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Discretionary Trusts are an Asset Planning Vehicle: Discuss

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Institution

Discretionary Trusts are an Asset Planning Vehicle: Discuss

Nature of a discretionary trust

A typical discretionary trust is one where assets are held for the benefit of a family, with the trustee having a complete discretion to distribute or accumulate income and distribute assets amongst a wide range of potential beneficiaries, being family members and their associated companies and trusts.

A discretionary trust is usually established by a small settlement (gift) made by a person called a settlor.¹The bulk of the trust property comes from gifts or loans made later by the person who seeks to transfer assets out of his or her own name. The trust can help protect family assets and enable income to be spread among members of the family.

The trust fund is held by the trustee and administered in accordance with the terms of the trust deed². Although the trust deed may be more detailed and complex than is strictly required in a simple and straight forward family situation (such as where it is desired to hold only one or a small number of family assets, or perhaps assets which are not of significant value), the document is still appropriate as it allows for later growth, flexibility or complexity in trust arrangements.

Asset Planning features of the trust

The trust deed gives the trustee a complete discretion as to annual distributions or accumulation of income and capital up to the vesting day, and also upon the vesting of the trust fund³. Provisions relating to distribution of income have been drafted taking into account current income tax matters, including capital gains tax, franked dividends and foreign tax credits, and allow for distribution of different classes of income. Distributions can be made by cash, cheque, setting aside the amount for the beneficiary in the books of the trust or transferring specific assets.

The trust deed gives the trustee wide powers of investment, mainly to satisfy the requirements of banks and other financial institutions. It should rarely be necessary to add other investment powers, but this can be done when desired.

The trustee’s discretion is defined to be absolute and the trustee is not required to give any reasons for making any determination or exercising any power or discretion. Trustees, however owe significant duties to the beneficiaries, particularly where determinations are made but not distributed. You should read the trust deed carefully.

The trust deed entitles the trustee to be indemnified out the trust fund against all liabilities incurred.

The settlor, the trustee and any former trustee are excluded from benefits under the trust deed, which further declares that there can be no resulting trust to the settlor. This avoids problems associated with the trust being regarded as a revocable trust under section 102 of the Income Tax Assessment Act 1936⁴, where the Commissioner of Taxation may tax the trustee for the amount equal to the difference between the tax actually payable by the settlor and the tax the settlor would have to pay but for the trust. These provisions were also formerly relevant to avoid adverse death duty consequences, although death duties have now been abolished in all states and territories and federally⁵. Sometimes this provision is amended so that subsequent donors to the trust fund (but never the settlor) are not expressly excluded from benefits, but this is something which should be carefully considered before making the amendment.

Note: Amend the above paragraph if the definition of “Excluded Person” in the discretionary trust deed has been amended⁶. Refer to the note following the definition of “Excluded Person” in clause 1.1 of the trust deed.

Testamentary Discretionary trusts in Asset planning

There may be a number of estate planning benefits in using testamentary trusts as discussed below.

These issues need to be considered as part of the overall planning process.

What is a Testamentary Discretionary Trust (“TDT”)?

We have referred to Discretionary Trusts above. They are often referred to in the newspapers and magazines⁷. They are also becoming very popular in estate planning. It is therefore important to understand exactly what they are.

TDT’s are only another form of testamentary trust. The difference between a standard trust and a discretionary one relates to who are the beneficiaries. With a standard trust the beneficiaries have what is known as an equitable of beneficial interest in the trust property. This means that the trust property is an actual asset of theirs even though Trust Property is in the name of the Trustee.⁸ They can at any time call on the Trustee to transfer the Trust Property to them (subject to any express limitations in the Trust Deed or will and to their being sui juris i.e. of full capacity)⁹. However with a Discretionary Trust, there is a named class of beneficiaries to whom the Trustee may appoint trust income and/or trust capital at the trustee’s discretion. This means the beneficiary has no present interest in the trust property. The beneficiary has no entitlement to the trust income or trust capital until such time as the trustee appoints the same to the beneficiary or the beneficiary is entitled upon default of appointment under the provisions of the trust deed or will.

