In Australia, whether good or bad, it is easy to establish a trust fund, with online options prevalent and low-cost options available. This, however, is not the end of the process but rather the beginning. There is a lot of advice that trusts are some structure that will provide a lot of benefits, but rarely are the downsides discussed. All too often we face business owners that have created trusts without necessarily understanding the consequences of doing so, or those who have used their trusts for purposes for which they were never designed.
What is a trust or trust fund?
In Australia, a trust or trust fund is primarily an investment structure, one that allows flexibility in not only the holding of investments but also in the distribution of income between beneficiaries of the trust.
In setting up a trust, the trust needs to be settled, this means that someone, generally unrelated to the family group, makes a small contribution (usually ten dollars) to start this trust. This person is known as a settlor. As a trust is a quirky legal concept and has complex rules, put simply, the settlor is no longer involved in the trust after the original set up.
The trust is controlled by the trustee, this can be a company, a trust or individuals, these people have the ability to operate the trust, to buy and sell investments, to pay money to beneficiaries, to loan or lend money and effectively to be managers. The role of the trustee is to act in the best interests of the beneficiaries, it is often that the trustee and the beneficiaries are related or indirectly the same people and it can be difficult to differentiate the two roles.
What is involved in setting up a trust?
In order to set up a trust, firstly you need to decide what type of trust is appropriate for the strategy that is being undertaken, this is something that often people misunderstand or get wrong due to doing it themselves. The primarily types of trusts are:
- Discretionary or family trusts
A discretionary or family trust fund is a trust that has been established where no beneficiary has a direct interest in the assets of the trust. they are merely entitled on a discretionary basis. This can be a blessing and a curse, depending upon who is in control of the trust and what the underlying assets of the trust are.
The term discretionary is interchangeable with a family trust fund. They are the same thing, other than that there may be a limitation on the potential beneficiaries capped by linage or membership of the family group, but there is potentially no limitation if so chosen.
Assets that are held within a discretionary trust are not owned by specific people and are merely held on their behalf. This can often be a surprise to trustees of a trust who have always simply assumed that the assets in the trust are theirs to deal with as they desire. Instead the assets are held for the benefit of all beneficiaries and the trustee merely acting to hold them on their behalf.
The benefit of this type of structure is that the assets can generally be protected during divorce or family disputes and there is a level of protection against creditors where the trust assets have not been used to secure the obligations of an individual beneficiary.
Whilst these structures have substantial benefits, they can also be problematic when not properly planned or misunderstood. We have assisted many business owners that due to not understanding the structure have pledged assets by mistake, have paid distributions to incorrect parties or undermined the structure through giving fixed entitlements to beneficiaries.
The area is complicated and we always recommend seeking advice prior to deciding if this is the appropriate structure. Whilst setting up a trust may be simple from a documentation perspective, what happens from there can be complex and in need of clear structural advice.
- Unit Trusts
A unit trust operates similarly to a company in that instead of shareholders there are unit holders and there is a fixed entitlement to the involvement in the underlying assets of the trust. These structures are generally used in lieu of companies where there is a tax advantage to do so (such as holding property assets).
Setting up a trust is reasonably straight forward, similar to a discretionary trust, but with the need to articulate who the beneficiaries are and what their entitlement is. Units held in a unit trust are the assets of a beneficiary and are clearly defined.
- Hybrid Trusts
A hybrid trust is a combination of a unit and a discretionary trust and generally used for complex taxation planning. Setting up a trust requires specialist advice, especially as there are strict rules around distribution of assets and the operation of these trusts.
If you are needing advice with respect of these structures, we are able to assist you in understanding the operation of these trusts.
- Special trusts
Special trusts are a complex area and one where it is necessary to get specialist advice.
Why have a trust?
A trust offers flexibility for the holding of assets. In the setting up of a trust, we can define rules that allow for future planning, something that is often missing when undertaking structures or holding vehicles with direct ownership.
A trust moves the assets away from direct ownership, and if structured properly will offer a substantial level of asset protection, control and taxation benefits without necessarily handing over control to a third party. When exploring the benefits of having assets via a trust fund, it is important to be aware of the issues of control of the assets within the trust, and to understand if you (as a contributor) are willing to effectively step away from ownership and place your assets under the control of the trustee.
Trusts have substantial benefits for long term asset holding, and we have used them extensively as either an asset holding vehicle, a taxation planning vehicle or a succession planning vehicle and in a lot of cases a combination of them all.
Is a trust right for me?
There are costs above the establishment cost that need to be considered before establishing a trust. Setting up a trust may be a cheap part of the process, as you now have another taxpayer to deal with and the compliance costs that are associated with this.
Some lenders will not allow assets to be owned by a trust or will have onerous conditions attached to lending to a trust, if you are thinking of using a trust to buy an asset under finance, it is often best to confirm with the lender prior as to their position around ownership in a trust and whether there will be other considerations that will be placed onto the loan facility.
Understanding the role and expectations of a trustee are an important aspect of deciding if a trust is right for you, and we recommend that potential trustees inform themselves of their obligations and what happens inside a trust. Taking on the responsibility may seem easy, but there are potential pitfalls that are taken on at the time you become the trustee of a trust.
What will setting up a trust cost me?
The trust document on its own is about a $500 investment, but the advice surrounding the trust and the consequence of it depends on your circumstances and what you are looking to achieve. Each family group is different, and each trust fund has a different objective, plan or intention and it is important to tailor the trust and its operation to the needs to the family group. As a budget, we recommend that you should expect to pay $2,000 to $3,000 for the advice surrounding setting up a trust.
Will a trust save me tax?
There are taxation planning strategies that can achieve taxation efficiency but a simple answer is that it is unlikely that in the long term a trust will save substantial amounts of tax. Its benefit is more as a deferral tool (and much like capital gains tax is a deferral). There is no magic bullet in tax planning that a trust will bring.
The role of a trust fund in taxation planning is important and can have benefits in a wider group where there are opportunities to share income across the group. There are rules around this and there is no hard-fast position as to whether this will be beneficial or whether or not the structure will achieve any tax efficiency. It is dependent on the wider group.
Will this structure allow me to avoid creditors?
We have seen a lot of seminars promoting trusts that will defeat creditors. These appear to pop up every few years, but we are yet to see these structures properly work and are rarely (if ever) tested in court. Lenders are reluctant to undertake loans to these structures where there are promises of being able to avoid creditors.
If properly structured, assets held in a trust that has not been pledged for other borrowings should be protected in the event of insolvency or personal bankruptcy, but this is a complex area and needs specialist advice. We recommend that if you are facing bankruptcy or an insolvent event and need help, that our team can walk you through the assets held in trust and determine what options are available.
All too often we meet with a business owner who confidently tells us his assets are protected via a trust. It is a sad and tough conversation where we pull the trust apart and work out that the structure that was meant to protect the family assets has been dragged into the business insolvency due to ignorance or simply not understanding the rules of the operation of the trust. The best structures can be brought apart by not understanding what they are, how they operate and what you are able to do with them.
We like to meet with business owners before they start to establish a trust, to understand what they are trying to achieve and then to work out if a trust is an appropriate structure for them. It is a decision that needs to be made with an understanding of the wider group and generally should not be made in isolation from other decisions made with respect of the overall asset protection plan and structure of the family group.
Setting up a trust is only step one, and we encourage an understanding of what is involved before taking step two.
The team at C&D Restructure and Taxation Advisory are here to help. As part of the Vault Group we can offer the full suite of financial products and advice to help you navigate the business landscape. Schedule a meeting here via Calendly or give us a call on 1300 1 VAULT (1300 182 858)