INTRINSIC INVESTMENT MANAGEMENT

FAMILY TRUSTS & OTHER TRUSTS

The family trust is a commonly used asset structure in Australia. Essentially, a trust pools
assets (e.g. cash, real property, shares collectables and so on) into a single unit from which
the beneficiaries of the unit (i.e. family trust) can derive income. A family trust can operate for
up to 80 years and is useful if your family holds capital growth or income-generating assets.

A family trust is one of the most common small business structures in Australia. Family trusts
provide families with a great deal of flexibility in sharing the tax burden among family
members and protecting family assets (e.g. the family farm or business).

What is a trust?

A trust (including a family trust) is established whenever there is separation of the legal
ownership of an asset from the beneficial (equitable) or real ownership of the asset. For
example, the ownership of shares can be in the name of the Smith Family Trust, but are
actually owned by John and Mary Smith.

Different types of trusts

There are four common types of trusts. These are:

 Family Trusts;
 Discretionary Trusts (a family trust is also a discretionary trust);
 Fixed UnitTrusts;
 Hybrid Trusts.

More about these trusts later.

A Trust needs a Trust Deed

The Australian Taxation Office (ATO) is unlikely to accept the existence of any trust unless a
trust deed has been established. The trust deed is the document that sets out the terms or
rules under which the trust operates.

A Trust needs a Trustee

A trust is an obligation that binds a person (known as the trustee) to deal with and manage
property for the benefit of others (known as beneficiaries) in accordance with the
requirements of the trust deed. A person (e.g. John Smith) can be both trustee and a
beneficiary of a trust (of the Smith Family Trust). A Company or another trust can be a
trustee.

Why use a family trust?

Family trusts are used for many reasons. (You should seek professional legal and tax advice
before making any decision to establish a family trust).

Common uses include:

 Asset protection;
 Estate planning;
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 Masking the ownership of assets; and

 Tax planning

Masking the ownership of assets

Some people are sensitive about public disclosure of their assets and prefer to use names to
“mask” that ownership. For example, John Smith may choose a trust name completely
unrelated to Smith.

Asset Protection and Estate Planning

The pooled nature of a family trust means that beneficial ownership of assets and income is
somewhat blurred.

Thus, if John Smith was to accumulate wealth in the family trust rather than his own name,
then in the event of bankruptcy or insolvency (say of his business) the a ability of his
business’s creditors to seek compensation directly from John’s own “pocket” is somewhat
limited. Professionals such as company directors, lawyers, engineers, architects and medical
staff are more likely to be sued than ordinary workers and should consider using trusts as one
form of asset protection in the event of litigation. In addition, the self employed, such as
electricians, builders and plumbers are also open to litigation and potential bankruptcy or
make become insolvent. Groups such as these, often rely upon professional indemnity and
Directors and Offices insurance as protection at their peril. (Anyone remember HIH
Insurance?). Moreover, these types of insurance don’t cover you if you or your business is in
breach of the Law, such as insolvent trading.

Be aware that shifting existing assets particular those subject to capital gains may trigger a
tax payment to the ATO as beneficial ownership will have changed.

Also be aware that assets shifted into a family trust may be still subject to claim by creditors
for up to 5 years after the day they were shifted. This is designed to capture people who
suspect claims from creditors or litigation and shift assets in anticipation.

Family trusts also allow considerable estate planning benefits. This is a way you can preserve
assets (e.g. a holiday home) for succeeding generations and secure income for certain
beneficiaries, either for life, a specified period, or until a particular event (e.g. until the
marriage of a child or the competition of education).

For example, if you die at a relatively young age, your widow might inherit substantial wealth,
such as a life insurance policy. It is possible that your widow spends, lends or loses (or
remarries someone who does the same), this wealth leaving nothing for your children’s
education or general benefit. A family trust is one way of preserving capital and providing an
education for your children.

Tax Planning

There is no specific tax advantage inherent in the family trust. It is not a tax shelter. But it
does allow the trustee to vary income and capital distributions each year in order to minimise
overall family tax without incurring stamp duty or capital gains tax (CGT). This is particularly
useful where the income of individual family members fluctuates from year to year. Thus,
John Smith can elect to pay Mary Smith income this year, but not next year if it suits to do so.
This ability to distribute income to family members who are on low tax can be very useful. In
addition, the trustee can "stream" income: That is, the trustee can distribute one type of
income to one person (e.g. franked income and another type of income to another person

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unfranked income). Moreover, John can elect to distribute capital to himself and pay Mary
unfranked interest income. It all depends upon their relative tax positions each year.

Income not distributed in any one year is taxable at the top marginal tax rate plus the
Medicare levy. So there is a real stimulus to distribute income each financial year.

The decision as to which beneficiaries are to receive income technically has to be made by
the trustee by the end of each year It is the ATO’s practice to allow that to be done up to 31
August each year.

How to become a Family Trust

For tax purposes a trust becomes a family trust if the trustee makes an election to do so. Any
type of trust can become a family trust. But once it’s a family trust it cannot become another
sort of trust.

