and services are not able to claim back the tax paid on their inputs and thus have to reflect that fact in their price structure.
Q. If a company which is the sole trustee of a family trust becomes insolvent, what happens to the trust?
A. If such a company becomes insolvent then the machinery in the trust deed for appointing a new trustee would probably need to be used. Apart from that the trust continues as before.
However, many of such companies do not trade in their own right and thus insolvency would rarely be an issue for these.
Q. If a trading company which also acts as the trustee of a family trust becomes insolvent, can business creditors of the company as distinct from creditors of the trust itself gain access to the assets of that trust?
A. No. The position is similar to that in a deceased estate - the creditors of an executor in his personal capacity cannot be paid out of any deceased estates that he happens to be administering.
Q. If the business of a family trust with a corporate trustee makes a profit and pays its 30 per cent tax and then transfers the net profits is it correct that the trust does not pay tax on that income?
A. Such a business does not get taxed as a company. The trust pays no tax at all if it distributes in full. However, any undistributed profits would get taxed at 46.5 per cent (at 2006-07 rates).
There is no need to transfer anything - the transactions are already in the trust.
PERSONAL SERVICES INCOME (1)
Q. Do the government's rules dealing with the alienation of personal services income have any effect on trusts?
A. Indeed they do. This is explained in the trust return instructions and also on the ATO web site.
PERSONAL SERVICES INCOME (2)
Q. What are the tax implications if a family trust receives a cheque for work performed for a client by a beneficiary of that trust?
A. Tax is a function of the contractual relationship between the parties, not of the identity of the payee of a particular cheque.
If an individual buys shares then the dividends flowing from those shares are taxable in the investor's hands at his or her marginal tax rate.
If a trust buys shares then the dividends flowing from those shares form part of profits of the trust. Profits are taxed in the hands of the trustee if undistributed (at the top marginal rate) or in the hands of beneficiaries otherwise (at their respective marginal tax rates).
In the case of personal services income special rules of an anti-avoidance nature apply. In effect, such income (net of deductions) is attributed to the individual responsible for earning it, even if it goes through a trust structure - see Tax Pack for further details.
A TRUST PROVIDING A LIFE INTEREST
Q. My brother was made executor and trustee for my late father's estate. This estate has been divided equally between him and me. However, my brother is free to do as he wishes with his share, while I am not. My brother, as my trustee is to invest what money is mine and I can have the income arising from this. At the time of my death my daughters will inherit the principal.
I am 60 years old, and at present on a pension. I live in a government unit. My general cash flow is not good. I live for each fortnightly payday.
Is there any way I can change this very unfair set-up?
A. From your message it appears that half of your father's estate went to your brother absolutely and the other half was to be a trust fund with your brother as the trustee and you having a life interest in this fund and your daughters the reversionary interest in it.
Presumably your daughters are adults. If you and they are in agreement then the trust could be terminated by mutual consent. It would be advisable to get a solicitor to draft the documentation. He would no doubt wish to get an actuarial certificate to ascertain fair values for all parties, so there would be some costs involved.
Once you received the resultant lump sum you could deal with it as you saw fit. But bear in mind that your father probably wanted you to have the maximum possible income without having to worry about investments.
A lump sum would enable you to draw on the capital, but only at the expense of future income and with the risk of exhausting the capital long before you die. Alternatively, there could be capital left over when you die and this will have been at the expense of the higher standard of living which you could have had with the life interest.
Conceptually, the present arrangements do not seem inappropriate to your circumstances.
RIGHTS OF BENEFICIARIES
Q. As one of the beneficiaries of a discretionary family trust, can I demand that the trustees make a distribution each year? Also, have I the right to see and examine the trust's financial report?
A. Your rights would depend on the trust deed.
But in most cases you would not have the right to demand that the trustees make a distribution annually or in most States to see and examine any financial reports.
Beneficiaries are not parties to any contract. Accordingly they normally have no legal rights against a trustee, but they could get a court to order a trustee to comply with the trust deed.
If you suspect fraud or other improper conduct then you should report the matter to the police and/or seek legal advice.
However, mere discourtesy on the part of a trustee - such as not replying to legitimate correspondence - would, of course, not be actionable.
Q. We run two businesses, each operated under a separate family trust. This was recommended by my accountant. Last year we used the profit of one business to offset the loss from the other business and to reduce our tax.
My question is: why the need for two separate trusts?
A. In terms of tax, using two trusts is not a good idea, as losses in one trust cannot be offset against profits in another.
But your accountant may have had non-tax aspects in mind - for example, that you might one day wish to sell one business and keep the other. Separate unitised trusts would lend themselves for this.
Q. If a family trust distributes profits to beneficiaries and these profits include franked dividends from companies held as investments do such beneficiaries pay tax at their personal tax rates on those dividends or do the imputation credits get carried through with the transfer of the money?
A. The beneficiaries all pay tax at their marginal rates on both the dividends and the imputation credits. The beneficiaries then get a rebate or tax refund representing those imputation credits, in the same manner as for franked dividends received from their personal investments.
Q. Is it possible for the trustee and/or the beneficiaries to be the settlor of the trust as well? I have previously read that the ATO might not look on the arrangement too favourably, but no reasons were offered as to why.
A. The conventional wisdom is that it would be most unwise for a settlor to also be a trustee and/or a beneficiary, although theoretically this may be possible.
However, such a course of action could prove very expensive later on, particularly if death duties were ever to be reintroduced. There could also be a possibility of incurring additional income tax and penalties if the Taxation Commissioner were ever to challenge the bona fides of the arrangement.
Using an outside person such as a friend or business associate as settlor is so simple that it would seem very foolish to take any risks at all in regard to such a matter.
No sane investor would want to fight an expensive test case in order to find out just what the law in this area is.
Q. I have recently set up a discretionary trust and in the trust deed prepared for me the settlor is a third party whom I do not know.
A. That is quite common. The settlor is needed at the start of a trust for legal fiction reasons, but has no role after that.
Q. In the trust deed I am shown as the appointor. Does this mean that I am the only person who can remove a trustee and appoint a new one?
A. Basically yes, as long as you are still around - but check the precise wording in the deed.
Q. Or does the settlor have any power over me?
WINDING UP A TRUST (1)
Q. What are the requirements to cease a trust's life altogether? I will attend to deregistering the ABN, TFN, closing all bank accounts, selling assets, advising various external bodies and paying liabilities.
However, it is the internal issues that I am uncertain about - for example, minutes and advice to beneficiaries.
A. You seem to be on the right track. The resolution to wind up the trust needs to be minuted and the minute book and other records should be kept in a safe manner by the trustee.
Notifying key beneficiaries, if not already done with the final distribution, would be a nice courtesy.
WINDING UP A TRUST (2)
Q. I am currently a beneficiary of a family trust. All the beneficiaries and the trustee have collectively decided to sell the sole non-cash asset within the trust. As one of the beneficiaries I have offered to buy this asset and therefore close the trust. I am a little confused as to the process of to be used and the legal steps involved.
The asset, which generates income, has been valued to current market. In effect I will be paying out my two sisters and parents. There are no liabilities within the trust.
A. A simple way to proceed in this case would involve three steps, the first two of which could occur simultaneously (so as to minimise the cash flows).
However, do bear in mind that for capital gains tax purposes the proposed transaction would be regarded as a disposal of the asset by the trust.
WINDING UP A TRUST ONESELF
Q. Does one need a lawyer or an accountant to wind up a trust or can this all be done by a trustee if the trustee follows all the procedures - for example, passes a resolution, distributes the assets and lodges a final tax return?
A. This really depends on the skills of the trustee.
If an accountant was used during the life of the trust then it would make sense to use the same accountant at termination. However, if no accountant was used previously then there would seem no need to use one just for the winding- up.
A lawyer would seem desirable only in certain circumstances - for example, if real estate is involved or if disputes are expected.
TRUSTS THAT SHOULD NOT HAVE BEEN SET UP
Q. My husband and I set up a family trust in early 2004, feeling it would be a good vehicle for us to manage future investments and income distribution.
Currently my husband is the sole income earner (about $80,000 per year) and I am unlikely to return to the workforce for several years.
We purchased an investment property soon after the establishment of the trust and this is the trust's only asset. At best it will earn about $1,200 a year after expenses; at worst, it will earn nothing.
We found the whole process of setting up the trust was immensely complex and stressful. The process of finding finance to purchase the trust's first investment property was even more draining and unnecessarily complicated.
On reflection, we feel we have made a costly mistake by setting up the trust. From a tax perspective, and from the perspective of simplifying our investments, we feel that income-producing properties, shares and other investments would be better held in my name and that negatively geared property could be held in my husband's name.
We don't know whether to persevere and continue accumulating assets to be held by the trust, and hope that the benefits outweigh its negatives and limitations; or whether we should just write it off as a bad mistake and move on.
How costly and complex is it to wind up a trust? I imagine we would need to find another accountant as part of this process, as we don't feel that our current accountant has given us good advice.
A. Your problem seems to be with the investment you mention, not with the concept of a trust. An asset earning a mere $1,200 a year certainly does not justify a trust structure.
You do not describe your family circumstances, but if you had an asset earning, say, $50,000 per annum, then splitting it among three or four low-income beneficiaries could produce useful tax savings. On the other hand, if you are not comfortable having a trust then not persevering with it might well be appropriate.
Winding up the trust is relatively simple, as long as the trust deed gives the necessary authority (as it normally would). Any non-cash asset assets should preferably be disposed of first, possibly by sale either to outsiders or to associated persons - in either case capital gains tax could arise.
A resolution of the trustee to wind up the trust can then be passed and the cash can be distributed in the usual way. A final tax return would also need to be lodged, indicating that it was the final return.
TRUSTEES ALSO TRADING IN THEIR OWN NAMES
Q. I have remarried and would now like to change the structure of my present business to a family trust, and establish a company as trustee (my wife and I being the only directors and shareholders). I was proposing that this trustee company acquire the assets of the existing business.
Can the new company have the dual role of trustee and also trade under its own name, or do I have to register a separate business name to continue trading?
A. The one company can:
Naturally, its books would have to be kept accordingly. If a trust conducts a business then all contracts need to be carried out by the trustee.
It would be advisable to use a formula such as "XYZ Pty Ltd as trustee for ABC Family Trust" on letterhead, invoices, quotes, and so on, so that parties know that they are dealing with a trust and cannot successfully sue the company in its own right.
Business names are quite a separate concept, but probably worth using for marketing reasons. Such a name once established can also be a useful asset if you ever sell the business.
It is necessary to watch the capital gains tax aspects when transferring any assets.
While not ideal for "conflict of interest" reasons a company can also be the trustee and a beneficiary of the same trust.
COMPANY AS BOTH BENEFICIARY AND TRUSTEE
Q. I intend to set up a family trust with my existing private company - a share trader - as the trustee and myself, my daughter and the company as the beneficiaries. Future trading would be done through the trust, enabling profits t o be directed to the corporate entity where this results in lower tax that applying to the individuals. Are there any catches in such a scenario?
A. Probably not in practice, but theoretically there can be a conflict of interest if the beneficiaries include the trustee.
But also be aware that:
LOW INTEREST LOANS
Q. Are there any tax constraints which limit the use of low interest loans to transfer value to or from a trust?
A. If the loan is at call then there is no value shift, because the obligation to repay the loan involves the same amount as was originally lent.
