AN INTRODUCTION TO FAMILY TRUSTS

Q. What exactly is a Family Trust and what types of trust exist?

A. The word "trust" is a technical legal term which refers to a relationship, based on confidence, under which property is held by and formally vested in one party, who is known as the "trustee", as its legal owner, but on behalf of other parties who are entitled to the fruits of that ownership - the "beneficiaries" (or "objects") of the trust.

The term "family trust" is a purely descriptive one; it is not a legal term. The beneficiaries of such a trust would in the main be members of the family of the person instigating the arrangement.

Many different types of trust exist at law. To illustrate, superannuation funds normally involve trust arrangements, as do many charities. Solicitors, stockbrokers and other professionals use trust accounts in respect of clients' money. Other uses of the concept commonly encountered include cash management trusts and unit trusts generally.

An inter vivos family trust can be thought of as a similar arrangement to that provided by a will, except that it allows a person to pass on his or her assets while still alive. It is set up by means of a trust deed.

It is also possible to set up a family trust by will instead of by deed. Such a trust is known as a testamentary trust.

Q. What are the benefits of a Family Trust?

A. Those setting up a family trust usually have a range of overlapping objectives in mind, such as:

to make provision for their family, including in particular very young children and adult children with a disability

to attach certain conditions to gifts

to give children the benefits of family wealth without losing control over key assets

to create a legal framework for the family assets which will last for a long time

to protect these assets against actual and potential creditors

to pass wealth from generation to generation

to create a tax effective structure

to safeguard certain social security entitlements

to create a single relatively large pool of investment funds which has more scope to perform well and to develop a long term strategy than a series of smaller pools

to allow administrative, investment and recordkeeping functions and possibly also property management functions to be centralised and handled more efficiently and at a lower cost

to act as a de facto superannuation vehicle, without the restrictions applying to conventional superannuation

to escape death and gift duties should these ever be reintroduced into Australia

to vest discretionary powers in someone who can assist the above tasks.

Q. What are the disadvantages of a Family Trust?

A. Mainly cost and some loss of flexibility:

There will probably be preliminary expenses for the professional time spent on giving legal, accountancy, taxation and/or investment advice as to whether to proceed and, if so, as to what structure should be adopted.

There will be the actual setting up expenses - legal fees for the documentation, stamp duty, and so on.

There will be ongoing expenses - internal and external administrative costs for bookkeeping, taxation returns, separate bank accounts, and so on.

There may also be ongoing fees to any trustee who charges as a professional for the time involved and for the responsibility assumed.

There may be additional legal costs if disputes ever arise.

Potential lenders may impose extra charges to cover the expenses involved in vetting trust deeds and the like.

There will also be further costs when the trust is eventually wound up.

If a company structure is to be used as trustee then there will be additional costs for setting up or acquiring the company, for maintaining statutory records and for various filing fees.

Q. How does a Family Trust work?

A. Much the same as a deceased estate, except that it is set up while the instigator is still alive. Typically family trusts invest in shares, property and fixed interest securities in the same way as individuals. Some family trusts are used to run a small business.

Q. What are the current taxation implications for Family Trust operators?

A. If the trust is a discretionary trust then the tax consequences can be one of the factors taken into account when deciding which distributions should flow to which beneficiaries each year.

Clearly, the greatest collective tax minimisation occurs, quite legally, when distributions are made to beneficiaries on low or zero marginal tax rates. The ability to use the low income taxpayers' rebate may constitute an additional advantage.

In some cases the trustee's ability to make distributions within the tax-free threshold to one or more low income beneficiaries can lead to significant overall tax savings.

The more persons in such a position that are available to receive trust distributions the greater the total tax savings would be - although, of course, there may be non-tax features to such a scenario which make it unattractive.

No tax savings at all will occur when all the beneficiaries are already in the highest marginal tax bracket.

In fact, there can even be negative tax savings from using a trust structure in some cases - for example, where a child beneficiary is involved and a 66 per cent marginal tax rate applies or when losses in one entity cannot be offset against gains in another.

Any income in a financial year which is not distributed to beneficiaries is technically referred to in the Income Tax Assessment Act 1936 as income to which no beneficiary is presently entitled.

Such income is generally subject to a penal rate of tax under section 99A of the Act. This rate, being the maximum personal rate of tax in the system including the Medicare levy, is applied to the entire income, regardless of its size.

Q. Are there any current legislative or taxation issues which may impact family trust operators in the future?

A. No changes are imminent, but estate planners should always be aware that laws can change.

Q. Should everyone have a family trust?

A. No. Sometimes such trusts are recommended to persons with negligible assets and income and no dependants, mainly so that those making the recommendations can collect fees.

Q. What are the costs of establishing and maintaining a family trust?

A. In simple cases a few hundred dollars in legal fees and stamp duty on the trust deed will be incurred at commencement. Annual costs could involve the preparation of tax returns and minor outlays such as on correspondence.

Q. What is the best time to set up a family trust?

A. The best answer, having regard to both clerical and tax implications, is probably "as soon as possible".

In respect of existing family assets acting earlier rather than later means that:

Future earnings on those assets could be subject to lower tax.

Future capital gains tax on those assets could also be incurred at a lower tax rate.

Stamp duty and capital gains tax in respect of the assets being transferred into the family trust at its commencement are likely to be less than later on when these assets might have considerably increased in value.

In practice the smaller number of individual holdings likely to be involved in such an early transfer would also be an administrative advantage.

More generally:

Assets acquired in the future get the advantage of being in the trust as from the date of their acquisition. This applies both to assets being built up gradually out of savings and to large one-off items such as inheritances, lottery winnings, damages awards or lump sum superannuation payments. It applies equally to assets being acquired for their income potential and to those with capital growth prospects.

Assets acquired directly by a trust do not involve the stamp duty and capital gains tax liabilities applying to assets which are acquired by another party in the first instance and then transferred to the trust only later on.

As managing a trust involves a learning curve it is probably better to start off with a small operation than with a large one.

If the tax rules affecting trusts are ever changed by the authorities then existing trusts may be able to keep some privileges not available to new trusts set up, or to assets acquired, after the date of the change.

Assets transferred out of an individual's name well before any bankruptcy occurs cannot be clawed back by creditors.

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This page http://nickrenton.com/942.htm was last updated on 2008-02-22