Who are the players in a Family Trust?

1. The Settlor

The Settlor is the person/ company, who establish the trust by putting in an asset
(usually $10). After the family trust is set up, you transfer in assets or cash to
purchase assets into the trust. The settlor is typically a lawyer, accountant or financial
adviser. A Settlor should never be a beneficiary. (Income Tax Assessment Act (1936)
section 102(1)).

2. The Appointer (guardian)

This is the most important person in the trust structure as the Appointor appoints and
can dismiss the Trustee. The appointor can be anyone, but its wise to make the
Appointor yourself. Your spouse can also be an appointor along side you.

3. The Trustee

The Trustee is the legal owner of the trust’s assets (but not the real owner of the
assets) and manages the trust, including making investment decisions aimed at
increasing the value of the assets.

Trustees, among other things, must be fully acquainted with the terms of the trust,
know who the possible beneficiaries are, know what the assets and liabilities of the
trust are, keep proper accounts and prepare tax returns.

4. The Beneficiaries

Beneficiaries are the people who benefit under the trust. In normal family trusts the
beneficiaries are generally immediate, and sometimes extended, family. They have
no right or claim to any of the trust property until it is distributed or otherwise vested in
them under the terms of the trust. That means, they can be a beneficiary but not
receive anything unless the Trustee so determines.

A Typical Discretionary or Family Trust Structure

The following diagram shows a typical discretionary / family trust structure.

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Appointor
Settlor Appointor hires & fires trustee
Usually Appointor indirectly
Cannot be a beneficiary
controls the trust.
Settlor and trustee establish trust
Trust deed should provide for
by executing a Trust Deed
the future control of the trust
after the Appointor dies.

Trustee
Can be yourself and your spouse or your company
Trustee taxed on accumulated income and pays tax on behalf of non-resident, minor,
intellectually disabled or bankrupt beneficiaries
Trustee holds investments and/or conducts business on behalf of trust
Trustee has discretion to choose which beneficiaries are to receive income or capital (to the
exclusion of other potential beneficiaries).

Primary individual Tax exempt entities

and legal/de facto No tax is paid on income
spouse TRUST FUND distributed to tax exempt
Beneficiaries are taxed on any organisations
income paid or allocated to, or
applied for, them
Beneficiaries have no right to
Other defined family Tax deductible
Members claim any unallocated trust
entities
Includes children, income or capital
grandchildren, parents, Stamp Duty and CGT may be
grandparents, siblings, payable on transfer of assets to
nephews and nieces of
test individual or current the trust
spouse Less choice of beneficiaries if a Family Trusts with
family trust than a discretionary same Primary
trust, but fewer restrictions on Individuals
utilising company losses, bad
debt deductions, utilising or
carrying forward income losses
and no loss of Franking Credits Companies/Trusts
Current legal/ de
facto spouses of for post 1997 shares wholly owned by
family members family members

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What happens if the Family Trust goes broke?

The Trustee of the trust is indemnified out of the assets of the trust. The beneficiaries of a
trust are likewise personally indemnified. This means that should the family business find
itself in difficulty with creditors and you have signed no personal guarantees, then it is
possible that the only assets that can be called upon to pay these debts are those owned by
the family trust.

The trust can also limit the personal liabilities of individual members of the trust’s business.
Properly set up, the business is not owned by the individuals, as in the case of a partnership;
the business is owned by the trust for the benefit of it’s beneficiaries.

Can family trusts avoid the death taxes such as Capital Gains Tax?

Yes. A beneficiary does not own the Trust Fund. Thus, when a beneficiary dies the Family
Trust fund does not form part of your estate under your Will.

The Appointor and Trustee need to think carefully about who will takeover these roles in the
event of their death. Children are the obvious choice but this can cause problems as well.
Further, what happens when they pass-on? It maybe that you decide that this is the time that
the Family Trust is wound-up and the remaining assets distributed.

On going activities.

For most Family Trusts there is not a lot of daily management required. Most the work comes
at the end of each financial year when the financial accounts and distributions need to be
attended to. Other requirements of the Trustee include:

 Record keeping (minutes of meetings, bank statements etc);

 Fulfilling Statutory obligations (holding members tax returns, ABN numbers etc);
 Paying debts and receiving income; and
 Proper and diligent management of the Trusts affairs,

Other Types of Trust

 Fixed Unit Trusts

Unit trusts are similar to Family Trusts but the income and capital are distributed
exactly according to the units you hold in the Unit Trust. These trusts are usually
established as an alternative to companies. A public unit trust like those listed on the
Australian Stock Exchange are typical of fixed unit trusts.

 Discretionary Trusts

Discretionary trusts are the most common form of trust. A family trust commenced life
as a discretionary trust. Money assets or even whole businesses are generally
transferred into a trust by sale or gift. Discretionary Trusts can also be established by
a person’s Will. If so they are known as Testamentary Trust.

 Hybrid Trusts

Hybrid trusts are similar to fixed unit trusts except the Trustee has given discretion to
vary the entitlements to income and capital distributions.