Discretionary & Family Trusts

Discretionary Trust

An ordinary discretionary trust differs from other trust in that the beneficiaries do not have a fixed entitlement or fixed interest in the trust funds. Instead, the trust deed of the trust generally defines the potential beneficiaries of the trust very broadly, and the trustee is then given complete discretion to determine which of these persons are to receive the capital and income of the trust and how much each of them can receive.

Therefore, the persons for whose benefit the trustee holds the trust property are not technically beneficiaries of the trust until the trustee has exercised its discretion to distribute income of capital to them. Until that time, a person to whom the trustee can appoint income of capital is an “object” of the trust; i.e., they are each potential beneficiaries until the discretion is exercised in their favour. Nonetheless, although they are technically different, “beneficiary” and “object” are often used interchangeably.

It is common for discretionary trusts to have a very wide range of objects including entities such as companies, trustees of other trusts, or even children who are not yet born. However, these objects must be described with sufficient certainty so that it can be determined, at any point in time, whether or not a particular individual or entity is or is not a member of the range of objects. If not the trust could be void for uncertainty.

It is the generally accepted view that an object of a discretionary trust does not have a proprietary interest in the property of the trust – they only have the right to compel the due administration of the trust estate and the right to be considered by the trustee. This is often described as a “mere expectancy”. Refer, for example, to Gartside v Inland Revenue Commissioners (1968) AC 553.

However, a default beneficiary does have a contingent interest in the property of the trust. That is, a default beneficiary has an interest which is contingent upon the trustee not otherwise exercising its discretion, so that a default clause in the trust deed will apply to distribute part or all of the income of corpus of the trust to that default beneficiary. Refer, for example, to Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) HCA 4; 192 CLR 226.

The ATO is of the view that neither an ordinary beneficiary nor a default beneficiary has an ‘interest’ in a discretionary trust of the type referred to in S.104-70. This means that CGT event E4 will not happen when a payment of a non assessable amount is made by the trustee to such a beneficiary. Refer to TD 2003/28.

Advantages

• Streaming of income to lower tax rate beneficiaries
• The small business concessions can flow to the ultimate owners with no reduction in value
• Trust deed can be tailored to the needs of principals and beneficiaries
• Can make flexible distributions of income and capital
• 50% discount method for work out CGT is available
• The small business concessions can be accessed.
• For income distribution, you can employ principals and provide salary packaging.
• Simple to wind up
• Asset protection available through correctly drafted trust deed
• Extra asset protection available through use of a corporate trustee

Disadvantages

• Unless class of beneficiaries is sufficiently broad when trust established risk of resettlement when beneficiaries added.
• Accumulated income is taxed at top marginal rate
• Losses are trapped in the structure
• The complex trust loss provisions apply
• Cannot transfer losses to other controlled entities like companies
• Clients can have trouble understanding all terms of deed
• More costly than sole trader and/or company
• Beneficiaries can be subject to complex PAYG calculations
• May be restricted in who it can deal with after making a family trust election
• Varying the terms or objects of the trust can amount to a resettlement and have CGT and stamp duty consequences
• Trustees can be personally liable for the debts of the trust
• Are not entitled to the tax exempt threshold for land tax purposes

Family Trust

Although many discretionary trusts (and even some unit trusts) are often referred to as “family trusts”; i.e., having been set up to benefit a particular family, references, in these notes to a “family trust” are references to a family trust as defined for tax purposes in the trust loss provisions of Schedule 2F of the ITAA 1936. A trust needs to specifically elect to be a family trust for these purposes. Family trusts are discussed later in these seminar notes.

A family trust:

• is generally established by a family member for the benefit of members of the ‘family group’;
• can be the subject of a family trust election which provides it with certain tax advantages, provided that the trust passes the family control test and makes distributions of trust income only to beneficiaries of the trust who are within the ‘family group’;
• can assist in protecting the family group’s assets from the liabilities of one or more of the family members (for instance, in the event of a family member’s bankruptcy or insolvency);
• provides a mechanism to pass family assets to future generations; and
• can provide a means of accessing favourable taxation treatment by ensuring all family members use their income tax “tax-free thresholds”.

Advantages

• The Trustee has decision making power at their discretion.
• Flexible, because the profits are distributed in accordance with the Trustee’s wishes.
• Confidential – there is no searching of any register.

Disadvantages

• The Trust must run in accordance with the rules of the Trust Deed, and the Common Law of Trusts will imply many rules;
• A Trust has no separate legal entity from the Trustee. Thus, the Trustee is responsible for the liabilities of the Trust;
• Since the Trustee is liable, the Trustee may have to be a company to protect personal assets; and
• Onerous Trustee duties apply.

If you would like more information on trust structures and want to learn more about the most appropriate type of trust or trusts for your situation, please click here to submit an online enquiry form or call us on 1300 QUINNS (1300 784 667) or on +61 2 9223 9166 to arrange an appointment.