Clients often ask, “Why do I need a trust?” This question comes up when people want to make lifetime gifts to their children in the future, and even more frequently when it comes to the potential tax consequences which can arise where they are misused.
A trust can provide some protection from creditors and can accommodate a relationship between employers and employees. In family matters, the flexibility, control, and limited liability aspects relevant with potential tax savings, make trusts very popular.
What Is a Trust?
A trust is a legal concept that can look complex, but when explained, are easier to understand. A trust is a legal obligation or a relationship that is recognized by the courts which exists where one party gives a second party (the trustee) the ability to hold asset or property for a third party (the beneficiary). The trustee can be an individual, group of individuals or a company.
There can be more than one trustee and there can be more than one beneficiary. Where there is only one beneficiary the trustee and beneficiary must be different if the trust is to be valid.
Common Types of Trusts
Although the basic structure of different trust types is pretty much the same, there are several different types of trusts with different aims and characteristics. Generally, there are six common types of trusts:
1. Unit Trusts
Unit trusts are usually fixed trusts where the beneficiaries and their respective interests are identified by their holding “units” much in the same way as shares are issued to shareholders of a company. The beneficiaries are usually called unit holders.
For example, it is common for property that the trustee owns the property of the trust and distributes each year, income of the trust, to various unit holders with a common purpose. This common purpose includes minimizing the total income tax, capital gain tax and asset protection. Also, investment trusts (e.g., managed funds) and joint ventures can be structured as unit trusts.
Furthermore, a fixed trust is eligible for the land tax threshold. Revenue NSW’s definition of a Fixed Trust states that it is a trust where the beneficiaries (or Unit Holders) are considered to be owners of the land at the taxing date of midnight on 31 December prior to the tax year. This type of Trust applies only to NSW.
2. Discretionary Trusts
These are often called “family trusts” because they are usually connected with tax planning and asset protection of family members. In a discretionary trust (or family trust) the beneficiaries do not have a fixed entitlement or interest in the trust funds. The appeal of a discretionary trust is that the trustee has better control and flexibility on the disposition of assets and income because the nature of a beneficiary’s interest is that they only have a right to be considered by the trustee in the exercise of his or her discretion.
Also, a Family Trust Election (FTE) is a choice by the trustee of the trust to specify a particular individual around whom the family group is formed. Why should some clients consider making FTE? A trust is a family trust at any time when a family trust election (FTE) for the trust is in force. Generally, an FTE is in force from the beginning of the income year specified in the FTE (the election commencement time). The FTE must also specify an individual who forms the point of reference for defining the family group that is considered in relation to the election.
There are some circumstances a trustee should consider making FTE: the trust receives franked dividends, the trust has losses, the trust owns shares in a company with losses, to bring the trust within the family group of another trust, or where the trust is involved in a restructure under the new small business restructure roll over relief.
3. Holding Trusts (Bare Trusts)
Where there is only one trustee, one legally competent beneficiary and no specified obligations, the beneficiary has complete control of the trustee (or “nominee”). Put simply, as for property, a bare trust arises where the trustee simply holds property of and on behalf of the beneficiary. The trustee has no discretion and no active duties other than to transfer the property to the beneficiary when required.
When considering the use of a Bare Trust by a SMSF to borrow money and purchase assets, please keep in mind an SMSF can only borrow money to purchase an asset using a limited recourse borrowing arrangement and in such borrowing arrangements the SMSF Trustee receives the beneficial interest in the purchased asset but the legal ownership of the asset is held on trust by another holding trust or what is sometimes called a Bare Trust.
4. Hybrid Trusts
A hybrid trust, as the name suggests, is generally a hybrid of a discretionary and a unit trust. This type of structure is attractive because it contains the advantages of both and is an extremely useful structure. You can split the trust up into units while also having beneficiaries to distribute to at your discretion. The trustee of a hybrid trust has the power to allocate income and capital among the beneficiaries in a standard discretionary trust.
There are several advantages when considering hybrid trust, for example, asset protection, fixed interest, flexibility of distributions, capital gains tax, tax-free distributions, entry of new parties, employment benefits and low-cost. Make it with more details, as for capital gains tax, Hybrid Trust can help in redeeming units without triggering CGT, and for CGT to only be assessable in the hands of beneficiaries (although this depends on how the trust deed is drafted and detailed advice should be sought). Also, it is generally easier for tax-free (or low tax) distributions to be made through a Hybrid Trust as compared to a unit trust or a company.
5. Testamentary Trusts
A testamentary trust, often called a will trust, is an agreement made for the benefit of a beneficiary and only effective once the trustor has died. The assets included in a testamentary trust are overseen by the nominated trustee, whose job is to distribute the trust’s assets to beneficiaries complied with the trustor’s wishes.
6. Self-managed Superannuation (SMSF)
All superannuation funds in Australia operate as trusts. The deed sets up the basis of calculating each member’s entitlement, while the trustee will normally keep discretion regarding to such matters as the fund’s investments and the selection of a death benefit beneficiary.
There are also other different types of trusts which can satisfy additional specific needs. For example, instalment warrant trusts (superannuation), charitable trusts.
If you want more suggestions and seek for assistance about trusts, call BOA & Co. accountants in Chatswood on 02 9904 7886 and our Trust Specialist will be pleased to assist you.