What are trusts?
In simple terms, in Australian law a trust is an arrangement in which someone holds property or assets (e.g. money, shares or real estate) for the benefit of someone else. The one holding the asset or property is called a trustee and those for whose benefit the assets are held are called the beneficiaries.
In addition to money, shares or real estate, the type of property that can be held in a trust can extend to less tangible things such as intellectual property rights, equitable interests and contractual rights).
The trustee can be one or more individuals, or it can be a company (called a corporate trustee). The beneficiaries can be individuals and/or entities like a company or a charity or an institution. If there is only one beneficiary, the trustee and the beneficiary will have to be different for the trust to be valid.
There are all sorts of reasons why people have used trusts since the concept arose centuries ago, first under Roman law (in relation to deceased estates) and then under English law (where the law has continued developing to this day). These days, for example, there are often business or tax reasons to use them, as well as protecting assets or the interests of young or vulnerable beneficiaries. Charities use a trust arrangement for the objects of their charitable purposes. Superannuation also involves a regulated way in which trustees holds money and assets for the benefit of employees in anticipation of their retirement.
A trust is not a separate person or legal entity, although when registering for tax they are essentially treated as such. As the trustee can be personally liable the trust debts, companies are often used to act as the trustee.
The entrusting of property and responsibilities to a trustee for the benefit of others imposes what is called a “fiduciary duty” on the trustee, to be strictly enforced by the courts if breached. Trustees must act in the interests of the beneficiaries rather than in their own interests.
You can establish a trust by a written deed during your lifetime, but you can also set one up in your Will to take effect after your death. Trusts established in a Will are called ‘testamentary trusts’. Trusts established by a trust deed during your lifetime are often called ‘inter vivos’ trusts (Latin for between living people).
Who can be a trustee?
Any legally competent person, including a company, can act as a trustee. Two or more entities can be trustees of the same trust.
A company can act as trustee if its constitution allows it to. Using a corporate trustee can offer the advantage of limited liability, perpetual succession (the company does not “die”) and other advantages. The company’s directors will then control the activities of the trust. The trustee’s decisions should be the subject of formal minutes, especially in the case of important matters such as beneficiaries’ entitlements under a discretionary trust.
What are they used for?
The reasons to have a trust in place are too numerous to list in this Basic Guide. A few common examples of such reasons include:
- To give a trustee control of the asset(s) so that the beneficiary will still benefit from the asset(s) if the beneficiary is under age or suffers from a disability that affects their decision making.
- To provide added flexibility for tax planning purposes.
- To give the beneficiary added protection for assets against potential financial claims.
- To use as a trading trust for business purposes either for investing (e.g. for buying real estate or share) or for carrying on a business.
- To operate and manage a self-managed superannuation fund.
- To operate a charity.
And here are some other examples of how trusts can be used in everyday transactions:
- Shares are frequently held on trust by “nominees”.
- People often use cash management trusts and property trusts for investment purposes.
- The operations of joint ventures are often conducted using unit trusts.
- The holding of money in accounts for children generally involves a trust arrangement.
- By law, all superannuation funds (whether self-managed or otherwise) must be operated using a trust.
- An executor administering a deceased estates acts as a trustee for the estate beneficiaries.
- Solicitors, real estate agents and accountants operate trust accounts to hold client moneys.
- Trustees in bankruptcy (whether the Official Trustee or private registered trustees) hold and administer the property of a bankrupt as trustees for the benefit of creditors.
- Trustees for debenture holders (the trust being required under statute).
- Trusts are frequently used in family situations to protect assets and assist in tax planning.
- Some large companies are established by statute to carry on business as trustee companies.
The basics for establishing a trust
For a trust to validly operate, it must have certain features:
A trust deed: The trust deed (or, in the case of a testamentary trust, the Will) is the formal document which sets out how the trust will run and what the trustee is allowed to do. A trust deed or Will should be drafted by a solicitor.
A settlor: The settlor is the person who sets up the trust and names the beneficiaries, the trustee and the appointor. To establish the trust, the settlor must give the settled sum (which can be a nominal amount) to the trustee to be held on the terms of the trust for the benefit of the beneficiaries. For tax reasons, neither the settlor nor the settlor’s children should be a beneficiary under the trust.
A trustee: Trustees must administer the trust in accordance with the terms of the trust and their fiduciary duties. The trustee owes a duty directly to the beneficiaries and always has to act in their best interests. The trustee carries out all the transactions for and on behalf of the trust and attends to all the legal obligations imposed on the trust, such as payment of tax.
