Is your trust set up correctly?
You’ve probably heard that most wealthy people own nothing in their own names, but control everything through structures such as a trust.
If Australia’s richest people use trusts, maybe it’s something you should consider also.
Did you know that trusts have been around since the 12th Century?
The Lord Chancellor at that time could decide a claim according to his conscience, so it was then that the principle of equity was born.
Trusts were set up to protect assets, often for the knights who went to war and died in foreign lands
Today we still use trusts to protect our assets and even though more and more people are using trusts, often they are not set up correctly at the outset which potentially poses problems later on.
Before I outline how to set up a trust correctly, let’s consider the three main types of trusts:
- Discretionary Trusts (often referred to as a Family Trust) where distributions are all discretionary and decided by the trustee.
- Unit Trusts where there are fixed entitlements.
- Hybrid Trusts where there are both discretionary and fixed entitlements.
It’s important to understand that the name you label the trust does not determine its type.
It’s actually the wording of the trust deed that determines what type of trust it is, which is why it’s critical to administer each type of trust within the relevant commercial and tax regimes.
Now there is no specific wording required in a trust (other than for a superannuation trust), so it’s imperative to have a trust deed designed for your specific requirements.
So let me outline the aspects of trust you should understand.
1. The various positions within a trust
- Appointor – This person or persons have the ultimate power and it’s the appointor who decides who the trustee is.
- Trustee – This is the legal owner of the trust but not the beneficial owner. To close the loop on asset protection, flexibility and change of control, the trustee must be a company and not a person/s. As the trustee is the legal owner you’ll find their name on the title of any property owned by the trust. And having a company as a trustee also makes estate planning much easier.
- Beneficiaries – These are the beneficial owners of the assets of the trust. The trustee has no legal rights to the trust assets other than in some special circumstances, rather, the beneficiaries share in the income and capital of the trust.If it is a Unit Trust, then the beneficiaries have fixed entitlements, which makes them a good structure when there are multiple, or non-family, members who want their rights to income and capital fixed. In a discretionary trust, though, the trustee decides who to distribute to and beneficiaries only have a right to be considered.
- Settlor – Where a trust has discretionary rights it must have been set up via a gift from a settlor. This goes back to the 12th Century and today many trusts are set up with a $10 gift. The settlor cannot benefit from the trust and as such can’t be a beneficiary.The settlor must also give up the $10 and so it’s important not to use a settlor who has either not paid the $10 or has included the $10 in their costs to set up the trust. This is because an incorrect settlement can void the trust.
2. Asset protection
Some of the details of a trust you’ll need to understand relating to its asset protection benefits include:
- The Appointor – This is a personal position and can’t be taken over by someone else such as a receiver in bankruptcy.
- The Trustee – If the trustee is a person, then their personal assets could be at risk in successful litigation against trust assets, so we always recommend using a corporate trustee – a company you control.
- Beneficiaries – In a discretionary trust, a beneficiary only has a right to be considered for distribution. They don’t have a right to receive a distribution, which means if the beneficiary is sued, for example, a receiver in bankruptcy can’t demand a distribution or part of the trust assets. In a Unit Trust, the beneficiary owns units in the trust, which means they could lose their units in successful litigation as well as the assets in the trust. However, a correctly worded and administered Unit Trust doesn’t have this exposure.
3. Land Tax
In most States and Territories, there is a different land tax rate applied to trusts and individuals or companies that own properties.
The various State Governments don’t have the capacity to identify a trust because the Trustee is on the title.
Instead, the State Government will apply the rate for the trustee (company or individual).
So it’s the responsibility of the trustee to register for land lax and be identified as the legal owner with the trust as the beneficial owner of the property.
What this means is that if the trustee doesn’t register correctly, the land tax levied may be under-charged with penalties applying for underpayment if reviewed.
4. Surcharge taxes
Many State Governments have a surcharge tax rate applying to stamp duty and land tax for a trust that has discretionary distribution capacity and is purchasing or has purchased, residential property.
Again, that is why it’s vitally important to have a correctly worded trust deed to legally avoid these levies, which on average doubles the normal charge.
5. Trust distributions
The trustee must complete distribution minutes and resolutions prior to 30 June each year or the trust will pay a penalty tax equivalent to the highest individual marginal tax rate (currently 47 per cent).
6. SMSF
There are only very limited circumstances where a trust can distribute to an SMSF.
However, any income distributed to the SMSF will be deemed special income and taxed at 47 per cent, plus a penalty of up to 50 per cent of the SMSF assets.
7. Trust longevity
Trusts will normally have a vesting date, which is when the trust expires.
This will normally activate Capital Gains Tax and if the asset is transferred then a stamp duty liability may be triggered.
However, a properly worded and administered trust can have no vesting date and can be handed down through various generations without these taxes.
Another important consideration is the protection of trusts within the family.
Without this protection, a subsequent generation could see the loss of trust value if there’s a Family Law Court ruling to pay monies to a separated spouse, which can be avoided.
8. Tax deductibility
The ATO requires a trust to be correctly set up and administered to allow for the tax deductibility of funds borrowed to purchase assets.
This deduction can flow down to an individual to give that individual the benefits of negative gearing against PAYG income even if the property is in a trust, but it must have the right wording.
A common error is where the legal owner is different to the borrower.
Under these circumstances, the ATO may deny a tax deduction on borrowed funds.
While the bank will decide its lending policy and may enforce this difference, with additional documentation you can resolve the conflict.
Even with a different borrower and legal owner, a full tax deduction can still be achieved.
Recommendation
Trusts can be a very powerful and beneficial structure but if incorrectly set up or administered their benefits can be lost and create commercial and tax liabilities that could have been avoided.
If you are in business, you should have a review of your business structure to ensure it’s adequate for your business and investment circumstances.
For non-business owners, a full trust review is recommended to ensure income and interest deductions are correctly managed and avoidable taxes are not triggered.
Disclaimer
This article is general information only and is intended as educational material. Metropole Wealth Advisory nor it is associated or related entitles, directors, officers or employees intend this material to be advice either actual or implied. You should not act on any of the above without first seeking specific advice taking into account your circumstances and objectives.
