Peter Johnson highlights the complexities that arise from historical issues in SMSF trust deeds and provides practical strategies to address these challenges. […]
Answers To Your Top 10 Discretionary Trust Questions
Emily Pritchard, current as of: 4 August 2022.
A trust is not a legal entity in itself, but a fiduciary relationship recognised by law. It requires some form of property (trust property) to be held by a person or company (the trustee), who is obligated to deal with the property for the benefit of other persons (the beneficiaries). Beyond the essential, legal elements of a trust, there are a myriad of questions and considerations that arise. In this issue of Acis All Areas, we’re answering the 10 most common questions we’re asked in relation to discretionary trusts.
1. Why Establish A Discretionary Trust?
Some of the primary reasons to utilise discretionary trusts are:
- Asset protection: Discretionary trusts create a layer of protection from personal creditors of the trustee and beneficiaries, because the trust’s assets are held by the trustee, for the beneficiaries.
- Tax planning: Using a trust allows flexibility in the distribution of income to the beneficiaries each year to achieve the best tax outcome.
- Succession planning: Utilising a discretionary trust can allow for the intergenerational transfer of control of assets without undesirable tax and duty consequences.
2. What Is The Difference Between Place Of Settlement & Applicable Law?
As the name suggests, the Place of Settlement of a trust is the place in which it is settled or established (usually where the trust deed is signed). Any duty payable on the establishment of a trust is almost always determined by where the trust deed is signed ie its Place of Settlement.
Most modern trust deeds elect to adopt the laws of a specified State as the Applicable Law or Jurisdiction of the trust. The Applicable Law/Jurisdiction simply stipulates the jurisdiction in which any disputes between the Trustee and Beneficiaries are to be resolved. The Jurisdiction of the trust generally has no impact on duty that may or may not be payable on the execution of a trust deed.
Once established, a trust may commence business or acquire property in any Australian jurisdiction, and in doing so may be liable to pay duty. Any liability will usually be based on the duties regime in the State in which a relevant transaction takes place or an asset is located. Any liability to duty that arises from the acquisition of assets, is separate and distinct from duty that may or may not be payable on the establishment of a trust (or the need to have a trust deed establishing the trust stamped).
You might find this resource helpful: Where the Duty lies in establishing trusts
3. Who Should The Default Beneficiaries Be?
While they are not a legal requirement, it’s important to consider the particular circumstances surrounding each trust when determining whether it should have named, default beneficiaries.
A default beneficiary in a trust, or a taker-in-default, is a beneficiary who receives a distribution of income or capital because of the trustee’s failure to make distributions. One of the clearest potential benefits of having default beneficiaries is in relation to tax, so they may avoid income being taxed in the hands of the trustee at the highest marginal rate. This can be beneficial where more income comes to light after resolutions are prepared or, in rare cases, where the trustee has not distributed all trust income on or before June 30. There is potential benefit in selecting default beneficiaries who are on low tax rates, and it’s important that intended default beneficiaries are not minors, to avoid them being taxed at penalty rates.
It is also worth noting that, unlike a discretionary beneficiary (who is not automatically entitled to a distribution, but is dependant on the trustee making a determination to that effect), default beneficiaries are generally considered to have an interest in trust assets. This is important when considering making changes to default beneficiaries, as it may give rise to duty consequences.
While there may be benefits in naming default beneficiaries, we recommend determining their appropriateness and identity on a case-by-case basis.
You might find this resource helpful: Are Default Beneficiaries a Necessary Evil
4. Can The Appointor And Alternative Appointor Of A Trust Be Changed?
The Appointor is the position in a trust that generally has the power to remove a Trustee and/or appoint new Trustees. The role is significant because it effectively controls the trust by controlling the identity of the Trustee. As a result of that “ultimate” control, it’s important that succession planning is considered when determining who will act as the Appointor and Alternative Appointor of a trust.
To address this requirement, the Appointor provisions in the Acis deed are extensive and provide various mechanisms surrounding the resignation, removal and appointment of the Appointor and Alternative Appointor, ensuring the position is always filled.
If required, older and non-Acis deeds can generally be amended to provide the same level of functionality.
You might find this resource helpful: The Role & Powers of a Trust Appointor: A Snapshot
5. Where There Is More Than One Appointor, Do They Need To Act Unanimously?
The standard Acis Discretionary Trust Deed stipulates that, where there is more than one Appointor, decisions of those holding that position must be made unanimously. That said, if there is a desire for decisions to be made in a different manner, for example by majority, the trust deed can be modified (either at the time of establishment or subsequently).
In the case of an existing trust deed being amended to change the decision-making of Appointors, the existing Appointors would need to consent to that amendment being made.