In some cases, Part IVA relating to tax avoidance could apply to non-market interest rate situations - for example, if a taxpayer on a high rate of tax sought a tax deduction for interest at three times the market rate paid to a related party which itself did not pay any tax.
PARTNERSHIP VERSUS TRUST
Q. Is it better to conduct a substantial business through a partnership or a family trust?
A. If a business is conducted by a partnership then the partners can be sued for the liabilities of the partnership. They personally would normally have joint and several liability.
If a business is conducted by a trust then the trustee can be sued for the liabilities of the trust, but only the trust funds would be available for this purpose.
The above assumes that all contracts are drawn up in the correct name. Thus, for example, correspondence from the trust should be headed as from "ABC as Trustee of the XYZ Trust".
Q. I have discovered by chance that various members of my family are beneficiaries of a discretionary family trust which has been going for over 10 years. However, they have not received any benefits from the trust or any information about it.
A. Persons can be named as potential beneficiaries in a trust deed without being told about this. They become actual beneficiaries only if and when the trustee decides to distribute income and/or capital to them.
Q. Does the government regard the money invested in the trust as belonging to the named beneficiaries?
A. The government does not regard any money as belonging to them until it is actually distributed to them. Then the trustee has an obligation to give them all the information needed to complete their tax returns.
Q. How can they have their names removed from the trust deed? They are not interested in any financial benefits.
A. They have no right to insist on removal, although they can ask the trustee to amend the trust deed if they really feel strongly about this. But as they are not getting distributions anyway such removal would not seem to achieve anything useful.
Also, circumstances could change in the future.
Q. As two members of my family receive some benefits from Centrelink, it was Centrelink who advised them that their names were on the trust deed and the amount of money each one had in the trust, and how the interest that this money was earning was affecting their Centrelink benefits.
A. Naturally, any money actually received from a trust is regarded as income for both income tax and means test purposes.
Merely being named in a trust deed is not sufficient, except for two anti-avoidance provisions:
If neither of these conditions applies then Centrelink would be acting illegally by withholding benefits and the beneficiaries concerned need to ensure that the relevant facts were pointed out to the staff.
DEATH OF TRUSTEES
Q. What happens to a family trust when the parents who were the trustees pass away? The beneficiaries are the children and grandchildren. Who decides what occurs?
Can the will of a trustee override the clause in a trust deed dealing with the filling of vacancies in that office?
A. The trust deed would normally have a clause dealing with the filling of vacancies in that office. Such a clause cannot be overridden by unconnected documents.
The trustees have a legal duty to carry out the requirements of a trust deed. Their personal wishes are irrelevant.
If necessary a court could be asked to order compliance or even to replace the trustees, although this would be an expensive remedy.
UNHELPFUL ANNUAL REPORTS
Q. A trust has sold a property, but there is no indication in its annual report as to for how much the property was sold or where the money went. The only information in the annual report is that the property was sold.
Furthermore, money is being lent to certain beneficiaries, but again there is no indication as to the terms of the loans or the amounts to be repaid each year. The following year more loans are made and the existing loans get wiped off. Can this be don e legally in a trust?
A. As always, the answers depend on the precise wording in the trust deed.
But in many trusts there is no requirement to even prepare an annual report. Nor are beneficiaries entitled to get a copy even if one exists.
Typically, trustees can lend or borrow money with or without security, with or without interest and with or without a fixed repayment date. Trustees often lend money for worthwhile purposes, such as to help beneficiaries with the purchase of a house or a car, or to assist setting up a small business or paying school fees.
Q. If the family trust makes a loss, how is this loss distributed?
A. A loss cannot be distributed from a trust - it can only be carried forward for offset against future profits. It is different for partnerships.
Q. Can this therefore not make the trust insolvent?
A. It could, if the total losses to date exceeded the equity. The trustee would need to disclose that fact to any potential lender, but a lender might still be prepared to deal with the trust on the basis of security over assets out side the trust and personal guarantees.
Q. Would this require a capital injection to keep it afloat?
A. Technically, yes, but if the only creditors were family members they might be willing to live with the situation.
Q. It does not seem fair that income is distributed but a loss is not.
A. It happens to be the law.
DEDUCTIONS FOR INTEREST
Q. How could I use a hybrid trust to purchase a property where a loan is to be taken out to finance the purchase and a taxpayer on the highest marginal rate is going to claim a tax deduction for the interest? Could all the rental in come be distributed to taxpayers on lower marginal rates? Would it make a difference if the trustee were in fact a pty ltd company?
A. The type of trust is not relevant to the question. A discretionary trust is usually more suitable than a hybrid trust. Nor does it matter whether the trustee is a pty ltd company or some other entity.
Interest can be claimed as a tax deduction only by a borrower who used the loan funds to acquire an income-producing asset. In the situation described the trust would buy the property and would obtain the loan. Its net profit from the transaction each year would be the rent less interest and expenses.
The property would be registered in the name of the trustee and held in trust for the beneficiaries. The loan would be made to the trustee.
The trustee would then distribute the net profit to beneficiaries in accordance with the trust deed each year (or pay a penal tax on undistributed amounts).
Distributions could, if desired, be made to beneficiaries on low or zero marginal tax rates. But the interest would have been a deduction at the trust level, not directly in the hands of any individual beneficiary. In the same way the rent would have been income of the trust fund and not of any individual.
Q. I have a discretionary trust which currently does not own any property. I am the trustee of trust. My wife and son and I myself are named as the beneficiaries.
I also own a portfolio of properties in my own name. How could I control these properties through the trust without actually transferring ownership to the trust? I am keen to distribute the profits from the properties to the beneficiaries of the trust without the trust having actual ownership.
Is it possible to "lend" the properties to the trust and therefore enable the trust to receive the income?
A. While there are a number of ways of doing something on the lines of what you wish it is likely that all of them would be caught by Part IVA, the anti-avoidance provisions.
The only safe way is to have the trust acquire the properties by sale or gift. Thus would attract stamp duty and be regarded as a disposal for capital gains tax purposes.
LOST TRUST DEED
Q. We have a family trust somewhere. I sent the trust deed to be stamped at the State Revenue Office with a cheque for the duty. I contacted them yesterday and they have no record of receiving the documents.
I don't have a copy of the trust deed. My accountant may have a copy, but I am in dispute with him over several issues and am not getting any useful information from him.
Can I get a copy from another source or would it be better to set up a new trust?
A. If you cannot locate a copy of the missing trust deed then it might indeed be simplest to start again.
Q. We are now looking at buying an apartment and want to place this within the family trust. Our lender wants deeds or such about the trust to lend us the money. I am at a total loss as to what I should do.
A. Once the deed has been executed and stamped the trustee should pass a resolution authorising the purchase. The property can then be purchased in the name of the trustee. It would be normal for a lender to want to sight a copy of the trust deed and the minute of such a resolution, as well as getting personal guarantees and statements of assets, liabilities and net income. There could be a charge for perusing the deed.
CHANGE OF TRUST NAME
Q. The trustee of a family trust has now decided to change the name of the trust. Does this mean that a new trust registration would be required and that a new tax file number would need to be obtained?
A. A change of name would in no way alter the identity of a trust, just as a woman changing her name on marriage does not become a different person.
The trustee should pass a resolution in terms of the amendment clause of the trust deed.
The Australian Tax Office needs to be advised, but this can be done very simply by means of the first two items on the trust's next income tax return. The TFN definitely does not change.
As you would know, listed companies register shares in the name of the trustee, so that the only change would be to the designation <Smith Family A/c> or whatever. This can be achieved by filling in a form obtainable from the share registry and probably also by letter or online.
Q. When creating a family trust should the family home be included in the trust assets?
A. Definitely not, if minimising tax is the only consideration. But it could be included for non-tax reasons, such as protecting assets against creditors.
Q. Does any capital gain from the sale of the family home by the trustee change its character (exemption from capital gains tax) when these gains are distributed to beneficiaries?
A. Capital gains on a home are exempt from capital gains tax only where the home is directly owned by the occupiers. If it is owned by a family trust then it incurs capital gains tax on disposal at a profit in the same way as all other assets.
Note that all income tax, including capital gains tax, is levied to the trustee in the first instance. But if the trustee makes distributions to beneficiaries (the normal situation for family trusts) then the tax liability is usually also transferred to the beneficiaries.
Q. A company trustee controls our family trust. In addition, there is one person named as the appointor. Can this appointor remove the company trustee at any time, or can this happen only in the event of poor management decisions by the trustee?
A. Most trust deeds would give the appointor power to remove trustees at any time and without assigning a reason.
Q. Furthermore, can the appointor add beneficiaries to the trust, or does only the trustee have the power to do this?
A. Neither the appointor nor the trustee can vary the class of potential beneficiaries except through an amendment in accordance with the amendments clause in the trust deed. But such a change would be regarded as a winding-up and t he setting up of a new trust for stamp duty and capital gains tax purposes.
Q. Is it possible to amend the trust deed so that there is more than one appointor?
A. Most trust deeds would give the appointor power to appoint additional or replacement appointors by deed or will.
Q. Would a change of appointor be classified as a reconstitution of the trust, thus attracting stamp duty and potentially triggering off capital gains tax?
PROTECTION OF ASSETS (1)
Q. If my son set up a family trust and leaves his house to the trust fund can outsiders come and take it from him?
A. By "leaves" I assume that you mean "gifts" now, not "bequeaths".
then the property would indeed be beyond the reach of persons suing your son in his personal capacity.
Q. He has a home and he seems to have problems with relationships. He feels that others are only after what he has. How would this stand up in court?
A. In the absence of fraud on creditors this would stand up in court.
But bear in mind that the social security and capital gains tax privileges attached to owner-occupied housing do not apply to property owned by trusts.
PROTECTION OF ASSETS (2)
Q. We want to place an investment property into a family trust in order to reduce risk of other bodies being able to claim monies from us. At the moment we are in dispute with a major company. We feel that they may take us to court over certain matters.
A. Assets in a trust cannot usually be seized for personal debts, but you could be at risk if the assets are transferred after a dispute has actually arisen and a court concludes that the transaction was a sham designed to defraud creditors. You need expert legal advice which can take all your detailed personal circumstances into account.
CORPORATE TRUSTEES (1)
Q. If a company is the trustee of a family trust, can it still distribute income to beneficiaries in the same manner as a human trustee?
Q. Or do the beneficiaries have to become shareholders in order to receive income from the trust?
A. No. This would have no bearing on their entitlements to trust distributions, although it would give them entitlements to any dividends from the company out of its own profits.
CORPORATE TRUSTEES (2)
Q. I was drawn to a book of this nature because I am looking for a structure through which to run a business (my first one) and also to protect my personal assets.
I noted with interest that the proposal to tax trusts as companies has been thrown out because such rules were felt to be too tough.
I can't help but think that this might have had something to do with the fact that many of the politicians who make such laws are personally involved in trusts. However, I am sure that there was pressure from industry as well.
I initially became interested in trusts because I came across several organisations which are promoting and offering to set up family trusts with a company as the trustee and with the investor concerned as the sole director of that company. They claim that this keeps most of the advantages of both structures and also eliminates most of the disadvantages of both structures.
Could you possibly explain how they come to such a conclusion?
A. The following comments set out a brief analysis of the position:
Such a structure effectively keeps control of the enterprise in the hands of the person who is the director of the trustee company.