There are currently considerable advantages with a TDT because of the flexibility as to entitlement of trust income and trust capital:

Trust income can be distributed in a tax favourable way. The potential class of beneficiaries can have different tax circumstances from year to year. Therefore the Trustee can elect to appoint different beneficiaries from year to year to receive the trust income. Also as a variant on this, different classes of income can be distributed to different beneficiaries. In addition, there is the opportunity to take advantages of different rates of taxation e.g. franked dividends¹⁰.

Assets of the trust can be protected if any beneficiary becomes bankrupt, suffers family breakdown (where it is a third party trust and not a family trust of one of the marriage partners which holds matrimonial assets) or becomes mentally incapacitated.¹¹

Assets can be kept away from spendthrift children.

Many people are aware of family trusts. These are generally a form of Discretionary Trust However in our experience not as many people are aware that you can also establish a Discretionary Trust under the provisions of the will. The same advantages discussed above apply¹². At the present time TDTs are treated in a more tax favourable way than normal Discretionary Trusts created by trust deed as discussed below.

Tax Advantages of TDTs

Income Tax

The Income Tax Assessment Act 1936 applies penal rates of tax to income derived by minor beneficiaries of trust estates.¹³ The income of these beneficiaries has a tax-free threshold of only $416.00 per minor beneficiary with the excess being taxed at 66% (It should be noted that in addition to the $416.00 tax free threshold, a Low Income Earner’s Rebate may be taken into account. If the minor has no other income, up to $2,666.00 can be tax free).

This is to be contrasted with the $6000.00 ordinarily applicable to resident beneficiaries.

However these penal rates of tax do not apply to what is called “accepted trust income”. Assessable income of a trust estate that results from:

• a will, codicil or an order of a court that varied or modified the provisions of a will or codicil; or¹⁴

• an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of the estates of the person who died intestate”;

• is defined as “excepted trust income” which means it is not subject to the above penal rates of tax but is taxed at normal marginal rates¹⁵.

Therefore a trust estate established by a will can allocate income to minor beneficiaries with a tax free threshold of $6,000.00. This tax free threshold will apply to every beneficiary who has no other income. Therefore if there are 4 children who earn no other income there would be a total tax free threshold of $24,000.00 for the family.

The tax free threshold of course applies in any event to adult beneficiaries if they earn no other income.¹⁶ Further, if they are on a low tax rate it can be advantageous to distribute the income to these beneficiaries rather than a beneficiary on high tax rate eg income could be distributed to a non-earning spouse rather than the partner who is on a high tax rate. Also if the trust has capital gains it could distribute those gains to a beneficiary who has accumulated capital losses.

It is also possible for a beneficiary of a deceased estate to transfer the gift they received within three years of the date of death of the deceased to a trustee of a trust estate for the benefit of a beneficiary who could have received a benefit if the deceased had died intestate. Therefore if the will did not provide for such a trust estate it is possible for the named beneficiary to establish a trust estate with the benefit he or she received under the will provided they do so within three years of the death of the deceased. Such a trust estate could be a discretionary trust for the benefit of that beneficiary and his or her children¹⁷. The income earned from such trust estate will also be “excepted trust income” which means it is not subject to the above penal rates of tax but is taxed at normal marginal rates.

However there is a rider on the use of this second type of arrangement. Where property was transferred to the trust estate by another person for the benefit of a particular beneficiary then in effect the benefit of “excepted trust income” will only apply to the income earned on that part of the property that would have devolved directly upon that beneficiary if the deceased had died intestate¹⁸. In such a case one has to look at what the beneficiary would have been entitled to if the deceased had died intestate.

