The tricky world of trusts

Family trusts have advantages … but they can also be a minefield.

Summary: Discretionary trusts are the most common type of structure used by families for tax minimisation. But be careful what you wish for. Family squabbles and divorces can make them a can of worms when it comes to dividing up income and assets.
Key take-out: It’s important to get the advice of a lawyer who understands the nuances of family trusts, including trust law, tax law, and corporations law.
Key beneficiaries: General investors. Category: Tax strategies.

Lawyers say it’s a common request. A client with a family business and a trust comes to them. Years ago they set up a trust for their little girl who is now an adult and married.

Just one problem: it’s the son-in-law and his family, who have next to nothing. Scared of a future divorce, there’s no way they want the son-in-law or his loser family to get anything from the family business. The trust needs to be adjusted or advice taken.

Or there’s an issue with the appointor. Every trust needs an appointor – the person who can appoint and sack the trustee. In many trusts, a person is the appointor and their spouse is the default appointor. But what happens if there’s a divorce? You don’t want an ex-spouse gaining control of significant assets in the family trust.

Or what happens if one of them dies, and being close in age, the other is expected to go the same way? It’s just a matter of time. The trust has a default succession provision stating that in the event that an appointor dies, his or her personal representative or the executors of the estate will step into his or her shoes. In this case, the three children are the executors. The problem, however, is that in this case, two of the children are always fighting with the third. There’s a black sheep in every family. To get around it, the family business lawyer or accountant is given appointor powers with the ability to cast the deciding vote. Or alternatively, the parties can leave it up to the courts to decide. It happens.

Welcome to the world of trusts. Many private family businesses use trusts as a way of protecting the family’s assets. And because every family business is different, every trust has its own challenges. A trust is created by a deed. The deed sets out the governance and operation of the trust, and the powers of the trustee. Every deed, like every person, is different.

The most important advantage for a discretionary trust is tax minimisation, indeed substantial minimisation, by way of flexibility because income can be diverted to people with lower rates.

Trusts are highly complex and full of legal tripwires. But they are fascinating because they tell us all about human behaviour and what makes some people tick. The very public disputes involving Gina Rinehart and her children over the Margaret Hope Hancock Trust and the dispute relating to a family trust controlled by the Lew family are examples of battles about control over who gets what – issues that weren’t even contemplated decades ago when the trusts were being set up.

One of the big issues looming is the 80-year limit on the period during which a discretionary family trust can exist. The rule comes from English common law, which says you can’t have a legal agreement in perpetuity. It applies in all states except for South Australia. On the expiry of a trust its assets may attract capital gains, with beneficiaries forced to find up to 46.5% of the assets’ value.

Darren Sommers, a partner at Meerkin & Appel, says this is not focusing the minds of many family businesses now as most of today’s trusts were established from the 1960s onwards and, in any case, many businesses don’t last more than 30 years.

But he says more will start focusing on it as the deadline nears. They will then look at ways to move the assets into a new trust or a different company structure.

But here’s the problem: amending the deed can amount to a resettlement. When that happens, the Australian Taxation Office could regard that trust as being wound up and a new trust created. That could create potentially significant CGT and stamp duty liabilities.

That means one thing: anyone looking to restructure in anticipation of the 80-year rule will need the best possible tax advice. Tax lawyers and tax accountants will be cleaning up.

In cases where the ownership is being divided between different parts of the family, where one person’s advantage could be someone else’s disadvantage, Sommers says it would be better to place the business in a unit trust, not a discretionary trust.

A discretionary trust does not allow external parties to buy in or invest. A unit trust allows people outside the family to participate and it operates like a company. It has units which are like shares, and at the end of each year income is distributed to the unit holders in proportion to the units that beneficiary holds. That, in turn, may be distributed down to beneficiaries in the discretionary trust, assuming the discretionary trust is a beneficiary. However, there may not be a real benefit in having a unit trust if it’s all under the control of one family.

Sommers say many trusts face the compliance conundrum. At the end of each financial year, the trustee has to work out who gets what income. Two years ago the ATO ruled that this had to be done no later than June 30.

The problem for family businesses is they won’t have any idea of what their profits and taxable income will be until months later. This means that trustees need to draft minutes before they do their tax pertaining to who is getting what. The actual dollar figures can’t always be worked out until the trust accounts are finalised, which often happens after June 30. The means guesswork is involved. In those cases it’s better not to be specific with dollar figures. Instead, use proportion.

And, Sommers says, beware of the Family Court, which takes into account assets held in a family trust. Family business owners need strategies to deal with that.

Because most of the disputes over family trusts are driven by personal issues, it’s important to get the advice of lawyers who have all the experience to understand the nuances, not to mention the knowledge of trust, tax and corporations law. In an age when you get a trust deed off the internet (type trust deed into Google and you get more than 11 million results) it’s not a good idea to do it on the cheap. Don’t do it without a lawyer.


Reprinted with permission from Family Business Magazine.

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