Using a company as the trustee and thus the legal owner of the assets eliminates the need to make paperwork changes on the death or retirement of the person who would otherwise have been the sole trustee.
Furthermore, it achieves limited liability. Such protection is particularly useful in a business context, although professional lenders such as banks will probably still require personal guarantees from the individuals involved.
However, for income tax purposes a business structured as above is regarded as being conducted by the trust and not by the trustee. Thus if the trust is a discretionary trust - the common situation - then all the profits can readily be distributed to beneficiaries in a tax-effective fashion.
CARRYING ON BUSINESS THROUGH A CORPORATE TRUSTEE
Q. Suppose that a discretionary family trust has certain assets and carries on a business through a corporate trustee (a pty ltd company). Now also suppose that the trustee is sued for damages as a consequence of alleged negligence in the course of its business.
The assets of the trust are in the trustee's name, as they have to be, but the company does not carry on an enterprise in its own right. It acts as a trustee only for the benefit of the beneficiaries of the trust.
Are the trust's assets are under threat if the company trustee gets a verdict against it? Can the plaintiff touch the assets of the trust, either because these are in the trustee's name, or because the trustee acted and conducted the business of the trust?
A. The trust assets would indeed be under threat in these circumstances. But why should they not be? Plaintiffs ought not to be worse off just because a trust rather than an individual is involved in negligent conduct.
Q. I would find it most disconcerting if the answer here was in the affirmative, and yet this is just what I have been advised by a solicitor. It seems to me that trust assets would be way too vulnerable if they could be touched as a consequence of proven negligence by the trustee in the conduct of the trust's business.
If this solicitor is right, would it not be a better alternative to have the assets in question (such as property, cars and machinery) purchased and held in the name of beneficiaries who could then lend them to the trust, so that the trust could carry on a business for the benefit of the beneficiaries?
In short, if the negligence of a trustee is a potential liability to the trust itself, then it does not seem such a good idea to hold family assets in a trust.
A. There are at least three problems with your alternative:
Your scenario also highlights the importance of choosing as trustees persons who are honest and competent, thus reducing the risks for the beneficiaries.
GIFTS TO A TRUST
Q. I am presently looking at gifting some money to a family trust for asset protection. The trust is a discretionary trust and is already in existence. How should the gifted money be treated in the accounts of the trust? I assume that it should form part of the equity of the trust. Would this be correct?
A. Yes. You could just add it to the settled sum - that would be simplest. But, if you wished, you could credit it to a "gifts received account" or similar.
Q. If the gift is in the form of cash then it is my understanding that no stamp duty would be payable on the gifting.
A. That is correct. Gift duty was abolished throughout Australia when death duties were removed in the late 1970s and early 1980s.
Q. If in the future some beneficiaries were in need of extra money, could some of the gifted cash be distributed to the beneficiaries if the trust deed allows capital distributions? Would such distributions give rise to any stamp duty or capital gains tax?
A. You can certainly make capital distributions out of the equity of a trust if the trust deed permits this, as it normally would. A cash distribution would not attract stamp duty or capital gains tax.
But, of course, if assets were realised in order to produce the cash, or if non-cash assets were distributed in specie, then the normal rules (at the trust level) would apply.
Q. One of the advantages of a family trust is to protect an individual's assets from creditors. Since managed funds and family trusts have very similar legal structures, do managed fund investments owned by an individual offer the same sort of protection?
A. No. The assets of the trust fund would be protected against the liabilities of the fund manager, not those of individual investors.
The asset owned by an investor is the interest in the fund, usually units, which are as much at risk as any of the investor's other assets.
Q. A useful feature of a discretionary family trust is the ability for the trustee to define annually the proportions of the trust's income to be distributed to each beneficiary. Could the same thing be achieved through a managed fund?
Consider an investment in a managed fund made in the name of two individuals. It would make sense for the fund manager to allow the individuals to nominate how the distribution is to be split between them. Each time the individuals wanted to change the split, they could send a completed form to the fund manager. Is there a legal reason why managed funds do not provide this feature? Or are the fund managers too lazy?
A. The Australian Taxation Office would probably use Part IVA of the Income Tax Assessment Act 1936 (the anti-tax avoidance provisions) and its penalties against any such arrangement.
Conceptually, fund managers could provide such a facility, but not through their normal trust deeds. Also, the extra administration costs would need to be fed into higher fees, which would prejudice sales.
There would probably also be little demand for such a product - most managed fund customers tend to be unsophisticated and want simplicity. Those who are sophisticated would use their own trusts.
For listed trusts, you could achieve your purpose by executing off-market transfers before each distribution books closing date. But such transfers could trigger off capital gains tax.
However, it would seem much simpler to just use a conventional family trust and have it own the desired management fund investments.
Q. Trust structures protect an individual's assets from creditors by hiding them, so that the creditors do not know the assets exist. If the creditors somehow found out about the assets, then would they be able to lay claim to the assets?
A. No. The protection flows from trust law, not from visibility.
Q. What mechanism do creditors use to find out an individual's assets? Do they have the legal right to query the various banks, share registries and the land titles office?
A. Bank accounts, no. Share registers are public documents, but each one would need to searched individually. Similarly for land and interests in land, such as mortgages.
But, of course, assets can also be registered in the names of nominees, thus effectively hiding them from public gaze.
However, a person declared bankrupt can be interrogated as to that person's assets in a public examination (under oath).
Q. When trying to choose a managed fund, I have requested some fund managers to provide me with the last five annual reports. This would allow me to judge the tax effectiveness of a fund. Should I be surprised if the fund managers do not respond to my requests? Are they required to provide this information? Can I get this information elsewhere?
A. Fund managers can choose what information, if any, that they make available beyond a prospectus. If they do not respond to your correspondence, just do not use them.
But bear in mind that, in any case, the past is little guide to the future.
Try a few brokers and the State Library in your State. Files in newspaper libraries may also help, but understandably the papers do not encourage outsiders to use these.
STAMP DUTY RATES
Q. I understand that one tax on family trusts is the stamp duty payable on transferring assets in. Are you aware of any resource which compares the applicable stamp duty rates payable in the different States and Territories?
A. The annual Taxpayers' Guide by Peter McDonald published by Wrightbooks and obtainable in good bookshops has stamp duty rates for each State (as well as many other things).
But the duty on share transfers has been abolished and property transfers get taxed in the State where the property is located, so that you cannot really shop around for a low duty rate.
TRANSFERRING TRUST LOSSES
Q. Having regard to Part IVA, is it possible to structure a trust so that a trust loss is in some way available to a high income earner?
A. Only indirectly. For example, if a trust purchases an income-producing asset which an investor might otherwise have purchased outside the trust, then any tax losses available to the trust can be offset against that income. The investor's total personal income including distributions from the trust would then be lower, just as it would have been if the investor had been able to claim a tax deduction for the losses directly.
Q. Is a high income earner able to borrow money and purchase "income" units in a hybrid trust, with "capital" units given for a nominal amount to a low income earner? The trust then doesn't incur interest charges and thus does not make a loss. The high income earner then receives the net income and claims a deduction for the interest charges. Is this possible?
A. One does not need a hybrid trust and capital units for this purpose. Any unitised trust can issue two (or more) classes of units, each receiving a different rate of return at the trustee's discretion.
A taxpayer subject to a high rate of tax could then be given a low rate of return per unit, whereas a taxpayer subject to low rate of tax could be given a high rate of return per unit.
If the former taxpayer used loan funds to acquire the units then the interest on the loan would, generally speaking, count as a tax deduction, as an expense incurred in the earning of assessable income.
However, if the return on the units were very low in comparison to the interest being claimed and where the trustee is not at arm's length from the investor, then the Taxation Commissioner might well determine that the transaction was not a bona fide commercial one - and thus disallow the interest deduction.
TRUSTEES ALSO BEING BENEFICIARIES
Q. Are there any implications in the trustee of a discretionary family trust also being a beneficiary?
Apart from following the trust deed exactly and being cognisant of the inherent conflict of interest in deciding how to treat each class of beneficiary fairly, are there any other legal or practical aspects to be considered? Would it be important to clearly document the reasoning behind each decision taken?
A. You seem to be aware of the main considerations.
There is no theoretical reason for a trustee not to also be a beneficiary, but there are some risks - risks that you may be willing to accept. For example:
NAMING TRUST BENEFICIARIES
Q. Is there a practical limit to how many people one can name as beneficiaries in the trust deed of a family trust?
A. No, as far as trust law is concerned. But you may wish to make a family trust election for tax purposes, which would reduce your choices.
Q. Does one have to specify all beneficiaries by name, or can one say "all brothers and sisters of XYZ, their spouses and children (and their children)"?
A. You can specify them by category - for example, siblings, cousins, half-brothers and half-sisters, step-children, adopted children, de facto spouses, ex-spouses, homosexual partners, grandparents, and so on. These and others can all be included or excluded, according to taste.
But you may wish to define words such as "spouse" very carefully.
Q. My self-funded retiree parents, who are in their late seventies, have made wills that will create two testamentary trusts, one for me and my three children, and one for my sister and her three children.
They live on a 5-acre semi-rural property, which they own but which is becoming a burden to maintain.
They wish to move closer to me and lend my sister the money she owes on her house. They also wish to retain the property in which they are living, with the view that its zoning will eventually change, increasing its value considerably.
With regard to their housing needs, I see four options for them. Could you please comment on them?
A. Your questions involve lifestyle issues which an outsider cannot sensibly address. Both you and your parents should choose housing that each of you like. If this includes a house already in the family, fine - this will save buying and selling expenses, but this saving has to be weighed against the comfort aspects.
As to subdivision or extension, this can make sense if the land concerned is valuable. But you will need to talk to an architect and real estate agents to assess the economics.
Not everyone enjoys being a developer or has the necessary spare time for the task.
Also bear in mind that the criteria for a home and an investment property are often quite different.
Q. With regard to the semi-rural land, would it be possible create a primary-production business, and transfer this asset to it?
A. Yes, but this would make sense only if you want to have such a business.
Q. Would there be benefit in my parents creating an inter vivos discretionary trust in this situation?
A. Definitely. See Family Trusts, Chapter 21, for a detailed analysis.
Q. Are inter vivos and testamentary trusts mutually exclusive?
A. The literal answer to your question is, of course, "yes" - a person cannot be both alive and dead at the same time.
But a person could set up an inter vivos trust which continues after that person's death (the normal situation).
That person could also set up a separate trust by will, funded by assets in the testator's personal estate (which naturally would not include any assets previously transferred to the inter vivos trust).
However, if the same set of beneficiaries is to be involved in both trusts then it would be much simpler to make a bequest to the first trust, rather than to create another entity.
LAND TAX CHARGED TO A TRUST
Q. We have a family trust that has owned a house for over 30 years. The land tax bill has now become unmanageable. We had thought of moving into the house in order to benefit from the principal residence exemption, but we now find that this is not available for land owned by a trust.
Selling the property to ourselves first would involve substantial stamp duty, which we would naturally prefer not to incur.
Is there a way around this dilemma?
A. The only way for the trust to avoid land tax is to dispose of the property.
If it is sold on the market then the purchaser would pay the stamp duty. You could invest the proceeds in property trusts if you wanted to stay in investment property without incurring a direct land tax bill. Or you could buy shares or other assets. But whatever you buy will be subject to the capital gains tax provisions on disposal, whereas the property your trust purchased before 1985 is exempt.
