A trust is an entity that holds assets on behalf of the beneficiaries of the trust. While beneficiaries have a ‘beneficial entitlement’, they do not actually own the assets. Instead, a trustee is in charge of the trust and distributes assets and income in line with the directions given under the trust deed. A trustee must act in accordance with this deed and under the terms of common law, they must act in the best interests of the beneficiaries in all dealings with the assets of the trust.
There are two main types of trust structures. Firstly, unit trusts are where assets are divided into a number of units and a certain amount allocated to each of the beneficiaries. Any distributions from the trust to the beneficiaries are in accordance with the number of units held by that beneficiary. Second, there are discretionary trusts, in which the trust still holds the assets for the beneficiaries, but the entitlement to distributions is determined by the trustee who, under the trust deed, has the discretion to make distributions as they see fit.
Two things that must be considered here are:
- The trust deed provides the rules under which the trust must be governed and if there are any special considerations for the trust, the deed must allow for this. An example here could be that the rules state that there should be no direct distribution to a person until they attain a certain age.
- The trustee must act in the best interests of the beneficiaries, they have a duty of care to act on behalf of the beneficiaries.
As a structure, a trust may be seen as a conduit for distribution. While holding assets in name only, a trust must distribute any income or capital gains to the beneficiaries unless otherwise directed by the trust deed. Distributions made are added to the income of the beneficiary and taxed based on their assessable and taxable income levels. Should a trust retain income, it will pay tax on that amount at the highest personal marginal rate.
It may be that a discretionary trust is the most appropriate for clients who wish to reduce their tax liability. For instance, consider a couple purchasing an investment property. One of them is on the highest marginal tax rate and the other is on a 15 per cent marginal tax rate. If the property were purchased in joint names, the income would be split equally and half taxed at the highest marginal rate. If the couple used a discretionary trust and the trust deed stipulated that income can be distributed as seen fit by the trustee, the entire rental income could be directed to the lower-income-earning spouse and taxed at 15 per cent.
Be aware that using such a structure may mean the loss of some of those valuable tax benefits. Since the trust owns the asset, the individuals who ultimately receive the income have no access to those valuable tax and depreciation benefits. Such benefits can help with personal cash flows in those early years when an investor needs them most to manage day to day expenses and personal needs and significant tax benefits which increase personal cash flow can help to pay off other debts.
The trustee is ultimately accountable for the maintenance and day-to-day decision making for the trust. Trusts may borrow funds for investment, but where additional income is required for the trust to support repayments for borrowing, the beneficiaries may be required to provide personal guarantees as security against the amount outstanding.
The benefits of trusts arise because the beneficiary, while having an entitlement to the assets and income, does not own the asset. Therefore, in the event of one beneficiary becoming bankrupt or being sued and losing their personal assets, the assets held in the trust structure are protected. Having said that, both ASIC and the Family Court can unwind a trust to seize assets so this protection is questionable.
Trust beneficiaries cannot include trust assets as part of their will because they do not own them. Furthermore, trusts should include provision for being wound up in the event of the death of the beneficiaries. In the event of the death of a single beneficiary, the trust retains the assets and continues to distribute any income to the remaining beneficiaries.