A beneficiary or beneficiaries: It is the beneficiaries (people or companies) for whose benefit the trust is created and administered. They can be either primary beneficiaries (who are named in the relevant trust deed) or general beneficiaries (who often are not named individually but are identified as part of a class of individuals, such as existing or future children, grandchildren and relatives of the primary beneficiaries).
An appointor: The appointor is a person or company named in the trust deed as having the power to appoint and remove the trustee. The appointor is also sometimes given the power to veto amendments to the trust deed. This power makes the role of the appointor very important and effectively makes the appointor the person who controls the trust (commonly so in the case of family trusts).
The trustee’s liabilities
A trustee is liable for the debts of the trust, as the trust assets and liabilities are legally those of the trustee. For this reason, if there are significant liabilities that could arise, a limited liability (private) company is often used as trustee. However, in the absence of fraud or misconduct by the trustee, the trustee is entitled to use the trust assets to satisfy those liabilities as the trustee has a right of indemnity out of the trust assets and a lien over them for this purpose.
Powers and duties of a trustee
A trustee must act in the best interests of beneficiaries and must avoid conflicts of interest. The trust deed will set out in detail what the trustee can invest in, the businesses the trustee can carry on and so on. The trustee must exercise powers in accordance with the deed and this is why deeds tend to be lengthy and complex so that the trustee has maximum flexibility.
Trust legislation
All states and territories of Australia have their own legislation which provides for the basic powers and responsibilities of trustees and their supervision by the courts. This legislation does not apply to complying superannuation funds (since the Federal legislation overrides state legislation in that area), nor will it apply to any other trust to the extent the trust deed is intended to exclude the operation of that legislation. It will usually apply to bare trusts, for example, since there is no trust deed, and it will apply where a trust deed is silent on specific matters which are relevant to the trust – for example, the legislation will prescribe certain investment powers and limits for the trustee if the deed does not exclude them.
How long can a trust operate?
In Australia, a private trust can operate for up to 80 years. The duration of the trust is generally set by the trust deed, which can specify a shorter term. The term can be based on the happening of a specific event, e.g. the date that someone dies or reaches a specific age. The end date of a trust is usually called the ‘vesting date’.
The various types of trusts
Common types of trusts include the following:
- Discretionary trusts (e.g. family trusts)
- Unit trusts
- Fixed trusts
- Hybrid trusts
- Bare trusts
- Superannuation trusts
- Testamentary trusts
- Charitable trusts
It is not the purpose of this Basic Guide to fully explain all these different types of trusts. However, it is worth noting that the two types most commonly used by individuals and businesses are the discretionary trust and the fixed or unit trust.
Dealings with and distribution of trust income and capital is a common concern of beneficiaries and trustees alike. Beneficiaries may have different rights to income or capital depending on the type of trust being used. Because the right to a share of income or capital under a discretionary trust is a discretionary matter for the trustee, beneficiaries of such a trust cannot demand payment. On the other hand, under a fixed trust the beneficiary may have fixed rights to income, capital or both.
Briefly, here are some general characteristics of the types of trusts listed above:
Discretionary (or family) trust: This is the most common form of trust used by families. The beneficiaries of the trust have no defined or fixed entitlement to the income or the assets of the trust. Instead, the trustee has a discretion to decide each year whether any of the will receive any of the income or capital of the trust and, if so, to how much. 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. This allows greater flexibility and control over the disposition of assets and income for the purposes of tax planning for those beneficiaries. Greater asset protection is also available, because the discretionary beneficiaries have no ownership interest in assets of the trust.
Fixed or unit trust: Unlike a discretionary trust, the beneficiaries of a fixed trust do have a fixed or defined entitlement under the trust. Owning units in a unit trust is similar to owning shares in a private company. The trust is divided into units in a way that is similar to a company being divided into shares. The trustee does not have discretion in decisions about distributing the capital and/or income of the trust. Fixed or unit trusts can be used for joint venture arrangements, e.g., in the case of two families who want to own an asset together.
Hybrid trust: A hybrid unit trust is one that is a blend of a fixed and a discretionary trust, e.g. having fixed entitlements to trust capital and discretionary entitlements to trust income.
Charitable Trust: As the name suggests, charitable trusts are established for a charitable purpose such as reducing poverty, providing education or improving social and public welfare. As charitable trusts with deductible gift status may receive tax deductible public donations, perform public services and receive tax exemptions, charitable trusts are subject to registration with and regulation and monitoring by the Australian Charities and Not-for-profits Commission (ACNC). The rule restricting the duration of private trusts to 80 years does not apply to charitable trusts.
