Settlors as Beneficiaries?

Acis, current as of: 16 September 2016.

Most practitioners will have noticed that almost all modern trust deeds prohibit the settlor from receiving any distributions, or benefit from the trust. Generally speaking, amending the trust deed to remove that prohibition is also out of the question.
While there is nothing preventing the settlor of a trust from also being a beneficiary, having the settlor named as a beneficiary where the trust deed prohibits distributions to the settlor, can mean invalid distributions. This results in the trust having undistributed income which is assessable to the trustee at the top marginal rate.

Why we exclude the settlor as a beneficiary

It’s good practice to exclude the settlor of a trust from being a beneficiary to avoid the adverse consequences of section 102 of ITAA 1936, which allows the ATO to assess tax on the trustee of a revocable trust. This means the trustee may be assessed on all trust income rather than the beneficiaries if:

• The settlor can revoke or vary the trust and take back the trust property or receive trust income, in which case the ATO will assess all trust income to him/her; or
• Any of the settlor’s minor children are able to receive distributions.

This is, of course, the reason that modern trusts have a settlor who is entirely unconnected to the beneficiaries and who is specifically excluded from receiving any benefit from the trust. For example, Acis uses an independent company called Acis Settlements Pty Ltd. The exclusion of the settlor means, where a beneficiary is named as settlor, that person cannot receive distributions.

The impact of notional settlor provisions

It has generally been considered that a person who donates further property to an existing trust is not a settlor (or creator) of a separate trust which would trigger section 102. Some trust deeds, however, also exclude notional settlors from being beneficiaries for the same reasons as the original settlor is excluded.

Where notional settlors are excluded, a potential beneficiary may not be able to receive distributions if, for example

• Loans have been made to the trust at less than market interest rates by that person; or
• Assets have been gifted or sold to the trust at less than market value by that person.

Difficulties arise because it is highly likely that the persons intended to primarily benefit from the trust will have made such loans or transferred or gifted assets to the trust. This raises a significant risk of invalid distributions being made. For example:

• Any distribution to the potential beneficiary mentioned above may be invalid; or
• Distributions may be invalid if the trust receives distributions from another discretionary trust and the distributions constitute a transfer at less than full value.

If the trust deed contains valid default distribution provisions, these may save the situation by deeming the undistributed income to be paid to the default beneficiaries; however, in many cases the default beneficiaries will be the same person or persons.

Where a notional settlor provision exists in a trust deed, the trust deed should be amended to remove the restriction although many such deeds will also prohibit the amendment of the deed to permit a notional settlor to benefit.

Please contact Legal Services to discuss your questions, or if you have a trust deed which contains a notional settlor exclusion.