6. Can Children Be Named As Primary Beneficiaries?
While this is technically not an issue, it can be problematic to specifically name minors as beneficiaries of trusts. Banks generally require 100 points of ID from all named beneficiaries when opening bank accounts, and personal guarantees from named beneficiaries when trusts are applying for finance. Minors cannot give personal guarantees, and, for obvious reasons, it can be difficult to provide 100 points of ID.
In most cases, minor children will likely fall within the description of Secondary Beneficiaries, for example as a child of a Primary Beneficiary, so they will still be potential beneficiaries of the trust and naming them is generally unnecessary.
7. Why Should A Corporate Trustee Be Appointed?
The primary driver for using a corporate trustee is one of asset protection. The overriding principle is to separate risk from assets.
As trusts are not considered to be legal entities, there must be a person or other legal entity that becomes primarily liable for the debts of the trust. This is the trustee, of course, but the issue is that they incur personal liability for the debts of the trust. Whilst the Trustee is usually entitled to be indemnified for any personal liability by recouping any such amount out of the assets of the trust, what happens if the trust does not have sufficient assets to pay that liability for the trustee? The Trustee is personally responsible for those liabilities, whether or not the trust has sufficient assets. Any Trustee who cannot claim against the indemnity has their personal assets exposed to the claims of creditors of the trust. This is a very good reason to have a corporate trustee.
You might find this resource helpful: Why use a Corporate Trustee
8. How Do I Know if a Beneficiary is Eligible?
A discretionary trust deed generally identifies, by name or description, the potential beneficiaries of the trust. This usually includes a wide range of potential beneficiaries, including natural persons, companies and other trusts. The Trustee of the trust has a discretion to determine which of these beneficiaries are to receive distributions of income and/or capital from the trust and in what amounts. The Trustee may only make determinations to distribute to those persons or entities that are eligible beneficiaries of the trust. Situations change, and it’s important to determine that intended beneficiaries are eligible beneficiaries each and every time a distribution is to be made.
Example: The Trustee resolved to distribute to a company on the basis that it was a beneficiary of the trust because it was a “corporation of which a Primary Beneficiary is a Director”. The Primary Beneficiary passed away, ceasing to be a Director of the relevant company, breaking the beneficiary link. The Trustee continued to distribute to the company without confirming it continued to be a potential beneficiary of the trust, resulting in years of invalid distributions.
If the trust deed does not record an intended beneficiary as a potential beneficiary of the trust, an amendment to the trust deed to include that person or entity should be prepared prior to any distributions being made.
You might find this resource helpful: Beneficiaries in a Discretionary Trust
9. What Should I Do If The Trustee Intends To Distribute To Foreign Persons?
Most States and Territories have either foreign person land tax surcharges or foreign person duty surcharges. Many have both. It’s important to consider the impact of these surcharges on trusts so that, where the trust owns property, It’s not inadvertently assessed at surcharge rates. The standard Acis Discretionary Trust Deed excludes foreign persons for the purposes of all States and Territories that have surcharges, except NSW. A version that excludes foreign persons for NSW purposes can also be ordered.
In some circumstances, there’s a genuine desire to distribute to foreign persons, and the imposition of the surcharges is acceptable to the Trustee. In such cases, a trust deed that does not exclude foreign persons should be considered (and can be ordered on request).
10. Can Beneficiaries Be Restricted To Close Family Members Only?
Insolvency, bankruptcy, family breakdown and death are just some of the common concerns that arise in the context of asset protection, estate planning and investment or business structuring. For these reasons and others, it’s conceivable that the standard group of potential beneficiaries in a discretionary trust might need to be varied prior to establishment . Alternatively, Acis Lineal Descendants Discretionary Trust could be an option.
The Acis Lineal Descendants Discretionary Trust (LDDT) is, as its name suggests, a type of discretionary trust. The Trustee of the trust, in both standard Discretionary Trusts and LDDTs, has a discretion to determine which of the beneficiaries are to receive distributions of income and/or capital from the trust and in what amounts. What differs between a standard discretionary trust and the LDDT, is who falls within the definition of Beneficiary in each case.
The potential beneficiaries in the LDDT are a much more finite group than in a standard Discretionary Trust, and are largely restricted to the children, grandchildren and remoter issue (i.e. the lineal descendants) of the Primary Beneficiary/ies. While the Trustee still has discretion to determine which of the beneficiaries are to receive distributions and in what amounts, the group of beneficiaries in whose favour the trustee can exercise that discretion is much more limited.
You might find this resource helpful: Keeping it All in the Family
To assist, the Acis Discretionary Trust Checklist is available here.
Above all else, please remember that if your query hasn’t been answered here, the Acis team is always happy to help. Contact us.