CGT

The 50% discount capital gain applies to trusts as well as individuals under current tax laws. The previous proposal to tax trusts as entities did not proceed and does not appear to be on any current political agenda. The trust also has the same choice as the deceased had in relation to post- CGT and pre-21 September 1999 assets as to whether to take the frozen indexation or the 50% discount capital gain.¹⁹

The current advantage of having the assets of a deceased estate in a TDT is that CGT can be deferred, CGT does not arise until a CGT event occurs which is usually a disposal of the asset.²⁰ Generally death does not constitute a CGT event or “disposal”. The CGT will not be payable until that asset is sold by either by the Trustee or the Beneficiary. Where the asset was pre-CGT or exempt from CGT in the hands of the deceased then the cost base will be its market value at the date of the deceased’s death.²¹

Therefore the assets can be retained by the trust until a suitable time for disposal.²² Alternatively they can be later transferred to a beneficiary in satisfaction of a particular share of the estate of that beneficiary who can elect to sell the same at a time when their tax rate reduces the amount payable or when they have capital losses available to offset the capital gain.

Asset protection advantages

There are not only tax issues to be considered. The question of asset protection for and from beneficiaries can also be as important. Typical situations where a testator/testatrix may wish to interpose a trust for protection of assets are:

• where there may be current or potential family law problems between a proposed beneficiary and the spouse of the beneficiary;

• where a proposed beneficiary is presently bankrupt or in a precarious financial position;

• where a proposed beneficiary is a spendthrift and unlikely to be able to manage the inheritance;

• where there are minor beneficiaries;

• where a proposed beneficiary suffers from some physical or intellectual disability;

In some cases this issue may be more important than the tax issues²³.

Assets outside the estate — estate planning issues

Not all assets or notional assets that a deceased may consider “his” of “her” assets pass to his or her estate²⁴. Quite often there are assets or notional assets that are unaffected by or treated differently without actually passing to the executor and then to the beneficiaries under the will.²⁵

When preparing an estate plan “other assets” of a deceased need to be taken into account. If they are not, it can result in sometimes unintended unequal distribution of assets. This cannot only leave problems for the deceased family but almost certainly will cause an application by a dissatisfied beneficiary under the Inheritance (Family Provisions) Act to seek a more equitable distribution.

Some examples are:

Jointly owned assets

Jointly owned assets can be owned as joint tenants or tenants-in-common. The major difference is that an asset owned as a ‘joint tenant” automatically passes to the survivor. It does not go to the estate of the deceased joint tenant²⁶.

The most common asset owned as “joint tenants” is real estate. Generally married couples own their own home as “joint tenants”.²⁷

This raises a number of issues to be taken into account in planning an estate:

Do the joint owners intend the other to automatically receive their interest In the property upon death?

For example an engaged couple, a de facto couple or a second married couple may not necessarily want this to happen²⁸. If the joint owners want to be able to specify what happens to their interest on death they should sever the joint tenancy and have the property transferred to themselves as tenants-in-common in the appropriate shares.

Will the joint owner receive a disproportionate part of the total assets of the deceased that will cause problems for the deceased’s other beneficiaries?

For example with a second marriage the major asset may be a house. If that house was owned as joint tenants the survivor would receive the deceased’s interest automatically and could then leave it to a stranger in their will. This would mean that the deceased’s children from a first marriage would miss out. (The testator may intend this but it must be ascertained that he does in fact intend this consequence).

There are CGT consequences

The joint tenant will be deemed to have acquired the deceased’s interest in the asset in the case of a pre-CGT asset at market value at the date of death of the deceased or the deceased’s cost base, indexed cost base or reduced cost base in the case of a post CGT asset. The main residence exemption however would continue to apply²⁹. Therefore, unless the asset continues to be exempt from CGT (eg the main residence exemption) the joint tenant will need to keep proper records and may have to obtain a market value of the deceased’s interest in the property if the asset was a pre-CGT³⁰.

Superannuation death benefits

Changes have been made to superannuation in the past couple of years. However it is still a good vehicle for asset protection and tax planning. There is still the advantage of the fund going into pension phase which enables the avoidance of CGT on disposal of assets acquired pre‑pension phase³¹.Although that was going to be removed due to protests, the legislation was never enacted.

In relation to self-managed superannuation, there is also the question of succession to the fund. You can only have four members for a fund, so if there are two children they can be members of the fund but if more than two there is an issue. Some people consider appointing children as members of the fund once one of the members (father or mother) dies to keep the fund open.

