What are the advantages of Discretionary Trusts?

Corporate & Commercial 2 October 2020

Discretionary (or family) trusts have been in existence for hundreds of years. Until about twenty-five years ago their principal use was to hold property to ensure that probate and estate duties were not payable on such property in the event of the death of an individual family member. Because the individual family member did not own the relevant property, then the property was not caught for probate duty. There are now no probate or estate duties in Australia.

However, discretionary trusts have a number of important advantages, which include the following:

1. To protect your assets in the event of litigation and/or bankruptcy/insolvency proceedings.

Business structuring or family asset structuring is often framed around holding the valuable family or business assets, for example, real estate, in one or more discretionary trusts, with the business assets held in another structure – perhaps another trust, or a company.

Litigation risks are more likely to occur relative to the conduct of business as opposed to passive land holding.  So, for example, a partnership or company may run a business, using plant and land owned by one or more discretionary trusts.  This can assist in limiting the assets at risk in the event of judgement against a specific entity to only those assets held by that entity.

Additionally, structuring your business or family assets in this way can help protect certain assets from being affected or taken in the event of bankruptcy or insolvency proceedings.

2. To protect assets against a challenge to your Will

After your death, any eligible family member who is disgruntled has the ability to challenge your Will and seek greater provision from your estate, which comprises the assets you personally hold at the date of your death.

While you may have 100% control of a discretionary trust, by way of being a trustee or appointor of the trust, right up to the moment of death, you do not own the trust’s assets.  Provided that you  have made appropriate arrangements for control of the trust to go to an appropriate/trusted family member, by way of the provisions of the trust deed or your Will, the trust’s assets will be protected after your death and will not be available to be contested by the disgruntled family member.

3. To protect family assets in the event of marriage breakdowns or bankruptcy

In the event one or more of your children is going through marriage separation, bankruptcy, or even just may struggle to manage their money, it may not be appropriate to leave substantial assets to them personally on your death by way of your estate planning.

In this instance, it may be more prudent to either set up a discretionary trust in life, with that child as a beneficiary and with persons you trust to be placed in control of the trust in the event of your death, or otherwise look into creating a testamentary trust through your Will.  A testamentary trust is similar to a discretionary trust and means that the portion of your estate left to that child or children does not go to them personally, but rather goes into a trust for their benefit.  This can help protect family assets in the event of marriage breakdown, bankruptcy or even just where the

How is a discretionary trust structured?   

The most common type of trust is a discretionary trust (also known as a family trust), because this type of trust gives a discretion to the trustees as to whom they will distribute the income earned by the trust, and a discretion to distribute the capital or assets of the trust, to any eligible capital beneficiary of the Trust.

In the main, the Deed of Settlement provides:

(a) Who will be the Trustee or Trustees of the trust, that is who will be responsible for the administration of the trust and any business the trust may conduct.

If a trust is to conduct a trading business, it is generally recommended that a company be formed to act as a trustee and in that case, decisions have to be taken as to who will hold the shares in the company and act as the directors.  If a trust is to hold land and/or investment capital, and not actually to conduct a business, then generally there is really no need to form a company, but rather the trustees can be individual persons.

It is essential to ensure that the ultimate control of the trust upon the deaths of the senior family members, passes to those members of the family to whom the assets to be transferred to the trust would otherwise have been willed.

(b) Who will be the Appointors of the Trust.

The Appointors have the power to change the Trustees at any time, so whoever has that power really holds effective control over the Trust and its assets.

The Appointors of the Trust may simply be the parents, or the survivor of them, but the Deed of Settlement will then set out precisely who will hold the office of Appointor upon the death of the survivor of the spouses.

The importance of the Appointor role cannot be overstated.  It is important to review the trust deed to ensure that the trust deed sets out what happens on the death of the Appointor, or last surviving Appointor.

Many Deeds of Settlement provide that the Appointor does have the right to nominate a successor, but if that right is not exercised, then the Executors of the Will of the last surviving Appointor take the office.  The Appointor should carefully consider whether this is appropriate in their own circumstances.  In making this decision, the Appointors should be aware that once appointed, an Appointor has the discretion to exercise their rights to change the Trustee.  That new Trustee has the broad power to deal with the trust, including to distribute any and all assets out of the Trust to any of the beneficiaries of the Trust.

It is important to check the Appointor provisions to ensure that the office will pass to trusted family members, likely being those who are also entitled to the Trust’s assets.

(c) What powers the Trustees has.

The Trustees are broadly empowered to own or lease land, to mortgage land, to borrow money and broadly to conduct any possible type of business activity which anybody might be likely to engage in.

If the Trust is to conduct a business then family members can lend money to it to finance its activities.  Overdraft facilities can be arranged with the bank and the bank will always require personal guarantees for any borrowings by a discretionary trust, but of course that doesn’t impose any greater financial liability than was previously the case.

(d) Who will be eligible to receive assets out of the Trust if the Trustees ever wish to distribute any assets out of the Trust.

In some cases, this may affect certain exemptions or concessions available to the trust on the transfer of assets, in particular real property.

For example, if a Trust is to take a transfer of farming land free of stamp duty in Victoria, the beneficiaries must be restricted to the parents, their   children and the spouses of the children and grandchildren and their spouses – but a recent amendment also allows nephews and nieces to be included. If any wider range of beneficiaries is included then the transfer to the Trust will not be exempt from Stamp Duty.

It ought to be stressed however that merely being a member of the beneficiary class does not confer any rights on the beneficiaries to demand any share of the Trust assets.

(e) Who is eligible to share in the income of the Trust if the Trust does earn income.

There is no restriction on the range of family member beneficiaries who can receive income. Each year the Trustees decide how the income earned by the Trust will be distributed. Different decisions can be made from year to year, depending upon the incomes which various family members may have.

Again, no family member has any right to demand any particular portion of the annual income which the Trust earns.  It merely makes them entitled to share, if the Trustees resolve in their favour.

(f) The Trustees are given the right to transfer any part of the capital – that is the assets of the Trust – to any beneficiary.

This right to distribute capital ensures that the assets of the Trust are not “locked up”.  The potential of a capital gains tax issue arising upon the disposal of an asset though, must carefully be looked at.

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