While the effort and time to accumulate assets can take years, loosing what you have accumulated can take seconds. One wrong choice or even the right choice taken at the wrong time can result in you losing your assets and wealth.
Assets need to be protected at all times and one of the more common means of seeking to protect assets is to use a legal structure known as a trust.
What is a Trust?
A trust (including a family trust) is established whenever there is separation of the legal ownership of an asset from the beneficial (equitable) or real ownership of the asset. For example, the ownership of shares can be in the name of the Sergi Family Trust, but are actually owned by William and Maria Sergi.
Different types of trusts
There are three common types of trusts. These are:
Fixed Unit Trusts
Unit trusts distribute income and capital according to the units you hold in the Unit Trust. Unit trusts are usually established as an alternative to companies. A public unit trust like those listed on the Australian Securities Exchange are typical of fixed unit trusts.
Discretionary Trusts
Discretionary trusts are the most common form of trust. Money assets or even whole businesses are generally transferred into a trust by sale or gift.
Hybrid Trusts
Hybrid trusts are similar to fixed unit trusts except the Trustee has given discretion to vary the entitlements to income and capital distributions.
Forming a Trust
Each of the common forms of trust is usually established by a document. A trust can be established during a person’s life time or upon their death through the deceased person’s will.
A Trust needs a Trustee
A trust is an obligation that binds a person (known as the trustee) to deal with and manage property for the benefit of others (known as beneficiaries) in accordance with the requirements of the trust deed.
A person (e.g. William Sergi) can be both trustee and a beneficiary of a trust (of the Sergi Family Trust). A Company or another trust can be a trustee.
Trusts are used for many reasons. (You should seek professional legal and tax advice before making any decision to establish a family trust).
Common uses include:
Asset protection;
Estate planning;
Masking the ownership of assets; and
Tax planning.
Asset protection and estate planning
The pooled nature of a trust means that beneficial ownership of assets and income is masked. Thus, if William Sergi was to accumulate wealth in a trust rather than his own name, then in the event of bankruptcy or insolvency (say of his business) the ability of his business’s creditors to seek compensation directly from William’s own “pocket” is limited.
Company directors, lawyers, engineers, architects, doctors, electricians, builders and plumbers are exposed to litigation and potential bankruptcy being more likely to be sued than other workers and should consider using trusts as a form of asset protection.
Be aware that transferring:
• Existing assets particularly those subject to capital gains may trigger a tax payment to the ATO as beneficial ownership will have changed; and
• Assets into trust may be still subject to claim by creditors for up to five years after the day they were shifted. This is designed to capture people who suspect claims from creditors or litigation and shift assets in anticipation.
Trusts allow considerable estate planning benefits. You can preserve assets (e.g. a holiday home) for succeeding generations and secure income for certain beneficiaries, either for life, a specified period, or until a particular event (e.g. until the marriage of a child or the competition of education).
For example, if you die at a relatively young age, your widow might inherit substantial wealth, such as a life insurance policy. It is possible that your widow spends, lends or loses (or remarries someone who does the same), this wealth leaving nothing for your children’s education or general benefit. A trust is one way of preserving capital and providing an education for your children.
Tax planning
Trusts are not tax shelters. Discretionary trusts do permit the trustee to vary income and capital distributions each year to minimise overall family tax without incurring stamp duty or capital gains tax.
This is particularly useful where the income of individual family members fluctuates from year to year. Thus, William Sergi can elect to pay Maria Sergi income this year, but not next year if it suits to do so.
This ability to distribute income to family members who are on low tax can be very useful. Trustees can "stream" income. Income streaming, is, where the trustee distributes one type of income to one person (e.g. franked income and another type of income to another person - unfranked income).
Income not distributed in any one year is taxable at the top marginal tax rate plus the Medicare levy. So there is a real stimulus to distribute income each financial year.
The decision as to which beneficiaries are to receive income technically has to be made by the trustee by the end of each year. It is the ATO’s practice to allow that to be done up to August 31, each year.
Who are the players in a Family Trust?
1. The Settlor
The Settlor is the person/ company, who establish the trust by putting in an asset (usually $10). After the family trust is set up, you transfer in assets or cash to purchase assets into the trust. The settlor is typically a lawyer, accountant or financial adviser. A Settlor should never be a beneficiary. (Income Tax Assessment Act (1936) section 102(1)).
2. The Appointer
This is the most important person in the trust structure as the Appointer appoints and can dismiss the Trustee. The appointer can be anyone, but it’s wise to make the Appointer yourself. Your spouse can also be an appointer alongside you.
3. The Trustee
The Trustee is the legal owner of the trust’s assets (but not the real owner of the assets) and manages the trust, including making investment decisions aimed at increasing the value of the assets.
Trustees, among other things, must be fully acquainted with the terms of the trust, know who the possible beneficiaries are, know what the assets and liabilities of the trust are, keep proper accounts and prepare tax returns.
4. The Beneficiaries
Beneficiaries are the people who benefit under the trust. In normal family trusts the beneficiaries are generally immediate, and sometimes extended, family. They have no right or claim to any of the trust property until it is distributed or otherwise vested in them under the terms of the trust. That means, they can be a beneficiary but not receive anything unless the Trustee so determines.
What happens if the Trust goes broke?
The Trustee of the trust is indemnified out of the assets of the trust. The beneficiaries of a trust are likewise personally indemnified.
This means that should the family business find itself in difficulty with creditors and you have signed no personal guarantees, then it is possible that the only assets that can be called upon to pay these debts are those owned by the family trust.
The trust can also limit the personal liabilities of individual members of the trust’s business. Properly set up, the business is not owned by the individuals, as in the case of a partnership; the business is owned by the trust for the benefit of it’s beneficiaries.
Can trusts avoid the death taxes such as capital gains tax?
Yes. A beneficiary does not own the Trust Fund. Thus, when a beneficiary dies the Family Trust fund does not form part of your estate under your Will. The Appointer and Trustee need to think carefully about who will take over these roles in the event of their death.Children are the obvious choice but this can cause problems as well.
Further, what happens when they pass-on? It maybe that you decide that this is the time that the Family Trust is wound-up and the remaining assets distributed.
* Steve Brown is chairman at Etienne Lawyers Parramatta. Email: sbrown@etiennelaw.com