Superannuation Trust: The purpose of a superannuation trust is to provide financial support to working people when they retire. Under Australian superannuation laws, all superannuation funds are superannuation trusts. They are subject to federal legislation laying out the rules and standards that all superannuation trusts must comply with. Most working Australians are members of large regulated public superannuation funds, such as industry super funds. Privately owned “self-managed” super funds (SMSFs) are also superannuation trusts that allow their members to control their own retirement funds and determine investments. The Australian Prudential Regulation Authority (APRA) supervises regulated superannuation funds (other than SMSFs), whereas the Australian Taxation Office (ATO) is responsible for regulation and supervision of SMSFs.
Testamentary Trust: Testamentary trusts are created by a person’s Will to hold assets distributed from a deceased estate. This type of trust only arises after the testator’s death upon terms set out in the deceased’s Will, which are commonly like those used in discretionary trusts giving the trustee full discretion over the assets and their distribution. Testamentary trusts can provide beneficiaries of a deceased estate with flexibility and options to better manage tax impacts of an inheritance, as well as providing asset protection for inherited wealth.
Bare Trust: Bare trusts permit a trustee to hold assets for a beneficiary without giving the trustee any discretion or control over decisions concerning the assets. Bare trusts have one trustee and one beneficiary, with the beneficiary having complete control over the nominated trustee. The trustee will only be responsible for holding the assets and must follow the beneficiary’s instructions. Due to the control in the hands of the beneficiary, a bare trust does not provide the same level of asset protection compared to other forms of trusts and creditors will have access to it.
A bare trust is used in the superannuation context when SMSFs need finance under a ‘Limited Recourse Borrowing Arrangement” (LRBA) to buy residential or commercial property as an investment (with the bare trustee also being called the ‘custodian’). Bare trusts can also be used as a way of legally hiding the identity of the real buyer of assets or shares, where the bare trustee is the apparent purchaser and holds the asset on trust for the real purchaser. Another common example of a bare trust is a nominee shareholding, where the shareowner holds shares on behalf of someone else who does not want to be identified.
Choosing the correct type of trust
Given the range of different trusts and the variety of purposes for which they may be used, you will need to obtain professional advice from a solicitor and tax or financial advisors before proceeding with any arrangements involving the use of a trust.
What happens when a trust ends?
Apart from charitable trusts, when the ‘vesting date’ arrives the trust will end. When that happens, the beneficiaries become absolutely entitled to the trust assets and income and the trust will be distributed and wound up. The trustee must distribute all assets and income to them according to what is required under the trust deed. It is important to obtain legal and tax advice before the vesting date arrives, because there can be significant capital gains tax (CGT) and income tax implications for the trust and the beneficiaries arising from the vesting of the trust assets.
Extending the vesting date
If the trustee or beneficiaries want to extend the life of the trust (within the limits of the 80 year vesting rule), this can only be done if there is an express power to do so contained in the trust deed. The trustee will otherwise need to seek approval of such an extension from a relevant court (which might not approve the proposed extension). Otherwise, extending the date of the trust could have CGT consequences through the creation of a new trust (or a ‘resettlement of trust’) or other form of transfer of trust assets. Care must therefore be taken in such cases and obtaining legal advice is essential.
Do trusts pay tax?
A trust must have its own tax file number and lodge annual tax returns. Generally, a trust is not liable for tax if all its annual income is distributed to beneficiaries, who then pay the tax based on their applicable marginal tax rates. A trust that carries on a business can register for both an ABN and GST.
How can Craddock Murray Neumann Lawyers help?
Trusts and trust law are complicated and can change. Before you set up a trust or if you already have a trust, the solicitors at Craddock Murray Neumann Lawyers may be able to help in various ways, including:
- Advising you on whether a trust suits your goals or objectives.
- Advising you on which sort of trust is right for your needs.
- Explaining how the trust works and ensuring that you have taken account of all aspects of how your trust will be governed.
- Helping you identify the appropriate trustee and appointor.
- Explaining the implications of trusts in your estate planning, family law issues and asset protection requirements.
- Drafting the trust deed and setting up the trust.
- Working with your accountant (where applicable).
For more information on how our Wills & Estate Planning lawyers can help you with Trusts, please contact our team at craddock@craddock.com.au.