Explainer. What is a Trust?

Commercial, Property

Federal opposition leader Bill Shorten has said that if he wins the next election he will introduce an across the board 30 percent tax rate on discretionary trust distributions to people over the age of 18. He said that the non-discretionary trusts such as special disability trusts, deceased estates, fixed trusts, farming trusts and charitable trusts will not be touched.

Given the announcement I thought it useful to explain what a trust is and how they can currently help family business structures and other people with tax planning and estate planning benefits. I took a group of Newcastle business people and investors through this information at a recent seminar that also included Westpac Private Bank’s Chief Investment Director, George Toubia and Sidcor Founder and Managing Director, Paul Siderovski as speakers. Read more on their commentary at that event here.

A trust is a relationship whereby property is held by one party for the benefit of another. A trust is created by a settlor, who transfers the property to a trustee. The trustee holds that property for the trust’s beneficiaries.

Trusts can be traced back to England in the 1300s. They were formed to help enable people to “hold land” for others such as religious groups. While the basic premise remains trusts have evolved to offer people an opportunity to manage real estate, shares and other assets tax effectively. According to ATO figures there were 823,448 trusts in Australia in 2014/15.

Trust administration is complex with many pitfalls for the unwary or inexperienced.

Key parties and elements to a trust

Before we talk about the types of trusts it is important to know the key terms. A Settlor sets up the trust and is often a lawyer. They name the Trustee and Beneficiary and can’t be a beneficiary. A Trustee is appointed to administer the Trust and act for the benefit of of the beneficiaries. A Trustee can be a company or person. These Beneficiaries are the people or companies for whom the trust is set up. They can be either primary beneficiaries (named in the trust deed) or general beneficiaries (often not named individually). The latter are usually existing or future children, grandchildren and relatives of the primary beneficiaries. The Trust Deed is a very important and essential document. It sets out what the Trustee is allowed to do. An important check and balance is an Appointer. This person (or persons) possess ultimate control over the Trust and can remove the trustee.

Which trust? Types of trusts

The most common form of trust is a Discretionary Trust. It gets its name from the fact that the beneficiaries have no defined entitlement to the assets or income. Each year the Trustee has the discretion to determine which beneficiary is to receive income and how much. A key benefit is flexibility for tax planning as not all beneficiaries are entitled to income. Creditors cannot attack the Trust’s assets.

At the other end is a Unit Trust where the Trustee has no discretion with distribution as unit holders have a defined entitlement to the assets or income from the trust operations. People have a certain amount of units, similar to owning shares in a company. There can be different classes of units. This trust is often used for joint ventures such as two families owning one asset. A key benefit is that units may be transferred without Stamp Duty if property is valued less than $2M.

A Hybrid Trust is a combination of a discretionary and unit trust, offering greater flexibility. The trustee can distribute to the Unit Holder and/or their eligible beneficiaries.

Self Managed Super Funds are a type of trust. They have significant taxation advantages over other structures. Business owners can have their premises in a SMSF and have their business rent it from the SMSF. There are Capital Gains Tax savings if property is sold. An SMSF also offers asset protection and can be an effective Estate Planning tool.

Last but not least is a Testamentary Trust. it is similar to Discretionary Trust but is created by a Will. Assets are held in trust for beneficiaries such as children until they reach a certain age. The Trustee can separate assets if it is stated in the Trust Deed.

Beware of some pitfalls

Since June 2016, the Government has imposed a surcharge duty if a named beneficiary of a trust is a foreigner. The issue here is that if a trust ends up being extended to benefit children and their spouses, if one of those people happens to be a foreigner then the entire trust is subject to this duty. There are a number of ways trust can be set up and managed to reduce these and other risks.

Regularly review

The message here is to review your trust deed and trust beneficiaries regularly. Trusts last for up to 80 years in NSW so it is important to plan for when a trust is approaching the conclusion of its operating period.