Selling the property to yourselves in order to live in a house built on the site would involve stamp duty. But this would not make sense unless you really wanted to live in it.
Q. What is the status of a family trust when it becomes insolvent and there is nothing more for the beneficiaries to receive?
A. No action is required. The shell of the trust can just stay there inactive till it automatically ceases on its scheduled termination date. It could still accept gifts in the meantime and this might be useful in the future.
If you have been lodging income tax returns let the ATO know that the last return was a final one.
NON-RESIDENT TRUSTEES (1)
Q. Does the trustee of an Australian trust have to be an Australian resident? If the trustee is a company, does each director have to be an Australian resident?
A. Trustees and directors do not need to be Australian residents, but for tax purposes trusts operating in Australia would need to appoint a resident public officer. A company needs to have a resident secretary.
NON-RESIDENT TRUSTEES (2)
Q. Would having a New Zealand corporate trustee have any ramifications or adverse consequences that an Australian corporate trustee would not pose? Is it immaterial in which country the corporate trustee is incorporated, provided that all domestic compliance is fulfilled?
A. There is no disadvantage in an Australian trust having a non-resident trustee, apart from postal delays and the like.
If the trust deed is brought into an Australian State then it would be liable for stamp duty in that State - this is best paid before the trust acquires assets.
A resident adult individual would need to be appointed public officer for tax purposes.
AN UNDOCUMENTED INVESTMENT LOAN
Q. In 1998 my husband and I utilised the equity in our home to invest $50,000 in a block of land. We have never claimed on our tax for the block expenses, loan interest, council rates, etc., because we were told we couldn't because it wasn't set up as a separate investment loan.
Why when we sell it soon for $200,000, will we be hit with CGT to the tune of about $30,000? It seems so unfair that we saved for our future, back when we were on much lower incomes and could barely afford it - and now once we sell and make a profit, we will get hit hard for the privilege.
Would transferring the profit (from the sale of the block) into reducing our existing home loan, or even putting the profit into a family trust help us pay less CGT?
A. The expenses you describe would increase the cost base of the land and would thus reduce your CGT. This is not as good as an annual deduction, but is better than nothing.
The loan interest is more tricky, as you apparently increased a loan originally granted for domestic purposes. But if you wrote to the lender at the time seeking funds for an investment purpose then that would probably be sufficient evidence that the interest also constitutes part of the cost base. But set out full details as an attachment to your tax return.
Moving the profit around would be no help.
RECORDS FOR PROPERTY TRUST DIVIDENDS
Q. I am considering investing directly in listed property trusts (LPTs) and then reinvesting all income using distribution reinvestment plans (DRPs). This should increase the overall long-term return via compounding.
As I understand the rules, a percentage of the income from LPTs is tax-deferred and is becomes subject to capital gains tax (CGT) when the shares are eventually sold. I believe the tax-deferred income is used to reduce the cost base of the shares.
For CGT purposes, I understand that every new parcel of shares allotted by the DRP (in lieu of cash) is treated as constituting a separate asset purchase. However, for income tax purposes, every new DRP allotment is also deemed to be taken as the equivalent distribution payment.
As LPTs generally pay income quarterly, this would mean that there are four new parcels of shares allotted via the DRP each year. Therefore, each new parcel of shares would require separate, multiple calculations for reducing cost bases.
Over the long term, this would make record keeping enormously complex: - for example, 20 different new parcels of shares via the DRP, and 20 different tax deferred payments over five years.
What is the simplest method of keeping records for CGT purposes in this instance?
A. Your summary is correct, and for this reason many investors avoid participation in DRPs. However, in practice the Commissioner is prepared to accept reasonable approximations and, in the case of partial disposals, even calculations based on averages.
Unless your original holding is enormous each quarterly distribution and thus each additional parcel will be relatively small. The tax deferred component will be smaller still. Rather than try, in the case of the 21st payment (say), to write down the cost base of 20 small parcels and 1 large parcel just apply the total deferred component in the 21st distribution to the cost base of the original holding. Similarly each time.
If you quit your entire holding this will in practice usually give you the same total result under the discount method as if the theoretical approach in the legislation had been followed strictly, except for parcels held less than 12 months (when no discount is available). You can make manual adjustments for these, writing down the cost base of the last four quarterly parcels as required and writing up the written-down cost base of the original parcel by the same amount.
This one-off approach when needed at the end is a lot easier than trying to deal with all parcels as you go. It does not deprive the ATO of any revenue.
In the extremely rare event of a written-down cost base becoming negative some further manual adjustments would be required.
DISTRIBUTIONS OF ASSETS
Q. Can the ownership of an asset held by a discretionary family trust be distributed to a beneficiary?
A. Normally, yes, but it would need to be via a distribution of income and/or capital and in accordance with a specific resolution by the trustee.
Q. If so, is stamp duty incurred?
A. Stamp duty has been abolished on share transfers, but still applies in respect of property.
Q. Would capital gains tax be incurred as a result?
A. Such transfers are disposals for the trust at the current market value and acquisitions for the beneficiary at the same value. Thus if a gain has occurred then normal CGT would apply.
If that gain is distributed to any beneficiary then that beneficiary would become liable for the tax. Otherwise the trustee would have the liability.
A MARRIAGE SETTLEMENT
Q. A husband and wife entered into a marriage settlement by deed. The deed states that the wife is to have a life interest in the settled fund, with the remainder interest in the fund going to the next of kin.
Under the deed the husband has covenanted to transfer to the trustees of the settlement any property he receives from his father's will, but he forgot to give the trustees some antique furniture from his father's estate.
The husband died, leaving the estate to his wife. The next of kin suggests that the antique furniture should be vested in the trustees.
A. On the basis of what you say the trustee will control the assets from the husband's father's will, including the furniture (even if it was not physically handed over).
The same assets cannot also be transferred by the husband's will, as he no longer owns them. Any purported bequest would therefore be ineffective.
The wife cannot get any of the trust assets ever - she is entitled to only the income. The next of kin, as remainderman, will get the trust assets on the wife's death.
Q. I am thinking that the marriage settlement by deed giving the wife a life interest in the settled fund is a living trust (inter vivos trust).
Q. Does this mean that the trustees hold the assets of the husband until he dies and then give her the estate?
A. No. But she is entitled to income from the fund whether he is alive or dead.
Q. I am thinking that the trustees will hold the assets and she can get benefits from them until she dies but not actually hold the property?
Q. I think the next of kin would possibly have some rights to get the furniture under equity law?
A. There is no need to resort to equity.
Q. Does the fact that he left his estate to his wife in any way override the living trust?
ACCREDITATION FOR PROFESSIONAL TRUSTEES
Q. I have decided to set up a family trust and would like to go with a corporate trustee with directors who are not beneficiaries, for both independence and expertise reasons.
Is there any form of accreditation for organisations providing trustee services? Are professional trustees required to hold formal qualifications? Are there independent awards recognising excellence in this field?
A. The statutory trustee companies are governed by their own legislation. Accountants and lawyers are subject to professional standards. Possibly some university courses deal with being a trustee as a by-product of something else.
One would have to be very sceptical about attempts to measure professionalism in this field. For one thing, trusts are very private affairs. Apart from that, how would one measure "excellence" on any objective basis?
LOCKING IN ASSETS
Q. I own a property bought in 1978 on which I am currently building a holiday house. I wish to put the house plus money to maintain it into some sort of family trust so that it will be locked into the family for future generations to enjoy and not be sold off on my death.
If for some reason in the future the trust were to be wound up, the proceeds should go to a worthy cause. I am not interested in tax minimising, which seems to be main thrust of the questions sent to you. Is a family trust the way to achieve this aim?
A. You could certainly use a trust, but it would seem much simpler to deal with such wishes in your will.
However, too much "ruling from the grave" is not a good idea, as circumstances can change. You would not want your heirs to be locked into an obsolete asset that they cannot use while short of money for essentials. They may also need to work in another State.
Furthermore, the term "worthy cause" would need a careful definition.
TRUSTS AND PERSONAL DEBTS
Q. I am in a situation where I owe the tax man some money. I am the trustee of one trust of which I am a beneficiary, and a trustee of two separate trusts of which I am not a beneficiary.
Can the tax man grab any of the assets of the trust of which I am a beneficiary? And are the two other trusts at risk?
A. Provided that the documentation is in order, the assets of the trusts cannot be touched for your personal debts. But, of course, any actual distributions to you become your assets and thus liable.
Furthermore, any assets that you transfer into the trusts specifically in order to avoid your creditors could be at some risk.
TRUSTS OWNING FAMILY COMPANIES
Q. I am the sole director of and a part shareholder in a company that provides a service in construction. I have been told to set up a trust to protect my assets in case the company becomes insolvent (which I hope it never does). Would that be worth while?
Also, could the shareholders receive dividends through the trust, so that we don't pay as much tax?
A. Generally speaking, shareholders and directors of a company cannot be successfully sued for debts incurred by the company.
If you use a trust to own the company then its profits after tax could remain in the company or be distributed to the trust, as you saw fit.
From there subject to the trust deed they could be distributed to the individual beneficiaries on the lowest tax rates.
INVESTING AND BORROWING THROUGH A TRUST
Q. I am a young (27) professional engineer who has just obtained chartered status and is now able to sign off on designs. While this has resulted in an increase in pay it has also opened the door to clients that may wish to sue the company I work for and ultimately myself.
To this end I am very interested in placing as many of my assets in a family trust as I can, with my primary focus being asset protection, with possible tax minimisation as a secondary benefit.
I am currently unmarried and have no children. My intention is to provide a capital injection of about $50,000 into the trust and then allow the trust to borrow additional funds using my home (in my name) as security for the loan.
Am I correct in assuming that as the trust pays the interest on the loan as an expense before distributing any remaining income to beneficiaries, the tax benefit would be the same having the loan in my own name?
A. For tax deductibility to be available the loan must be taken out by the entity using the funds for business and/or investment purposes.
Interest incurred by a trust reduces the profit available for distribution. The value of the tax benefit then depends on the marginal tax rates of the beneficiaries.
Q. If I were sued and creditors took my home that was used a security, how would this affect the trust? Would the trust have to pay back the value of the loan or find other security?
A. As in practice the lender would have a mortgage over the home your creditors could acquire only your equity in the home, and not the actual home. The trust would thus be unaffected.
Q. I am most interested in growth assets, as these will allow me to pay less tax now. At some point in the future I might have a wife that I can distribute funds to.If I receive fully franked dividends of $70 (plus franking credits $30) and unfranked dividends of $50 but have expenses totalling $85 I will have only $35 for distributions. What happens to the $30 franking credits?
A. If a trust makes the transactions described it would distribute not only $35 cash but also $30 franking credits. The beneficiary who received the $70 franked dividends would also get the benefit of the $30 franking credits.
Q. If I keep gifting additional funds each year to cover expenses, am I able to distribute this money and the initial $50,000 to beneficiaries at a later date tax free or is this considered unfranked dividends?
A. Subject to the deed capital distributions can be made at any time and these would not attract any tax. The deemed unfranked dividend rules affect only private companies.
DELEGATING INVESTMENT POWERS
Q. My intention was have a company trustee for a family trust with my mother as the sole director initially. This would allow me to appoint a wife and then later an adult child as directors without all the transfer issues and it also distances me, thus more securely protecting my assets.