The deceased may have filled in a nomination form and given it to the trustees of the Superannuation Fund nominating to whom they wish their superannuation benefits to be passed to upon their death. If the nomination is made to a person other than the estate then this may be an asset dealt with outside the will³².

There are two types of nominations, binding nominations and non-binding nominations. A binding nomination means that the trustees must follow the direction given whereas with a non-binding nomination, the trustees may but need not follow the nomination of the deceased member³³.

In order to make a binding nomination the superannuation trust deed must permit one to be made and in addition certain requirements must be met which are similar to the requirements to the making of a will. These are that the notice must be in writing and witnessed by two adult witnesses who are not beneficiaries. In addition the nomination is only effective for a maximum of three years so it must be made every three years³⁴.

• Where the nomination is not a binding nomination then the trustees have in fact a discretion as to how to apply the monies but generally would do so in accordance with the election.

• Unless the deceased has stated the benefits are to go to his estate then the trustees will pay the proceeds to the person or persons nominated in the election.

This payment can be a major proportion of the deceased’s total assets. As with joint tenancy if consideration is not given as to how this asset is dealt with problems can arise. The following discussion applies for superannuation death benefits paid as and from 1 July 2007.

The following is a summary:

The superannuation death benefit should be directed to a “superannuation death dependant” wherever possible. If this is not done then the taxable component of the lump sum is assessable income subject to a tax offset that ensures the rate of income tax on the taxed component within the fund is no more than 15% and the untaxed component within the fund is no more than 30%;³⁵

The payment of the superannuation death benefit to a superannuation death dependant may result in a disproportionate amount of assets going to one party, eg second marriage estates. This effect must be taken into account;

The election form should be regularly updated, eg because of marriage, divorce, entering into or leaving a de facto relationship, children becoming adults, etc³⁶. There would be nothing worse than for an superannuation death benefit to go to an ex-spouse rather than the new spouse because the deceased forgot to change his election form when he divorced his first wife particularly where the ex-spouse has already received a property settlement from the deceased which took the superannuation into account;³⁷

If the superannuation death benefit is left to superannuation death dependants then sufficient other assets should be left to other potential beneficiaries to minimise the likelihood of Family Provision Act applications (unless the Testator does not intend this in which case he should say so and why).

• As from 1 July 2007 a superannuation death dependent is any of the following:

• the deceased person’s spouse or former spouse; or

• the deceased person’s child, aged less than 18; or

• any other person with whom the deceased person had an interdependency relationship (as defined) just before he or she died; or³⁸

Any other person who was a dependant of the deceased person just before he or she died.

Two persons (whether or not related by family) have an interdependency relationship under this section if all of the following apply:

• they have a close personal relationship; and

• they live together; and

• one or each of them provides the other with financial support; and

• One or each of them provides the other with domestic support and personal care.

If the two persons do not satisfy the interdependency relationship test because one or more of the last three bullet points do not apply to them then they may still have an interdependency relationship (whether or not related by family) if:³⁹

They have a close personal relationship; and

The reason they do not satisfy the above requirements is that either or both of them suffer from a physical, intellectual or psychiatric disability.⁴⁰

Bibliography

Articles and Books

Bates, G. M., & O’Shea, J. (1992). Environmental law in Australia (pp. 42-43). Sydney: Butterworths.

Braithwaite, V., & Levi, M. (Eds.). (1998). Trust and governance. Russell Sage Foundation.

Bryan, M., Vann, V., & Thomas, S. B. (2017). Equity and trusts in Australia. Cambridge University Press.

Coveney, J. (2008). Food and trust in Australia: building a picture. Public health nutrition, 11(3), 237-245.

Covick, O. (2004). Put not your trust (s) in tax reform: rather, do the opposite. Economic Papers: A journal of applied economics and policy, 23(3), 257-270.

D Denemark, D. (2012). Trust, efficacy and opposition to anti-terrorism police power: Australia in comparative perspective. Australian Journal of Political Science, 47(1), 91-113.al Pont, G. (2015). Equity and trusts in Australia.

Donald, M. S. (2011). What contribution does trust law make to the regulatory scheme shaping superannuation in Australia. Australian Prudential Regulation Authority.

