Trusts; what are they?

A trust is an arrangement where a person (“the trustee”) holds property or assets for the benefit of others (“the beneficiaries”).

Unlike a company, a trust is not a separate legal entity, although it is treated as a separate entity when it comes to registering for tax. That means the trustee is liable for any of the trust’s debts, which is why many people choose to have a company as trustee.

Trusts can be set up by deed during a person’s lifetime, or by Will to take effect after the person’s death. Trusts established by Will are known as testamentary trusts.

What’s the benefit of a trust?

To separate the beneficiary from control over an asset (the trustee), where the beneficiary is under age or suffers from a disability that affects their capacity to make decisions

To provide greater flexibility in tax planning

To protect assets from financial claims made against the beneficiary, and

To use as a business entity either for investing (for example, to purchase real estate or a share portfolio) or for trading.

What are the elements of a trust?

The settlor: The settlor is the person responsible for setting up the trust and naming the beneficiaries, the trustee and if there is one, the appointor. For tax reasons, the settlor should not be a beneficiary under the trust.

The trustee: The trustee (or trustees) administers the trust. The trustee owes a duty directly to the beneficiaries and must always act in their best interests. All transactions for the trust are carried out by and in the name of the trustee.

The beneficiary or beneficiaries: The beneficiaries are the people or companies for whose benefit the trust is created and administered. Beneficiaries can be either primary beneficiaries (who are named in the trust deed) or general beneficiaries (who often are not named individually); usually existing or future children, grandchildren and relatives of the primary beneficiaries.

The trust deed: The trust deed (or, in the case of a testamentary trust, the will) is the formal document setting out how the trust will run and what the trustee is allowed to do.

The appointor: Many, but not all, trusts also have an appointor who has the power to appoint and remove the trustee.

What kinds of trusts are there?

The two main types of trusts which are used in business and by individuals:

Discretionary trust:

A discretionary trust or family trust is the most common form used by families. The beneficiaries of the trust have no defined entitlement to the income or the assets of the trust.

Each year, the trustee decides which beneficiaries are entitled to receive the income and how much they should get.

Fixed or unit trust:

Unlike a discretionary trust, the beneficiaries of a fixed trust have a defined entitlement under the trust, similar to a shareholder in a company.

The trustee does not have any discretion as to how they distribute the trust’s capital and income.

A fixed or unit trust is often used for joint venture arrangements – for example, two families want to own an asset together.

Other Types of Trusts:

There are many different kinds of trust including superannuation funds, charitable trusts and special disability trusts.

How long does a trust last?

In NSW, a private trust can last for up to 80 years. The trust deed will set out how long it should last (known as the ‘vesting date’) – often based on a specific event happening, such as someone dying or reaching a certain age.

“[t]he common-law rule prohibiting a grant of an estate unless the interest must vest, if at all, no later than 21 years (plus a period of gestation to cover a posthumous birth) after the death of some person alive when the interest was created”

What happens on the vesting date?

When a trusts vests the beneficiaries become absolutely entitled to all of its assets and income. The trustee must distribute all assets and income to them in line with the trust deed. A trust deed will usually have a set of rules the trustee must follow when doing this.

Does a trust pay tax?

A trust has its own tax file number and is required to lodge tax returns annually. However, the trust generally is not subject to tax if all its annual income is distributed to beneficiaries, who pay the tax based on their marginal rate of tax.