Can the director of the company trustee appoint me to manage the fund but not give me the power to make distributions? In this way I would be able to make the day to day investment decisions for the benefit of the beneficiaries but the director/s would maintain control over the distributions.
A. Subject to the deed, the trustee (through its board) could delegate the investment decisions to you.
Q. Alternatively could I have three directors of the trustee company with myself being one and making it a requirement that at least two of them are needed to make a distribution to beneficiaries while only one is needed to move money into and out of investments within the trust?
A. The trust deed and constitution of the company could certainly be drafted to achieve this, but the inflexibility could be a cause of regret later on.
BUYING A BUSINESS
Q. I am interested in buying an established cafe. It seems that my best option is to set up the business in a family trust with a company as trustee. I know that I need to first set up the family trust and buy a shelf company.
A. It would be better to set up or acquire the company first, so that it can be named as the trustee in the trust deed.
Q. My husband has a mortgage loan currently that has been invested in managed funds. I am the guarantor for that loan. Pre-approval has been granted for an extension of that loan.
Do I need to set up the trust and the company before I make an offer for the shop, because what happens if then the deal falls through and the company and the trust are no longer required?
A. The usual practice is for such purchases to be made in the name of a person "or nominee". Thus you would not need to set up the trust and the company before you make an offer.
Q. When signing the contract, who actually makes the offer to buy the business? The company as trustee, the family trust or me?
A. See above. You then nominate the company as trustee as the purchaser.
Q. If the money offer is accepted and the deal goes through, which entity should take out the extension of the loan - the company, the trust, my husband (who then makes a gift to the trust)?
A. The entity running the business and wishing to claim the interest as a tax deduction needs to do the actual borrowing. Other parties can act as guarantors if the lender requires this.
Q. Can the cafe business make repayments on a loan granted to a company or a trust or my husband, and call these "expenses"?
A. Loan repayments, as distinct from interest or fees, are capital items and can never be claimed as deductions.
Q. If I don't want to change the name of the cafe, what will be its new trading name: The XXX Coffee Shop trading under XYZ Pty Ltd as trustee for the XYZ family trust? Is that how I will set up the bank accounts?
A. You can register any name not already registered as a business name for your cafe or you can get an assignment of the existing name from the vendor, preferably as part of the deal.
The style could be "ABC Pty Ltd as trustee for the XYZ Family Trust trading as ..."
Q. We recently sold a small business - a cafe which we had held for about two years. In that time no profit was recorded and we lost money on the sale because of a hitch with the lease.
On the advice of our accountant we set up a family trust at the start up of the business. Is it better to close it now to avoid more costs? We are quite disillusioned with accountants and solicitors as we don't think that we received adequate advice, and their costs were very high.
A. It would be better not to close the trust even if it does nothing at the moment. You might find a trust structure useful in the future, and not starting another trust will save you stamp duty. There are no costs involved in retaining an inactive trust. But in your next return you should advise the ATO that you do not need to lodge returns for the time being.
Q. As we now have a large capital loss to recover (around $90,000), if we start another business can we claim that loss?
A. If the entity which actually made the capital loss makes capital gains in the future then it will be able to deduct the capital loss from those gains.
Q. My partner is an income earner with an investment property also which returns about $90,000 per annum. I am now working part-time to pay off the loan on the cafe. Could we utilise the trust in some way to save tax and perhaps recoup some of the loss?
A. Capital losses can never be set off against revenue gains.
Furthermore, personal services income, even if earned by a trust, gets attributed to the individuals responsible for it for income tax purposes.
But, for the reason mentioned above, it could be worth while making any new investments in the name of the entity which made the capital loss.
TRUSTEES MOVING INTERSTATE
Q. My wife and I are trustees of a family trust and at the end of the year we will move from NSW to the ACT to live. In one of your books you wrote: "A trust deed should on no account ever be sent outside the State in which it was created without proper advice. Such an action could make an established trust subject to substantial additional stamp duties." You also advised leaving the original trust deed in the State of its registration and taking a copy only for administrative purposes.
Are there any other implications for the Trust apart from having to leave the original deed in NSW?
A. Probably not, apart from the obvious one of notifying various parties such as share registrars, titles office, ATO and land tax authorities of the change of address.
Q. I am a bankrupt. My grandmother has just passed away leaving me a portion of her estate. I had hoped to buy a house with this legacy, but I will lose most of the money straight away.
The will cannot be changed, so what can I do to overcome my problem?
A. If the executor of your grandmother's estate has already paid you or agreed to pay you then the trustee of your bankrupt estate would treat the money as part of your assets available to your creditors.
If this has not happened yet, then try to persuade the executor not to formally admit your claim, and not to make such a distribution, until after your discharge from bankruptcy.
Q. One of the beneficiaries of a discretionary family trust looks as though he will have to go bankrupt due to a failed business. Will either creditors or the ATO be able to attack distributions in his name under the trust?
A. Once a distribution has actually been made to a beneficiary the proceeds become part of the overall assets of that individual and are therefore available to creditors in the same way as any other assets.
However, the beneficiary could request the trustee of a discretionary trust not to make any further distributions to him for the time being and for the duration of the bankruptcy, accumulating the amounts involved within the trust fund instead.
This would have taxation implications, because undistributed profits get taxed in the hands of the trustee at the maximum marginal tax rate in the system (46.5% from 1 July 2006), which may be higher than the marginal tax rate applying to the beneficiary personally. However, if after the conclusion of the bankruptcy the accumulated net amounts are distributed to the beneficiary concerned then no further tax would be involved.
While not compelled to do so, in practice most trustees would co-operate on the lines indicated.
Q. Say a discretionary family trust received dividends of $70 fully franked (with $30 franking credits attached), and paid interest expense of $50 during the year. I understand from your book that net income of $20 can be distributed to the beneficiaries. How should this distribution be reported in the beneficiary's tax returns?
If the trust also received capital gains in the year, how should the trustee selectively offset the interest expense of $50 against dividends and capital gains?
A. Actually, in your example the beneficiary receives a $50 trust distribution, being $20 cash and $30 franking credits. On the taxation return for individuals (supplementary section) the $50 goes into 12U and the $30 goes into 12Q.
Capital gains are calculated net of the expenses relating to the acquisition and disposal of assets disposed of during the financial year concerned. All other expenses are deducted from the total gross income other than the capital gains. They do not need to be apportioned.
However, trusts cannot distribute net losses, although these can be carried forward.
TRUST DISTRIBUTIONS IN DISPUTE
Q. I have a question about a simple family trust - my previous partner (domestic) received distributions in the years 1999/2000 and 2000/2001 and declared them on her tax returns. She is now in June 2006 claiming she did not receive them. The funds were used to make direct payments to creditors and suppliers with her verbal agreement.
Can she still make a claim for so long ago?
A. There are two aspects to your question:
Firstly, the statute of limitation prescribes the period within which a legal action to enforce a right must be taken, after which any such action will be statute barred. For example, in the case of simple contracts (those not under seal) the period ends six years after the cause of action arose.
Secondly, there is the question of evidence. Presumably the records of the trust would show
(a) the resolution setting out the amounts to be distributed to the claimant and
(b) a series of payments made to parties on her behalf which in total come to exactly the amounts in the resolutions and in the tax returns of both the trust and the beneficiary.
Bear in mind that the onus of proof would be on the claimant to demonstrate that she had not received the benefit of the distributions.
She should be reminded that, if she takes this matter to court and loses, then she will become liable for the costs of both sides.
ALLOCATING FRANKING CREDITS
Q. Does a trust have to specify who gets the imputation credits? How does that affect the $416 that can be allocated to each child?
A. The trustee of a discretionary family trust would specify which beneficiaries get which amounts of franked dividends. The franking credits attached to those dividends would then automatically flow to the beneficiaries receiving those dividends.
The trustee can decide which beneficiary, adult or child, or gets any amount. It is not necessary to treat each beneficiary the same.
The relevance of the $416 figure to which you refer is that this is the nominal threshold for a minor's income beyond which tax is payable.
However, franking credits and the low income taxpayers' rebate mean that in many cases a higher threshold effectively applies.
TRUSTS FOR HIGH RISK BUSINESSES
Q. I wish to use a discretionary trust structure to hold unlisted shares in a high risk business that I have recently bought into. I intend to transfer the shares from my name into the trust shortly, thus protecting the shares from any future creditors of my own, and also to distance myself from the shares as they represent a 30 per cent voting interest in the company's high risk activities.
I am concerned that if I designate myself as the appointor as well as one of the beneficiaries, the trust's assets may be challenged by a future creditor of mine, given it may be deemed that I ultimately control the trust. Am I correct in my understanding or does this concept only apply in a family court situation? If this is indeed an issue outside of the family court, would it help if I appointed my partner as a joint appointer to reduce my control?
I am also planning to use a corporate trustee structure where my partner and I would be the directors and shareholders. As well as my partner and I being beneficiaries of the trust we also plan to make our corporate trustee a beneficiary (this may prove to be a flexible scenario in the future if we appoint a different trustee one day). Would our relationship as trustees and beneficiaries be sensible given that the assets may be subject to an attack from creditors one day and we both work in high risk occupations in terms of litigation and creditor risk?
I understood that the assets of the trust remained protected in the trust regardless of the trustees' financial position, likewise the trustees' personal assets were indemnified by the trust deed, but would our position as beneficiaries jeopardise this protection?
In an answer to the question: "Are there any implications in the trustee of a discretionary family trust also being a beneficiary?" you indicated that the ATO might conclude that such a trust was a sham - why would that be the case?
Finally, in another answer you mentioned that one could name "companies" as a class of beneficiaries or one could name a specific company. But you warned that, depending on how things were structured, this could make a family trust election impracticable. My interpretation of this led me to think that I may be able to simply state the word "companies" as a category in the beneficiaries section and then in the future distribute the monies to companies as I incorporate them? Is this really that simple or even possible?
A. The positions of appointor and trustee are separate, but in the circumstances you describe it would seem better, if you wish to be a beneficiary of the trust, that you be neither. Being one of two trustees would probably not solve your problem either.
Legally, the assets of a trust cannot be seized by creditors of individuals. However, the more interwoven your roles as trustee and beneficiary are the more likely it is that the trust structure could be regarded as a sham.
As regards the Australian Taxation Office, Part IVA of the Income Tax Assessment Act 1936 gives the Commissioner the power in effect to treat any transactions of an uncommercial nature as not affecting the tax liabilities of the parties concerned.
Theoretically, "any company registered in Australia" or something similar could probably be named as a class of beneficiaries. However, to reduce the risk of the documentation being regarded by a court as void for uncertainty, it would seem better to have some link to other beneficiaries - such as specifying as a category companies of which at least one shareholder is an individual beneficiary of the trust.
CONFLICT OF INTEREST
Q. I want to buy my own home; however, I cannot currently afford to buy the home that I want. My parents have kindly offered to help me with the purchase of the home with the proviso that eventually I buy them out. The bank has said that if we purchase the house as tenants-in-common we will each be liable for the full mortgage, which is not a suitable arrangement for us.
If we purchase the house in a unit trust structure of four units of 25 per cent each, with my owning one unit, can I then rent the house from the trust or would this be regarded as a conflict of interest?
Also, can I sell the other units to anyone so that I could buy a better house and how would I go about advertising this?
