Types of Trusts

There are a variety of different trusts. Each trust must have a trustee who is the legal owner of all the assets of the trust, and one or more beneficiaries who are entitled to the benefit of what the trust owns. Originally, trusts were set up to protect those unable to deal with their own affairs, such as children or the mentally ill. The trustee would manage the trust estate for their benefit.

Fixed Trusts

Fixed trusts, such as unit trusts, provide for a fixed proportion of interest to each nominated beneficiary. For instance, if there are 100 units in the unit trust, a person who holds ten units will be entitled to 10% of the income of the trust. However, it is possible to have different rights to income from the trust. So it could be that only holders of A class units share in the capital or assets of the trust, plus income flowing from the trust's investments, while holders of B class units share in income only.

Discretionary Trusts

A discretionary trust works on the basis that a nominated person, usually the trustee, can decide who will gain the benefits from the trust (usually by way of resolution at the end of the tax year). The persons who can benefit are within the class of beneficiaries listed in the trust deed. For family trusts, this has the flexibility to have the income of the trust distributed to the lower-earning members of the family who pay less tax.

Importantly, unlike partnerships, trusts cannot pass on losses to individual beneficiaries. The very purpose of a trust is to protect its beneficiaries, and only benefits can be passed on to the beneficiaries. This means that beneficiaries cannot offset trust trading losses against their other income in the same way as a partnership can. However, the trust can carry forward the losses to be applied against earnings in future years.

Superannuation Funds

A superannuation fund is a very effective investment vehicle. A self-managed, regulated fund that complies with the Superannuation Industry (Supervision) Act 1993, is only taxed at 15% on its taxable income - which will comprise all taxable contributions made by or on behalf of members and all investment income, such as interest, rent and dividends net of all deductible expenses. Accordingly, a superannuation fund may quickly generate wealth from the reinvestments of after-tax income.

The control of (and legal ownership) of any assets held by a superannuation fund rests with the trustee of the superannuation fund. The trustee can be individuals or companies. To better protect assets, it is recommended that a company (of which the members of the fund must be directors) act as trustee.

Any capital gain made by the superannuation fund prior to a member being eligible to receive a pension from the superannuation fund is discounted by one third if the asset is held for more than 12 months.

It is important to note that if a superannuation fund is self-managed, restrictions apply as to the investments the fund may make and any financing (borrowing and lending) that the trustee of the fund may propose to be involved in.

Employers may be entitled to a tax deduction for the amount of superannuation contributions made on behalf of employees. As from the 1st July 2007, the self-employed are also entitled to claim the full deduction upto $50,000 for contributions made. However, by the 2009 Budget, the Government will reduce the following concessional contribution caps.

• From the 2010 income year (i.e. from 1 July 2009), the concessional contributions cap for individuals aged under 50 will be reduced to $25,000 (indexed) per annum (from the existing $50,000 indexed amount)
• The transitional concessional contributions cap (applicable to individuals aged 50 or more for the 2010,2011 and 2012 income years) will be reduced to $50,000 (non-indexed) per annum (from the existing $100,000)

Contributions made to a complying superannuation fund are subject to tax at the rate of 15%.

Asset Protection

Assets can be held by a trust, a company or one or more individuals. The choice of how an asset will be held depends on many factors, including the business and personal circumstances of the individual.

The general principle behind asset protection is that any assets which are not in your personal name or control and in respect of which you have no legal or equitable rights cannot be used to meet claims by creditors, trustees in bankruptcy or even spouses in family law property disputes. Accordingly, any assets that are not owned by you personally, but rather by separate legal entities such as companies, unit trusts, discretionary trusts and superannuation funds, may be protected from claims by third parties - provided appropriate control mechanisms are established. There are several important exclusions to this rule and these should be discussed with a legal practioner.

Asset protection mechanisms are often used to achieve one or both of the following objectives:

1. Isolating a particular asset(s) which may in the future be the subject of claims from assets held in other separate legal entities over which the "principal" has control; and

2. Protecting a particular asset(s) over which the principal has control from any potential claims made against the principal (for example, as a director of a company).

Who should own the family home?

It is suggested the spouse not exposed to business risk should hold the family home.

For family law purposes, the family home is an asset of the marriage. Accordingly, although one spouse may have legal ownership of the family home, this will not hinder the other spouse from claiming a right to the family home because it is an asset of the marriage.

If the family home remains in the name of an individual (being the spouse not exposed to business risk) and the home is that person's main residence, then upon the disposal of the family home, no capital gains tax is payable on the proceeds.

Who should hold personal assets such as insurance policies, holiday homes and investment properties?

It is recommended consideration be given to holding certain personal assets in a discretionary trust because this may:

1. Minimise the risk of these assets being exposed to claims which may arise in the future because of:

• the person's position as a director of a company
• the result of personal transactions such as the calling in of a loan
• the enforcement of payment of a personal guarantee given to a relative , friend, associated entity or other party; or
• the breakdown of a marriage or of other domestic relationships

2. Simplify intergenerational transfers of the assets

Who should buy the holiday home?

It may be appropriate to hold the family holiday home in a discretionary trust.

The family holiday home will not be exempt from capital gains tax on its disposal. If the family holiday home is in a discretionary trust it may be isolated from business risks and, upon its disposal. access to the general 50% discount on any capital gain made on the sale may be available.

Alternatively, the family holiday home may be held in the name of the spouse not exposed to business risk. That spouse may also be able to treat the capital gain as a discount capital gain and access the 50% discount on any capital gain made upon the disposal of the family home.

Insurance policy issues

When an individual enters into an insurance policy, they need to ensure that the policy had flexible payment options (for example, covering payment to a deceased estate, testamentary trust, the policy holder, surviving parents or children in their own right).

There are many other issues that should be considered in relation to insurance policies, such as the use of policies in business succession agreements (buy/sell agreements). Specific advice should be sought in these circumstances.

Who should hold investment properties?

A negatively geared investment property requires careful planning. If such an asset is placed in a discretionary trust the property owner will need to ensure that there is other income to offset the losses created by the negative gearing. This is a complicated area that requires considerable analysis of an individual's situation and advice specific to the proposed fact scenario should be sought.

Who should purchase the motor vehicle?

The purchase of a motor vehicle by either an individual or an entity involves the consideration of several issues, including fringe benefits tax, income tax and asset protection. Each case will need to be examined on its facts and consideration needs to be given to the extent the motor vehicle is used for private and business purposes during the ownership period and the nature of the income derived by the vehicle's owner.

How should shares be held?

If the shares are public company listed shares held for the long term in order to obtain capital growth, either a superannuation fund or a discretionary trust can hold the shares.

When the shares are disposed of by a discretionary trust, the trust may be able to treat any capital gain as a discount capital gain and access the 50% discount on any gain made.

In respect of a superannuation fund, the dicount will be 33-1/3 per cent. However, in a superannuation fund, the resulting taxable capital gain will be taxed at 15% (effectively, 10% on the total capital gain) whereas in a discretionary trust, the taxable capital gain must be distributed to an individual and the amount is then taxed at marginal rates - which may be high.

How should I prepare my will?

An important aspect of succession planning, asset protection and tax planning is to have a testamentary trust in place. This trust is created by a will. The testamentary trust gives the principal beneficiaries of an estate the opportunity to:

• keep assets in a trust where they are protected from creditors because the creditor of a beneficiarry cannot seize the assets of the testamentary trust to satisfy the debt.

• keep assets in a trust protected from family law property disputes 

• attempt to adjust the needs and expectations of a surviving spouse and surviving children 

• distribute income to such members of the family as the trustee determines

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