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Key Rules for Creating Trusts that Work when Needed

Dung Lam

Introduction

You want (or have been told) to create a trust. Do you know why? And if you know why, do you know how?

If your answer to both of these questions is yes, then a trust will work for you and your family. If your answer is no to either question, you will design a trust that is destined to fail.

Family or discretionary trusts are good for tax planning and asset preservation, but there is so much more to them. It is estimated that there are more than 850,000 of these trusts in Australia, potentially holding wealth approaching $3,000,000,000,000! So, if you want (or have been told) to create a trust, presumably it will hold part of your wealth.

However, do you know why, and do you know how?

Give the trust some thought

You need to understand why you want a trust and what you want to achieve from it, as well as what you do not want to see from it.

These thoughts will form the foundations of your trust. Ask yourself, what will it invest in? Where will the money come from? Who is to get the trust assets? Is there anyone who must not get the trust assets? 

Most off-the-shelf family discretionary trusts include the spouses of children, spouses of grandchildren, spouses of great grandchildren and so on. Our experience is that most do not know that spouses are beneficiaries, and most do not want this to be the case. Their mistake was not caring about it in the beginning and taking the time to read it, despite the fact it controls so much family wealth.

You should use the motivating forces for your trust to shape it into what you want it to be and what you want it to do; tailoring the trust rules to your needs, wants and desires.  

Understand the role of the settlor

The settlor creates the trust - they put to the trustee the first amount of money over which the trust is created. Once established, the settlor has no further involvement.  

However, what seems like a simple role is in fact vital - an essential building block for the trust's success.

Whenever the ATO or a bankruptcy trustee seeks to attack a trust, they first look to see if they can argue sham. If they can show the trust is a sham, the whole thing will fail and the trust's purpose will be destroyed. This happened in the 1990 Federal Court decision of Faucilles, where the ATO successfully argued that part of the trust was a sham. One of the reasons was that the taxpayer was unable to call the original settlor as a witness in support of the trust.

It is a crucial trust law concept that the settlement sum is a gift from the settlor. The best settlor is someone who has a relationship with the beneficiaries and will genuinely make a gift to the trustee (think in terms of a close family friend or potentially even a relative).  

For tax purposes, the settlor and the settlor's children should be excluded from benefiting under the trust. 

Carefully consider the beneficiaries

Take your time to think about the persons and entities you truly want the trust to benefit. If you never intend to distribute to your siblings, nephews, nieces, aunties, uncles and their spouses (including your children's spouses), why include them as a beneficiaries? This can only lead to future problems.  

An unnecessarily broad class of beneficiaries, without there being a particular purpose for it, can be detrimental. Such a broad family discretionary trust has a greater potential to be dragged into a family law dispute where 'spouses' are included as beneficiaries.  

The payroll tax grouping rules are broad, and it is possible for a passive discretionary investment trust to be burdened with the payroll tax liabilities of another entity which is grouped with the trust. For instance, in Smeaton Grange Holdings one brother’s family trust was grouped with his brother’s failed company business, exposing it to the latter’s outstanding payroll tax liabilities. This was because the ‘failed’ brother was named as a discretionary beneficiary in the other brother’s family trust.

More recently, broad beneficiary classes have caused discretionary trusts to be subject to higher rates of stamp duty and land tax under the foreign person surcharge provisions. Generally, we find that the 'foreign person' beneficiaries were never intended to benefit but their mere inclusion as a beneficiary still triggers the extra tax.

Getting your beneficiaries right in the first instance can save you legal costs, taxes and potential family law disputes in the future.

Have a succession plan for the trust

The trust will survive you; it will continue after you're gone. Is succession planning built into your trust?

Start with the role of the trustee - the trustee has immediate day-to-day control so trustee succession is important. 

Where you have a corporate trustee, you have the ability to pass on the shares in the corporate trustee to the intended controller - this may be your children. Your children will then be able to control the corporate trustee and run the trust moving forward. 

Another benefit of a corporate trustee is timing. You have the ability for the corporate trustee to nominate alternate directors who can step-in immediately in the event of an unfortunate disability. 

Succession of the appointor should also be considered. The appointor is the ultimate controller of the trust because of the appointer’s ability to replace the trustee with a new one. You should ensure that successive appointors can be nominated, in the event that the appointor is unable to act. 

A tailored trust deed will always be stronger than an off-the-shelf trust deed

Why have a trust that caters for everyone when you can have one that caters specifically for you? 

Off-the-shelf trusts are designed for the masses and may not address the previous four rules. 

By failing to have a tailored deed, you may find yourself amending the trust's terms time and time again to achieve your desired result. This may include removing and adding beneficiaries, inserting restrictions or creating additional powers and inserting succession planning mechanisms. Ultimately, a tailored trust deed may end up saving you money in the long run! 

More importantly, by having a trust deed crafted for your needs, you can ensure that your trust will work when needed.

If you require assistance in this area, Coleman Greig’s Trusts team would be happy to assist you.