Trusts Decoded

types of trust



Trusts Decoded


A dictionary definition of a trust is: “A fiduciary relationship in which one person (the trustee) holds the title to property (the trust estate or trust property) for the benefit of another (the beneficiary).”


Why create a trust?
One of the main reasons to create a trust is asset protection. Property and assets can be moved into a trust for protection from creditors, to maintain an estate until a beneficiary becomes old enough to have legal possession, or isolate valuable assets from a trading company that may be more exposed to litigation, for example.


Trusts, if set up in the right way, can help you legally minimize some tax liabilities. But it is a tricky area, and the taxman is always on the lookout to plug perceived loopholes or an over-enthusiastic stretching of the scope for reducing tax.


The word used to name these types of arrangements – ‘trust’ – is appropriate. A trust is a structure that separates control and legal ownership from beneficial ownership; so that at least one person and/or company agrees to hold and manage assets or property in a way that will benefit someone else (beneficiary). A trust therefore is a formal structure for an obligation, where ‘beneficiaries’ place their trust in the controller or holder of assets (called the trustee) to manage those assets for their eventual benefit.


Other parties in a trust structure include a “settlor” who contributes the initial trust asset (which may be anything, including a nominal $10 cash or even a house) to bring the trust into existence, and an “appointor” who generally has rights to appoint, replace and remove trustees.


You could almost liken a trust to a private jet. The jet is put under the control of a pilot (the trustee) to fly the jet while carrying the passengers (beneficiaries) to a destination (when the trust ends, or is “vested”) where the cargo or luggage (assets and property) is unloaded and given to the passengers again. During the flight, the luggage is maintained in the best condition possible and the passengers may occasionally be offered food and drinks if the ticket contract (trust deed) allows it (the beneficiaries may be paid distributions from the trust).


Separate control from beneficial ownership
The structure of a trust allows a business or asset to be put into the hands of a third party (trustee) who is given legal control and has a duty to operate that business or manage these assets to benefit someone else (beneficiaries). This is known as a “fiduciary duty”.


There are various types of trusts. You can have a fixed trust, unit trust and family trust, each with unique characteristics. A deceased estate is also a trust, being property and assets that are held and managed by the executor (the trustee) for those who will inherit them.


Modern trusts are generally governed by written trust deeds that mention how it is set up and the rules for its maintenance, the rights and obligations of all parties, and also how income from the trust’s assets is “distributed”.


Distributions and tax


A trust calculates its annual taxable income under the usual tax laws and then the trustee distributes and/or retains the income. Income that is distributed to beneficiaries will be treated as though the beneficiaries earned it directly and will be taxable at their own marginal rates. On the flip side, the trustee has to pay tax (on behalf of the trust) on any taxable income that is not distributed. Undistributed income is taxed at the top rate (including Medicare levy).


When the trustee decides whether and how much to distribute to each beneficiary, the trustee should take into account each beneficiary’s financial, taxation and personal circumstances and distribute income in the way that best serves everyone. Of course, the trustee is restricted by the terms of the trust deed.


Types of trust


In a fixed trust, the share that beneficiaries have in assets and income (which may be proportional or absolute) are pre-determined and “fixed”, leaving no leeway for the trustee to vary income distribution. Unit trusts are typically fixed trusts as each unit held in the trust represents an entitlement to a certain proportion of the income and/or capital.


A discretionary trust provides the trustee with a “discretion”, as the name implies, over who receives distributions from the trust. The discretion must be exercised in accordance with the terms of the trust deed.


Family trusts


A discretionary trust can generally be a “family trust” for tax purposes if the trustee so elects, but distributions need to be restricted to members of a particular “family group” – only distributions outside this group will attract tax at the highest marginal rate (including Medicare levy).


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