A. The term conflict of interest refers to the state of affairs when a person in a decision-making situation has a duty to others which could be at variance with a benefit to that person - for example, a person negotiating a contract between himself or herself in a personal capacity as one party and himself or herself in the capacity as the trustee of a fund as the other party.
Thus a conflict of interest would not arise merely because you were a tenant of the unit trust, as long as you had not been involved in the decision-making process. Thus you must not be a party to the decision to lease the premises to you or to set the rent or other conditions.
The trust deed can be drafted so as to give you the right to sell your unit in the trust to anybody at large. However, it may be difficult in practice to find a willing buyer at a reasonable price, although you could discuss the possibility of this happening with one or more estate agents in the area concerned.
Of course, the possibility always remains that your unit may be purchased by one or more of the other unit holders or some other member of your family.
Q. Is it possible to set up a family trust between siblings? My brother is single and on a high salary and wants to ensure his nieces and I are his beneficiaries, and would like that to be more active than the way it is set up at present, which is in his will.
In my own will I am also leaving him in charge of my estate. My children are still of primary age and he can obviously contribute directly to an education fund, which allows them to benefit now, but he and I would like to invest together, and a trust would seem to be a good way to protect any asset we invest in, as well as benefit us in the present.
A. Yes, siblings can be involved as trustees and beneficiaries in the same trust. But if the gifts to the trust and the distributions from the trust are widely different proportions then this could lead to friction.
To minimise conflicts of interest an independent trustee might be advisable.
Q. Can the family home be protected as part of a trust?
A. Yes, but this would make it subject to capital gains tax and it could prejudice social security benefits.
Q. Also, is it possible to be involved in more than one family trust at a time? My main goals are asset protection, further investment and benefits coming through to my children.
A. Yes, but this would involve bigger costs. It would also mean that capital and revenue losses in one trust could not be offset against gains in another. On the other hand, in some States there could be land tax advantages.
A single discretionary trust with a carefully drawn-up trust deed would probably achieve your wishes.
TRUSTS OWNING PROPERTY
Q. We are new family trust "users" and I was wondering if we purchase a block of land or a house, does this attract the normal stamp duty?
A. This is probably different in each State, but normal stamp duty would apply to properties purchased by trusts. However, houses in trusts are not eligible for the First Home Owners' Grant and in some States trusts are subject to higher land tax.
Q. I have established a family trust with a corporate trustee and corporate beneficiary. I was wondering whether the corporate beneficiary is able to provide an interest-free loan to the family trust.
The family trust can then invest the funds as it sees fit, repaying the loan at some time in the future. Would this be regarded as a deemed dividend to the family trust?
A. The corporate beneficiary is no doubt a private company and the trust is associated. It is therefore caught by sections 108 and 109B to 109ZE of the Income Tax Assessment Act 1936, which is designed to catch profit distributions disguised as loans.
If the company has undistributed profits (whether arising from trust distributions or otherwise) then the loan payment would be deemed an unfranked dividend.
However, if the company has no undistributed profits (either because it has distributed all past profits already or never made any) then the loan advance would be regarded as having been made out of its own capital resources and thus not as a deemed dividend.
Q. I have a question here about the trustee. My sister has a family trust set up with her husband. She is the primary beneficiary and her husband is a beneficiary and the trustee. Both of them are jointly the appointors. They are currently separated. So is it possible for my sister to request to change the trustee as he is no longer fit for carrying out the best interest of the beneficiary under these circumstances?
A. The word "joint" means that both persons must agree. Thus a change of a trustee can occur only with the support of both husband and wife.
Of course, your sister can make a request - but in the circumstances it seems unlikely that it would be granted.
It might be worth while considering a commercial rather than a legalistic approach - possibly husband and wife could engage a mediator with a view to evolving some compromise solution to the trust's affairs.
ASSETS AT RISK
Q. I am involved a civil court case. The problem was not my fault, and I was pushed into lodging a cross claim. If I lose the case, will the court seize my family trust?
A. If you lost the case the court would probably order you to pay a certain sum of money to the other side.
If you did not pay up then the other party could have you declared bankrupt or alternatively arrange for the sheriff to seize certain assets belonging to you personally and then auction them to produce money to satisfy the judgement debt, interest and costs.
Trust assets under the control of a trustee (whether yourself or somebody else) are not assets belonging to you personally. This assumes that the documentation is in order and that no fraud was involved.
In the case of bankruptcy any payments that you have made in the last six months could in many cases be reversed.
Q. What about my self-managed superannuation fund? Can it be seized as well?
A. The same principles apply here.
Q. Quite frankly I don't really understand why anyone would buy property in a trust if he couldn't claim any of the losses. Surely any structure that restricted someone's ability to buy more property should be given a wide berth and instead property ownership should be spread between husband and wife.
A. A single negatively geared property in a trust does not, as you say, produce a favourable tax and cash flow scenario in the short term. However, such a property as part of a portfolio which also contains shares or other income-producing assets which would allow the interest to be deducted in full would make sense.
Furthermore, a property which starts off being negatively geared can become positively geared over time as the rent increases and as the outstanding loan is reduced.
Any unused losses of the early years can be carried forward and used as offsets in later years.
TRANSFERS OF EXISTING ASSETS
Q. My wife and I are a little confused about in what name we should put our assets. We both read somewhere that one can have assets such as shares, managed funds, property and so on in a trustee's name held for a family trust.
I have a managed fund investment in my name and my wife has a unit in her name, so does this mean we can just "move" them into the family trust without having to pay stamp duty as the name has not changed? I assume that we would incur a CGT event. I assume also that the assets should be in the name of the family trust so that we can stream income?
A. Once a family trust has been set up assets owned by any person can be gifted to the trustee of the trust. This would require appropriate transfer forms and, as you say, would be a CGT event (a disposal at market value). Stamp duty would not apply to shares or managed fund units, but it would apply to property.
The trustee of a discretionary trust can decide which beneficiaries should get distributions each year.
TESTAMENTARY TRUSTS (1)
Q. Is it correct that, as long as a will provides for it, a testamentary trust can accept additional sums later on?
A. The expression testamentary trust is not a legal term. The tax legislation gives certain privileges to the "net income of the estate of a deceased person" and these would seem to flow from the origin of the trust by will - rather than by deed inter vivos - and not from how the wealth of the estate got there.
TESTAMENTARY TRUSTS (2)
Q. What should one do in regard to assets to be mentioned in a will if the family already has an existing family trust and wants to leave those assets to named beneficiaries in the existing family trust?
Specifically, is it better to use the existing family trust as the vehicle for this or should we establish a new testamentary trust effective upon our death?
If we do use the existing trust, are there any stamp duty/disposal of assets (CGT) issues, which we understand would not exist with the latter?
On death, we would want the assets to stay invested in the trust fund. This would then be used as the means by which annual distributions could be provided. Currently, the beneficiaries are all under the age of 18.
A. You can get the best of both worlds.
Your best strategy would probably be to provide in the will for a discretionary testamentary trust with beneficiaries including both the existing family trust and the children. Then while these are under 18 they can get annual distributions at the non-penal rates.
When they are all over 18 you could make a capital distribution to the family trust and then wind up the testamentary trust, so as to reduce future administrative effort. However, this might not be worth doing if it led to a loss of the pre-1985 status of any assets. Capital gains tax would not apply at the disposal to the family trust stage. Stamp duty would apply to property transfers.
CAPITAL AND INCOME
Q. Under what circumstances (if any) are contributions to trust funds from beneficiaries (or others) considered to be taxable income of the trust funds?
A. These would be capital items and thus not taxable.
Q. Suppose that you are the appointer/beneficiary of your family trust and you want to use the equity in your home to finance a purchase of investment assets by your family trust. My understanding is that the trustee would take out the loan on behalf of the trust (in order to ensure that the interest is deductible) and that you would give a personal guarantee for the loan and secure the guarantee by a mortgage over your home. The trust then invests the loan money and earns returns. The trustee uses the returns to pay the interest on the loan only (that is, no principal repayments) and then distribute the rest to you or other beneficiaries.
A. Fine. But, of course, the "rest" could be negative, in which case tax losses would need to be carried forward.
Q. Firstly, does this mean that the trust will not pay any tax (because its only income is offset by the cost of interest)?
A. The trustee would pay tax only if gross income exceeded outgo and the net balance were not distributed in the year concerned.
Q. Secondly, if you then use the money that was distributed to you to pay off some of the loan principal, is this considered to be income to the trust (or is it taxed in any way)?
A. Income distributed to you would be taxed in your hands, regardless of how you used it. Loan repayments would be capital amounts.
Q. Are any specific qualifications required and/or expected by the government or the ATO for a person who completes the ongoing returns and statements for a family trust or company?
A. No formal qualifications, but probably the following:
Q. Trustees have a legal and moral obligation to invest their trust funds in the best interests of the beneficiaries. Thus is it appropriate for them to use gearing, as long as their trust deeds permit such borrowing? In particular, may they engage in negative gearing?
A. The intention of all gearing for investment purposes is to access a larger pool of money - namely, the investor's own stake together with outside loan funds - than if only a smaller pool - the investor's own stake by itself - had been used instead, thus hopefully producing a much higher net return for the investor and a larger benefit from inflation.
Negative gearing in addition enables the investor to get a legitimate tax deduction for interest and expenses. This can be used as an offset against other income.
However, property investors who use borrowed funds expose themselves not only to the risks of investors in general and to the special risks of property investors in particular but also to some additional risks arising directly from the borrowing relationship.
In particular, apart from the possibility of making a loss instead of a profit, a trustee engaging in borrowing can also face the situation that the trust fund will not have the necessary cash resources to repay the loan on its due date (or at all) and that the lender will be unwilling in the circumstances to roll over the loan.
Trustees also need to have regard to the risk profiles and cash needs of their beneficiaries. There are thus no black and white answers to these questions, but clearly trustees should avoid some of the classic mistakes often made by individual investors. In particular, trustees should not:
FAMILY LAW ACT
Q. I am getting married shortly. I need to make provision to protect my assets (house and land, etc.) from the property distribution provisions of the Family Law Act. The properties are all in my personal name.
Instead of obtaining loan monies from a bank, I will borrow funds in tranches of $5,000 to $10,000 at a time. Will such a strategy be effective to protect my assets?
If so, what type of trust should I use? Should I be the trustee of this trust or should it be separate and distinct?
A. From the supplementary information you supplied it seems that the essential element of your proposal is the reduction of your personal wealth by a series of gifts to a trust. That would take the assets concerned out of the jurisdiction of the Family Court, but if you are a beneficiary of the trust then the court might take them into account when apportioning your other assets.
The type of trust will make no difference. Theoretically your being trustee should make no difference either, but it might help your case if you had a different trustee.
An alternative you might consider is a prenuptial agreement.
Q. I have five negatively geared properties in a trust. Income earned by the trust in the past has enabled me to accumulate sufficient cash to make a positively geared investment in the stockmarket. What I am considering is the following:
Shares will be purchased and the purchase of these shares will be leveraged (through margin lending). So there will be interest payable on the margin loans.
Options will be written on the underlying shares owned. This will earn fees. The fee income less the interest payments on the margin loans will be sufficient to cover the net interest cost of the property loans.
Can I offset the net income from my fees against my interest outgoings?
A. If all envisaged transactions are done by the trust then the trust's taxable income each year would include:
rent, dividends, franking credits, option premiums received, capital gains
interest on property loans, interest on share loans, capital losses
CHILDREN WITH DISABILITIES
Q. I am interested in trusts for children with disabilities. Are child beneficiaries with a disability are concessionally taxed? Or are they taxed as minors?
