What is a Family Discretionary Trust?

A Family Discretionary Trust is created by a legal document called a “trust deed”.

The Trust Deed:

  • outlines the purpose of the trust
  • details the rights and obligations of the trustees and beneficiaries
  • contains the powers of the trustee
  • identifies various parties such as initial Beneficiaries, Trustees & Appointor.

The beneficiaries of a family discretionary trust are usually family or related members of the same family.  The trustee has full discretion as to which beneficiary will receive a distribution of income or capital of the trust.

Many business owners prefer to run their businesses under a trust structure due to the many advantages that it offers compared with other structures.

The trustee owns the property of the trust and each year distributes the income of the trust to one or more beneficiaries.  A common objective is to minimise the total income tax to be paid on the trust’s net income.

The trust runs for 80 years or earlier.  The termination date is called “vesting day”, when the beneficiaries are entitled to all of the trust assets.  Until that day, the trust assets are held by the trustee.

The Settlor

The Settlor must be an independent person. The Settlor cannot be a trustee and cannot be a beneficiary of the trust, and their spouse and children cannot be beneficiaries.

A trustee or a beneficiary of a trust cannot act as the Settlor. The Settlor is usually a Lawyer or Accountant who helps the client to establish the Discretionary trust. The Settlor has no right to income or capital of the trust assets. Once the settled sum has been paid by the Settlor and the trust deed has been executed, the Settlor will have no further role in the trust.

When property is transferred to the trust from a family member, as settlement money, there could be stamp duty & capital gain tax issues. Care should be taken to decide this amount, which is usually below duty amount and is only $10.

The Appointor

The Appointor controls the trust, and can remove or replace the trustee. If the trustee does not follow the Appointor’s directions, the Appointor can simply remove the trustee and appoint another trustee.

Although it is not necessary to name an Appointor, it is recommended to handle the situations arising from the death or insolvency of a trustee. A Beneficiary or even the Settlor could be named as an Appointor. The “initial Appointor” is usually mentioned in a schedule to the trust deed.

The deed allows the Appointor to resign and nominate another person(s) as Appointor in their place. If an Appointor dies without making such a nomination, then the deceased Appointor’s legal personal representative can become an Appointor until another Appointor is arranged.

The Trustee

The Trustee is appointed by the Settlor with powers contained in the trust deed. The Trustee owes a duty of care of “good faith” to the beneficiaries and the deed requires that all trustee(s), at all times, act in the best interests of all beneficiaries.

The Trustee may be held personally liable for debts incurred in their capacity as a trustee but have the right to be indemnified out of the assets of the trust. A Trustee can resign by giving notice to the Appointor or to all the beneficiaries.

The Trustee is responsible to look after trust funds by investing & managing it and distributing the income to various beneficiaries at the end of each financial year. The Trustee must also maintain books of account and lodge relevant income tax returns with the tax office.

Who should be Trustee?

The Trustee can either be one individual or a few individuals or a company. Individual trustees should not be below 18 years of age and should not be a disqualified person. If the Trustee is a company, its affairs are controlled by its directors and eventually by its shareholders by virtue of their power to appoint or remove directors.

Usually a family member will incorporate a company to act as a Trustee, and nominates various family members as beneficiaries. Where there are not enough family members to reduce the total tax to be paid by the family on trust income, advisors may recommend that another company is incorporated and appointed as a beneficiary (see below), so that tax is paid on trust income at the company tax rate instead of the higher individual marginal tax rate.

Individual trustees can also be beneficiaries, however, most advisors would prefer a company to act as trustee of the trust and family members (who can also be directors of the trustee company) are beneficiaries of the trust.

There is no rule that Individual trustees cannot also be beneficiaries, but since trustees are to be seen to act in the benefit of ALL beneficiaries, having one or few Individual beneficiaries as trustees may break that fiduciary duty of trustees. Hence many advisors prefer a company to act as trustee.

When there is only one individual trustee and the same person is the sole beneficiary of the trust, this will be an invalid trust. The reason is that a person cannot hold an asset on trust for his/her own benefit. In such a situation, a company can act as a trustee with a sole director and that same person can be the sole beneficiary of the trust.

The Beneficiaries

A beneficiary is a person for whose benefit the trustee holds trust property.  In most trust deeds “initial beneficiaries” are noted in a schedule and are usually family members or other close relatives.  There are classes of beneficiary who can be parents, grandparents, brothers, sisters, children, grandchildren, aunts, uncles, nephews, and nieces of initial beneficiaries.  You can also have a related company or a charity as a class of beneficiary.

You must be careful in nominating another trust as beneficiary of the original trust as predominately income of the trust must remain in the family, other trusts may have other beneficiaries who are not family members of the original trust.

The root benefit of a discretionary trust is to distribute income of the trust to beneficiaries who are likely to pay the least amount of income tax.  Due to this trustee’s discretion, the beneficial ownership of assets of the trust does not pass to any beneficiary till “vesting date”.  The Trustee has legal ownership, but not the beneficial ownership of trust assets.  Hence, even if a beneficiary becomes insolvent, his creditors cannot claw back assets of the trust.

Advantages of having a company as a trustee

Besides fiduciary duty advantage as listed above, following are other benefits of having a company as a trustee:

  • Assets of the trust are held in the name of the trustee. If the trustee is a company then the private assets of individuals generally cannot be confused as trust assets;
  • In case of the death of an individual trustee all assets of the trust have to be transferred to the name of the new individual trustee. However if a company is a trustee, there is no change of ownership of assets even in case of death of director of trustee company;
  • The directors of Trustee Company can be beneficiaries in their individual capacity whilst still being in control of the trust.

Duties & Powers of Trustee

The Trustee must act in “Good faith” whilst handling trust affairs. This means that the Trustee must put the interest of the trust ahead of his or her personal interest; and act in a manner a person would in dealing his or her own personal assets.

The Trustee must:

  • follow the trust deed;
  • hold assets of the trust and manage its investments;
  • engage experts for the benefit of the trust;
  • delegate duties to a competent persons, however the trustee is still responsible for delegated tasks;
  • invest trust’s assets in accordance with law and as per the trust deed;
  • maintain proper books of accounts including minutes of meetings of the trustees/directors of the trustee company,
  • lodge tax returns with ATO; and
  • keep the trust’s assets separate from other personal assets.

Prepare your Family Discretionary Trust Deed

 →    Guide to preparing your customised Family Trust Deed

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