Asset structuring and family trusts

Commonly asked questions about asset structuring and family trusts

A trust is basically an arrangement where a person or company holds assets for the benefit of others.

The person establishing the trust, known as the “settlor”, must sign a document called the deed of settlement. This deed sets out the terms and conditions of the trust, including:

  • Who will be the trustees of the trust – that is, who will be responsible for the administration of the trust and any business the trust may conduct. In a family trust, the trustees are typically mum and/or dad (or, preferably, a company of which they are directors and shareholders).
  • Who will be the appointors of the trust – the appointors are given the power to change the trustees at any time, so whoever has that power really holds effective control over the trust and its assets. Usually, the appointor has nothing whatsoever to do with the day to day running of the trust.
  • The assets to be held by the trust.
  • Who is eligible to share in the assets which the trust may acquire if the trustees ever wish to distribute the assets out of the trust.
  • Who is eligible to share in the income of the trust. There is no restriction on the range of beneficiaries who can receive income.
  • The deed empowers the trustees to own or lease land, to mortgage land, to borrow money, to enter into partnerships, and broadly to conduct any possible type of business activity which anybody might be likely to engage in.

Each year the trustees decide how the income earned by the trust will be distributed to beneficiaries. Different decisions can be made from year to year, depending upon the incomes of various family members. Beneficiaries do not have to receive the same portion each year. The trustee is free to distribute income as they see fit.

A trust does not pay tax on income that is distributed to beneficiaries, but it does pay tax on any undistributed income. This is a strong incentive to distribute income at the end of each financial year. Undistributed income is taxed at the top marginal tax rate, currently 45%.

It is important to note that only members of the family group can have income distributed to them. Generally, if income is distributed to someone outside of the family group, then the maximum tax rate will apply.

  • The flexibility for trustees to increase or decrease income allocations to each family member in each year, as opposed to a partnership, where the percentage of income is fixed and invariable. As a result, if in a partnership one partner has other income, that partner’s taxable income may be substantially higher than the income of their spouse, and therefore a greater amount of tax may be payable than if the two spouses’ incomes were equal. Because of a trust’s flexibility, each spouse’s income can be kept equal, and tax thereby minimised.
  • The ability of the trustees to allocate some of the income earned by the trust between your children. Approximately $416 of trust income can be paid tax-free to a child under 18 years of age and the trustees pay the money to the parents of the child, who are entitled to use it for the child’s benefit. At the age of 18 any person is subject to the ordinary threshold limits for tax, with the first $18,200 of income being tax free. If there is a member of the family who is over 18 and studying, then quite often very substantial tax savings can be made by the trustees allotting income to that family member, who will use the income to cover living and educational expenses. Where there is not a discretionary trust in operation, the parents assist their children through the education years out of their after-tax income. By use of a trust, quite substantial funds can be directed towards the child or children being educated and become tax free within the family unit.
  • If a family member happens to have an investment which makes an income, which is then taxed in that family member’s name, it may be wise to consider giving the asset to the trust or lending it to the trust free of interest. The income made from the investment can then potentially be distributed from the trust more widely amongst the family, than if the income was just received by the one family member and taxed accordingly.
  • The trust deed can empower trustees to allocate a specific source of income, for example a fully franked share dividend or a capital gain, to a specific beneficiary. This is called “income streaming” and often creates very significant tax benefits. For example, if a trust has investments in shares which pay fully franked dividends, those dividends can be distributed to higher, rather than lower income earning family members, who can then claim the benefit of the tax credit applicable to the dividend, against the dividend income in their tax return.
  • If a beneficiary of a discretionary family trust becomes bankrupt or divorced, or is pursued by creditors, the trust assets are generally not at risk.

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