A. Child beneficiaries with a disability are taxed at the same rates as adults, but not at the penal rates applying to the investment income of other minors.
Q. Is it possible for a settlor to transfer land to the trust at a later date or must it be transferred at the time of signing the trust deed?
A. It can be transferred at any time.
Q. Is land considered transferred when the stamp duty on the land being transferred to the trust is paid or when the stamp duty for the trust deed is paid?
A. It is transferred when the stamped transfer of land form is lodged.
Q. If the land is still in the settlor's name, how can the land be sold by the trust?
A. No rational purchaser would buy land from a vendor who did not have title to it.
NON-RESIDENTS OWNING LAND
Q. If I were the trustee of a family trust and wanted to transfer a block of land from the trust into the name of my wife (who is a resident) and into the name of myself (who is a non-resident), what would be the best way for us to proceed so as to minimise tax?
A. Such a transaction would be no problem, other than possibly in regard to FIRB rules re non-residents buying land. Normal stamp duty and capital gains tax would apply.
CAPITAL GAINS TAX DISCOUNTS
Q. If a company is a trustee, will the trust still benefit from the 50 per cent capital gains tax deduction on the sale of land?
A. Trusts which distribute all their profits do not pay any tax at all, regardless of whether the trustee is a corporation or an individual and regardless of the nature of any asset disposed of.
If a trust distributes capital gains to individuals, then these would be entitled to exactly the same 50 per cent discount as if they held the assets directly.
TRANSFERRING ASSETS TO A TRUST
Q. Over the years I have accumulated a fair amount of personal investment assets. If I transfer my personal assets to a trust, then these assets are subject to CGT. Is there any way that I can at least minimise the effect of CGT?
It has taken me a great many years to build up my assets and only now I find out that I have to lose a lot of money in tax if I want these assets to be protected. These assets are the results of many years of my hard work.
A. As you obviously realise, assets transferred into a trust whether by sale or gift are regarded as disposals by their owner at their market value at the time. If these assets are all showing capital gains then you cannot avoid capital gains tax, but if some are showing capital losses then you would pay tax on only the net gain after deducting the losses from the gains.
If what you are trying to do is to get personal assets out of the reach of creditors then you might like to hang on to the actual shares but borrow against them (and possibly against other assets), to the maximum extent possible. You can then gift the resulting cash to the trust, thus reducing your personal assets. Later on you can make new investments within the trust.
The interest would not be deductible under this scenario, but it would be if the trust were unitised (or if you formed a new trust that was) and you purchased units instead of making a gift.
Q. Do tax losses have to be written off against profits in one financial year or can part of the losses be used in one financial year and the remainder in the next?
A. Both capital and revenue losses can be carried forward indefinitely, but they need to be used up against profits at the earliest possible opportunity. Capital losses can, however, be written off only against realised capital gains.
Q. If a company is the trustee, does it affect how losses are written off against profits or are the rules the same as in the case of a human trustee?
A. The same.
Q. Is a loan to the trust considered a loss and thus is it permissible to treat it as a write off against profit?
Q. When a trust pays off a loan, is the person who receives the cash liable for tax?
A. Only in respect of the interest component.
CHANGES ON MARRIAGE
Q. I am a beneficiary of a family trust and also a guarantor in respect of some of its liabilities. We currently run a business under the trust and we also have several investment properties.
I have recently become engaged to my partner. The family home is currently in my partner's name. If the trust is sued after we are married can the house be taken to satisfy any judgements against the trust?
A. Personal assets cannot be used to meet judgements against the trustee of the family trust.
However, you also mentioned that you are a guarantor. In that case, you may become liable under the terms of the guarantee.
Q. Does my partner have a say in the trust?
A. Not automatically.
However, the appointer under the trust deed may be able to make the partner an additional trustee or even a replacement trustee, if that is desired.
Q. Were do all our assets sit in relations to the trust? Do they become property of the trust, or do they stay as our individual property?
A. They stay as they are, unless you specifically transfer any of them to the trust fund by way of gift or sale.
Q. I was just wondering about trust accounts. My situation is that in my divorce settlement I will get a small sum, about $20,000, from my ex-husband's superannuation. He has stated that if he gives me that money he wants it to go into a trust account for our six-year-old son. What does this mean?
A. If the money is paid by virtue of a court order, then your ex-husband cannot attach any strings to it.
On the other hand, if the payment is voluntary, then he can attach whatever conditions he wants to it.
But, having regard to the amount of only about $20,000 involved, a trust arrangement does not really seem appropriate. It may well suit both of you to use a simple gentleman's agreement to the effect that the money will be paid into a bank account maintained by you and used only for purposes relating to your son - for example, for his education, clothing, medical expenses, dental expenses, and so on.
Q. My ex-husband may not be able to pay me any maintenance in the next few years, so would I be able to stipulate the use of some of that money for costs incurred in raising our son? Who should set up the suggested bank account? Should both our names be on the account?
A. Possibly, but it seems better that the two of you can go your separate ways.
Q. What are the costs involved?
A. Some banks do not impose fees on bank accounts for children. You need to shop around.
Q. As parents we are getting older and have the need to set up a family trust for a disabled son who will not be able to cope financially when we are no longer around.
I would also like to include my other sons in any arrangements, with the view to securing assets left for their future through a trust.
I am also considering sacrificing additional salary into a self-managed superannuation fund, so I would appreciate any recommendations on honest advisers to help set all this up.
A. Unfortunately, an outsider has no means of judging the honesty of investment advisers.
But it would be desirable to use an adviser who charges at an hourly rate and rebates all commission in full. That would reduce the conflict of interest inherent in commission-based advice.
SETTING UP A NEW TRUST
Q. My elderly parents have made wills appointing me as executor and trustee and leaving all their estate to my sister and me.
They also want to give me money now before they die, but because of the lifestyle my sister has chosen they do not want to give her large amounts of money. They are also concerned at what she would do with a lump sum of money when they die.
Their accountant has suggested a family trust in which my father is the trustee and my parents, my sister and I are beneficiaries. This is also intended to reduce the tax my father currently pays.
What happens when my parents die? As their executor I presume that I would also become the trustee of the family trust. Would I be obliged to make equal distributions of trust income to my sister and myself or would the distribution of the trust income be at my discretion?
A. A new trust can be set up to do whatever its creator wants it to do - for example, in regard to the identity of the initial trustee, the filling of vacancies in that office, the powers of the trustee, the discretions in respect of distributions and so on.
When preparing a trust deed it is most desirable to consider not only the legal aspects but also the practical ones in regard to who has the skills and other attributes appropriate for the office of trustee.
In your case, the executor of a trustee does not automatically become the successor trustee, but such a result could, if desired, be obtained by suitable wording in the trust deed.
The whole point of a discretionary trust is that the trustee has complete discretion in regard to distributions from the trust.
You say that the proposed trust is intended to reduce the tax that your father currently pays. That would depend on the relative marginal tax rates of the parties and it would also be necessary to take into account any capital gains tax and stamp duty that would be incurred when transferring assets into the trust.
CHOOSING A STRUCTURE
Q. I am 29, and have had a goal to achieve financial independence throughout my 20s. I have had some success so far, having now a net worth of $350,000. I recently married my wife and we have had our first child, who is now nine months old. I am also starting a technology business.
Since having our boy, the goal to make our family independent has become both much more important to all of us, and much more challenging. At the moment I own assets (property and shares) in my name. I want to establish a vehicle for our family to become independent within 10 years from now.
I have been researching a trust/company structure. At the moment I believe the best way to go will be to sell the properties in my name, and gift both the cash and shares to the trust.
Once the trust has its initial capital I will start purchasing investments on our behalf as one of the directors of the trustee company, and for as long as my wife is at home and not earning an income she can be the beneficiary for any income we derive.
As I start to build up my business I may decide to use some of the trust earnings to support these endeavours, too. When I decide to leave full time employment and start my business on a full time basis, and my wife returns to work, I can be the recipient of any income derived from the trust, as I will most likely not derive a salary from the business in its early stages.
Over the 10 years we operate this structure my intention is to make the best investments possible to increase the value of the trust's assets to over one million dollars. I would anticipate this amount will be sufficient to have an annual income from the trust (split equally between my wife and me), which will cover our outgoings, essentially rendering us financially independent.
At that point I imagine that we will continue to work, but will have the opportunity to choose our employer and our vocation according to what suits us rather than according to what is expedient.
How are assets owned by an individual transferred to a trust/company structure most tax effectively?
A. Existing assets could be sold or gifted to the trust, but either way this would be regarded for capital gains tax purposes as a disposal at market value by the asset owner.
Q. What are the pros and cons of an "on demand" loan to a trust?
A. The pros are its flexibility to both parties. The cons are that a demand by one party may not suit the other party.
Q. Doesn't that expose the loan amount to creditors if the individual the money is borrowed from becomes subject to litigation?
A. The loan would be an asset for the lender and thus available to creditors. But so would the money be an asset if it had not been lent.
Q. Would a cash based "gift" to the trust reduce that exposure?
Q. Am I right in saying that the downside of gifts as opposed to loans is that should a lender wish to receive the money back this could be done without any tax consequences?
A. Both loans and gifts are capital transactions and if in cash have no income tax consequences for either party.
Q. What requirements are there for statements, documents, returns, etc., for a family trust or company?
A. Trusts: the only legal requirement is for tax returns, but a prudent trustee would also produce minutes and annual accounts.
Companies: tax returns as for trusts, plus an annual return under the Companies Act 2001, as well as minutes and annual accounts.
Make sure that all returns are signed in accordance with the instructions.
Q. Can the accounting be done by an individual on behalf of the company and trust to reduce these ongoing costs?
A. Yes, if the individual has the necessary skills, time and authority.
Q. What is the maximum tax-free distribution that can be made to a minor without needing to file a tax return on behalf of the minor? On the ATO web site it says $772 for 2005-2006 financial year (this takes into account the low income tax offset). So the trust should be able to distribute this for every minor without any problems.
A. Yes, provided that this is the minor's only income.
Q. If the minor receives income with imputation credits and foreign tax credits associated with it, then I believe that the minor would need to file a tax return to get that money refunded?
TRUST TAX RETURNS
Q. I went around asking accountants to do the first tax return for my family trust. They are all asking around $1000 for this. I don't know why it is that costly. I've looked into the tax return (six pages) and it doesn't seem all that complicated.
A. It isn't. If you can cope, do it yourself (as trustee).
Q. Are there any public services available that can help out in filling out a trust tax return?
A. There are tax agents, but they work in the private sector.
There also trained volunteers who act pro bono - for example, for low income disabled persons (but only in respect of simple individual returns).
Q. Does the trustee of a family trust have to keep formal minutes?
A. There is no specific legislation dealing with minutes as such, but these would be regarded as good practice. Furthermore, taxpayers are required to keep adequate records. Presumably in some cases letters to beneficiaries and accounting entries signed by the trustee would suffice.
Q. I understand from my study notes that if the terms of a trust are changed - for example, in respect of the of beneficiaries - this would be regarded as a resettling of the trust or the establishment of a new trust, with capital gains tax and stamp duty implications.
If this occurs, is it the trustee who is liable for tax and stamp duty or can this be shared by the beneficiaries?