HUFNAGEL, S. (2017). Police Cooperation in Europe, China and Australia: Does Trust Depend on the Political System?. In A Question of Trust?: Social & Legal Imperatives in International Police and Justice Co-operation. Hart Publishing.

Ludwig, J. (2007). Anti-terror laws: trust in our courts. Proctor, The, 27(10), 28.

Mason, A. (2014). Discretionary trusts and their infirmities. Trusts & Trustees, 20(10), 1039-1054.

McDermid, J., & Young, S. (1998). Thin Capitalisation Changes-Effect on Trusts. Revenue Law Journal, 8(1), 6610.

Mitchell, B., & Pigram, J. J. (1989). Integrated resource management and the Hunter Valley conservation trust, NSW, Australia. Applied Geography, 9(3), 196-211.

Moffat, G. (2005). Trusts law: text and materials. Cambridge University Press.

Morton, A. (2016). A matter of trusts: Creating entitlements in discretionary trusts. Taxation in Australia, 50(10), 617.

Pollack, D. P. (2018). Indigenous land in Australia: A quantitative assessment of Indigenous landholdings in 2000. Canberra, ACT: Centre for Aboriginal Economic Policy Research (CAEPR), The Australian National University.

Smith, L. (2017). Massively discretionary trusts. Current Legal Problems, 70(1), 17-54.

Santow, G. K. F. (1980). Comparative Study-Discretionary Trust. Int’l Legal Prac., 5, xxiii.

Stibbard, P., & Bromley, B. (2012). Understanding the waqf in the world of the trust. Trusts & Trustees, 18(8), 785.

Stockwell, N., & Edwards, R. (2005). Trusts and Equity. Pearson Education UK.

Thompson, S., & Maginn, P. (2012). Planning Australia: An overview of urban and regional planning. Cambridge University Press.

Stranger, Mark, Donald Chalmers, and Dianne Nicol. “Capital, trust & consultation: Databanks and regulation in Australia.” Critical public health 15, no. 4 (2005): 349-358.

Ville, S. (1998). Business development in colonial Australia. Australian Economic History Review, 38(1), 16-41.

Wheeler, S. A., MacDonald, D. H., & Boxall, P. (2017). Water policy debate in Australia: Understanding the tenets of stakeholders’ social trust. Land Use Policy, 63, 246-254.

Cases

Burns, F. R. (2000). Giumelli v. Giumelli Revisited: Equitable Estoppel, the Constructive Trust and Discretionary Remedialism. Adel. L. Rev., 22, 123.

Chianti pty Limited Vs Leume Pty Limited

Clark Vs Ingles Case

Fischer Vs Nemeske pty Limited

Wilson Vs Chapman

Lloyds bank Limited vs O’Neara

Legislation

Pengilley, W. J. (1965). The Prospective Restrictive Practices Act of Australia. Antitrust Bull., 10, 155.

Income tax assessment act of 1976

Legal Profession (Admission) Rules 2009 (WA)

Legal Profession (Board of Legal Education) Rules 2010 (TAS)

Legal Profession Admission Rules 2007 (NT)

Legal Profession Uniform Admission Rules (VIC)

Others

Aitken, L. (2009). Control and the Discretionary Trust. Law Quarterly Review, 125, 542-544.

Board, T. P. (2011). TAXATION IN AUSTRALIA| JULy 2011 748. Resource, 727, 728.

Carney, T., & Keyzer, P. (2007). Private trusts and succession planning for the severely disabled or cognitively impaired in Australia. Bond Law Review, 19(2), 5503.

Ingram, P. (2019). Tax files: Discretionary trusts: Distributions in specie. Bulletin (Law Society of South Australia), 41(9), 26.