A. The government would not care whose money was used to pay the stamp duty. However, usually the original trust deed and/or the amending trust deed would authorise the trustee to pay such duty out of the trust fund.
As regards CGT, the "old" trust would be regarded as having disposed of the trust assets to the "new" trust at market value. This would trigger off CGT as for any other disposal. If the capital gains were distributed to beneficiaries then these would include their portions in their own tax returns; otherwise the trustee would pay CGT out of the trust fund as tax on "income to which no beneficiary is presently entitled".
In practice the parties to proposed resettlements might like to obtain a private ruling from the ATO before acting.
DONATIONS TO CHARITY
Q. I am aware that one of the advantages to using a family trust historically was the ability to make tax deductible donations to charities that don't normally attract such a concession, such as churches. Does this advantage still exist?
A. These days tax deductibility generally depends on the DGR status of the donee, not on the type of donor.
STARTING A TRUST
Q. I wish to create a family trust in Queensland. The family trust is to own all shares in a trading company which is yet to be incorporated. My husband will be the sole director. He and I will be the trustees and beneficiaries of the trust. I will also be the appointor. Other beneficiaries will be our children and grandchildren as usual.
The main purpose is for the protection of assets from possible adverse consequences of the business operation, while on the sideline the trust will provide a tax benefit if the business is doing well.
Can you see any problems with this structure, apart from conflict of interest issues or the risk of a change of legislation?
Q. Does the trust deed have to be witnessed by a third party? Does the witness need to be a JP?
Q. If we are happy with the contents of the deed, can we execute the deed without a solicitor?
Q. Do we need to file it with a solicitor?
Q. Do we need to lodge a copy of the deed with the Office of State Revenue and pay any duty on it?
A. In most States, yes, but Queensland is often different. There seems to be a duty only for corporate trustees. Contact the Office of State Revenue and explain your circumstances.
Q. Since the trust will own all the shares in the company, do we need to have the trust duty paid before we lodge an application with ASIC for a company to be incorporated?
A. It is usually better to establish a trust with only nominal assets and have any deed stamped at that stage, but if you want to name a corporate trustee then obviously it needs to be in existence first.
Q. As the settlement sum will be a nominal $10, how will I account for the fees paid to register the company? For example, should I account for the amounts paid as a gift or a loan to either the company or the trust?
A. The government would not care whose money was used to pay the registration fees but neither a non-existent company nor a non-existent trust can pay anything.
FORMING A RESIDENT TRUST
Q. My husband and I are Australian citizens who have been working overseas for the last three years and intend to be based overseas for a few more years. For tax purposes, our accountant has advised us to be classified as non-residents.
We previously bought a few properties under our names and now feel that it would be better if we bought more properties under a family trust. However, as we are non-residents our accountant says that we cannot set up a family trust until we resume residency in Australia. Is that correct?
Could we set up a family trust with my brother (who is an Australian citizen and resident)? If he were to be a co-trustee, could we further down the track remove his name once we resume residency in Australia?
A. You can easily set up a trust in Australia by having a person in Australia act as the settlor and execute the trust deed in an Australian State or Territory. The place of residence of the beneficiaries would be irrelevant.
Your brother could certainly act either as a sole trustee or as one of several trustees. You could be named as appointors, with the right to change the trustees later on.
It is best to use as settlor a friend who is neither a trustee nor a beneficiary.
For tax purposes you need either an Australian resident trustee or an Australian resident public officer, unless the sole income of the trust consists of dividends and interest subject to withholding tax.
Your accountant may have been alerting you to the restrictions on non-residents owning land in Australia, rather than to any family trust aspects.
Q. Does this mean that I have to get one person to be the settlor and another person to be the trustee? So my brother can't be both settler and trustee?
A. It is usually considered desirable to use different persons, to prevent legal challenges as to the bona fides of the arrangement.
But the settlor could be any adult resident who consents to the use of his or her name and who can spare 30 seconds or so to sign the trust deed and then forever disappear from the scene.
THE VALUE OF AN INDEPENDENT TRUSTEE
Q. I had a family trust set up some years ago to take care of our assets to be passed to the children. Recently I reviewed the trust deed, as I wanted to appoint an appointor in the event of my death. I wanted to appoint one or both of my children if the younger one has also come of age.
However, I noticed a clause in the deed which states that: "Notwithstanding anything else contained in this deed, a successor trustee is prohibited from being a beneficiary under the deed. This clause shall not be capable of amendment."
I thought that this defeats the whole purpose of having the trust, as my husband and I would naturally want our children to take over the trust when we are gone as successor appointors and trustees. This clause seems to render this intention useless.
Can we, as the original appointors and trustees of the trust, strike out this clause by amending this trust deed?
There is also another earlier clause which states that the trustees with the approval of the appointors may amend the deed as long as the amendment is not for the benefit of the trustees themselves. Can you comment?
A. It is possible, although unlikely, that the trust deed could be amended by a court. You will need to explore that with a solicitor.
However, before doing this, you might like to reconsider your wishes. The deed was obviously drafted with a view to protecting the children as beneficiaries from themselves, and for this purpose arrangements were made for the trustee to be independent of the beneficiaries after your death.
An independent trustee would be very useful in the event of disputes between the children and also if one of them becomes subject to a drug habit or a gambling habit or something of that sort. Apart from that, such a trustee can be chosen for his or her skills - for example, in investment matters.
Nothing in the wording you quote suggests that the children cannot still be beneficiaries of the fund, which presumably was your main intention when you set up the family trust.
CHANGE OF TRUSTEE
Q. My solicitor has informed me that if I were to be replaced by my daughter in the event of my passing as co-trustee (the other trustee being my husband), capital gains tax would be incurred as a result of the change of name on the title deeds of the assets (in this case, properties) because of the change of trustee. Is this correct?
I thought that the CGT should not have occurred as the trust's assets has not changed; what has changed is the trustee and if we can prove to the Titles Office that no property has changed hands, no CGT should have been charged.
A. No CGT is payable on a change of trustee. Self-assessment applies, but make sure that any change of trustee is properly minuted.
Nor is stamp duty payable on the change of name on title deeds, although the revenue authorities in your State will probably want a statutory declaration confirming that there has been no change of beneficial ownership.
GIFTING SHARES TO A TRUST
Q. We bought some shares, but now that we have started a family trust, can we gift those shares and pay capital gains tax once the trust sells them? Or do we pay capital gains tax when we do the transfer?
A. When you make the gift to the family trust you will be liable to capital gains tax on the difference between your cost base and the market value at the time.
The family trust will be liable to capital gains tax on the difference between this market value and the proceeds if and when it sells.
Q. What are the main pros and cons of negative gearing for family trusts? What are some of the common mistakes people make when using negative gearing?
A. Investing by trustees requires greater conservatism than investing by individuals.
Some of the pros of negative gearing are as follows:
The intention of all gearing for investment purposes is to access a larger pool of money - namely, the investor's own stake together with outside loan funds - than if only a smaller pool - the investor's own stake by itself - had been used instead, thus producing a much higher net return for the investor and a larger benefit from inflation.
Negative gearing in addition enables the investor to get a tax deduction for interest and expenses which can be used as an offset against ordinary income.
Some of the cons of negative gearing are as follows:
Property investors who use borrowed funds expose themselves not only to the risks of investors in general and to the special risks of property investors in particular but also to some additional risks arising directly from the borrowing relationship.
Apart from the possibility of making a loss instead of a profit, borrowers (and especially borrowers that are family trusts) can also face the unpleasant situation that they will not have the necessary cash resources to repay the loan on its due date (or at all) and that the lender will be unwilling in the circumstances to roll over the loan.
Some common mistakes are:
Q. I recently heard of a scheme being promoted in Geneva which is called a perpetual trust. It calls for a customer to deposit money into a special account. Only the depositor can reclaim this money and the interest thereon, but he can do that either in his present life or in a future life after his reincarnation.
To succeed in such a claim the depositor must give several passwords which he alone or his reincarnation will know. Thus wealth, hard earned in this life, will not be available to his progeny to squander, but it will be accessible to the deceased in any future early existence.
Does such an arrangement exist in Australia?
A. This must be the most unusual question yet.
Admittedly, some people believe in cryonics, the freezing of a recently deceased person's body to stop its tissues from decomposing. The body is preserved in the hope that new medical cures will be developed in due course that might bring the person back to life. Cryonics is viewed with skepticism by most scientists and doctors today.
However, it seems most unlikely that any trust on the lines you described would be recognised by Australian law at this time.
NON-RESIDENT BENEFICIARIES (1)
Q. One of the beneficiaries of my family trust is a permanent resident of Australia but has been overseas for the entire financial year. Would she be classified as a non-resident beneficiary?
A. The ATO's Tax Pack explains such matters in simple language.
NON-RESIDENT BENEFICIARIES (2)
Q. I am the trustee of a discretionary family trust. All the trust assets are in Australia. The trustee and all the beneficiaries except one are Australian residents. The concept of trusts is not known in the European country in which that beneficiary is living and the country concerned imposes a net worth tax on the world wide assets of its residents. It also taxes world wide income.
The accountant for that beneficiary has asked for an explanation of how our trust works, so that he can better look after the tax interests of his client. He also wants certain information in regard to the assets of the trust. What should I tell him?
A. You could write to him on the following lines:
"Under Australian law a trust is similar to a deceased estate, with the trustee corresponding to the executor and the trust deed corresponding to the will.
"The trust under discussion is a discretionary trust. The trustee has absolute discretion as to:
"The trust deed defines beneficiaries categorically. The class is large and includes persons not yet born and persons who become spouses of existing beneficiaries.
"The beneficiaries have no rights against the trustee except in respect of actual distributions to them. Most potential beneficiaries would not even be aware that they have that status.
"The trustee is an Australian resident and all trust assets are held in Australia.
"The concept of a trust of this type is based on ancient English law. Under this type of trust:
"Such a trust is not a legal entity in itself and is not taxed as an entity.
"Most trusts in Australia distribute all income to the beneficiaries each financial year ending 30 June. If a trust were to fail to distribute its income fully then the trustee would normally incur heavy tax rates for any undistributed income. It can safely be assumed that all the income of our trust will be distributed to the beneficiaries each year.
"Under Australian tax treatment the income distributed from a trust retains its character, that is, capital gains, interest, unfranked dividends, franked dividends and so on when distributed to a beneficiary are all treated as though that beneficiary had earned the same type of income.
"Tax on the distributed trust income is then borne by the beneficiary as though it were regular investment income of the same type.
"Australia taxes the Australian income of non-residents and this includes such income passing through trusts. In the case of interest and dividends the payer (a term which includes trustees) is required to deduct withholding tax and remit it to the government. This then exempts the recipient from the need to lodge an Australian income tax return in respect of that income.
"Australia does not tax the non-Australian income of non-residents and this includes such income passing through Australian trusts.
"Trustees in most cases will therefore consider the taxation position of the respective beneficiaries before deciding how to distribute the trust income.
"For cash flow reasons distributions are rarely made in cash. Normally the distribution is declared by the trustee, and the beneficiary agrees to lend the net amount back to the trust (usually at zero interest).
"The beneficiary for whom you are acting has no legal rights to any of the assets of the trust. Nor has that beneficiary any entitlement to information in regard to the net asset position of the trust. The trustee would not regard himself as being under any obligation to disclose the asset position of a trust to anyone other than the Australian tax authorities."
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