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1. Bates, G. M., & O’Shea, J. (1992). Environmental law in Australia (pp. 42-43). Sydney: Butterworths.↩︎

2. Braithwaite, V., & Levi, M. (Eds.). (1998). Trust and governance. Russell Sage Foundation.↩︎

3. Coveney, J. (2008). Food and trust in Australia: building a picture. Public health nutrition, 11(3), 237-245.↩︎

4. Income tax assessment act of 1976↩︎

5. HUFNAGEL, S. (2017). Police Cooperation in Europe, China and Australia: Does Trust Depend on the Political System?. In A Question of Trust?: Social & Legal Imperatives in International Police and Justice Co-operation. Hart Publishing.↩︎

6. Legal Profession Uniform Admission Rules (VIC)↩︎

7. Legal Profession (Admission) Rules 2009 (WA)↩︎

8. Thompson, S., & Maginn, P. (2012). Planning Australia: An overview of urban and regional planning. Cambridge University Press.↩︎

9. Moffat, G. (2005). Trusts law: text and materials. Cambridge University Press↩︎

10. Thompson, S., & Maginn, P. (2012). Planning Australia: An overview of urban and regional planning. Cambridge University Press.↩︎

11. Stibbard, P., & Bromley, B. (2012). Understanding the waqf in the world of the trust. Trusts & Trustees, 18(8), 785.↩︎

12. Lloyds bank Limited vs O’Neara↩︎

13. Smith, L. (2017). Massively discretionary trusts. Current Legal Problems, 70(1), 17-54.↩︎

14. Santow, G. K. F. (1980). Comparative Study-Discretionary Trust. Int’l Legal Prac., 5, xxiii.↩︎

15. Donald, M. S. (2011). What contribution does trust law make to the regulatory scheme shaping superannuation in Australia. Australian Prudential Regulation Authority.↩︎

16. HUFNAGEL, S. (2017). Police Cooperation in Europe, China and Australia: Does Trust Depend on the Political System?. In A Question of Trust?: Social & Legal Imperatives in International Police and Justice Co-operation. Hart Publishing.↩︎

17. Covick, O. (2004). Put not your trust (s) in tax reform: rather, do the opposite. Economic Papers: A journal of applied economics and policy, 23(3), 257-270.↩︎

18. Thompson, S., & Maginn, P. (2012). Planning Australia: An overview of urban and regional planning. Cambridge University Press.↩︎

19. Stibbard, P., & Bromley, B. (2012). Understanding the waqf in the world of the trust. Trusts & Trustees, 18(8), 785.↩︎

20. Fischer Vs Nemeske pty Limited↩︎

21. Aitken, L. (2009). Control and the Discretionary Trust. Law Quarterly Review, 125, 542-544.↩︎

22. Legal Profession Admission Rules 2007 (NT)↩︎

23. Carney, T., & Keyzer, P. (2007). Private trusts and succession planning for the severely disabled or cognitively impaired in Australia. Bond Law Review, 19(2), 5503.↩︎

24. Carney, T., & Keyzer, P. (2007). Private trusts and succession planning for the severely disabled or cognitively impaired in Australia. Bond Law Review, 19(2), 5503.↩︎

25. Trustees, 18(8), 785.

    Stockwell, N., & Edwards, R. (2005). Trusts and Equity. Pearson Education UK.↩︎

26. Smith, L. (2017). Massively discretionary trusts. Current Legal Problems, 70(1), 17-54.↩︎

27. Carney, T., & Keyzer, P. (2007). Private trusts and succession planning for the severely disabled or cognitively impaired in Australia. Bond Law Review, 19(2), 5503.↩︎

34. Braithwaite, V., & Levi, M. (Eds.). (1998). Trust and governance. Russell Sage Foundation.↩︎

35. Donald, M. S. (2011). What contribution does trust law make to the regulatory scheme shaping superannuation in Australia. Australian Prudential Regulation Authority.↩︎

36. Moffat, G. (2005). Trusts law: text and materials. Cambridge University Press.↩︎

37. Fischer Vs Nemeske pty Limited↩︎

38. Legal Profession (Board of Legal Education) Rules 2010 (TAS)↩︎

39. Carney, T., & Keyzer, P. (2007). Private trusts and succession planning for the severely disabled or cognitively impaired in Australia. Bond Law Review, 19(2), 5503.↩︎

40. Board, T. P. (2011). TAXATION IN AUSTRALIA| JULy 2011 748. Resource, 727, 728.↩︎