Summary
Many people involve a trust in their business or investment structures, but very few people fully understand what you need to do to maintain your trust to ensure that it not only continues to serve its purpose, but also doesn’t create headaches for you.
BASIC OVERVIEW OF A TRUST
A trust is essentially an agreement that Person A (called the trustee) will hold and deal with assets for the benefit of Person B (called the beneficiary). The trustee can be multiple people and/or companies, and there can also be multiple beneficiaries.
Each year the trust will add up its income and “distribute” that income to the beneficiaries, and the beneficiaries will pay tax on their share of the income. The trust may not physically distribute the income, instead keeping a record of the amount owed to each beneficiary in a loan account (as the trust may require that income to re-invest and grow).
TIPS FOR MAINTAINING YOUR TRUST
Click on the below headings to expand each one and read more detail.
We generally recommend updating the trust deed every 5 years to ensure your trust is “modern”.
The trust is governed by various laws, but also the Trust Deed. This deed specifies what the trust can and can’t do, who is the trustee, and who the beneficiaries are. As laws change, it can be prudent to amend the trust deed so the trust can remain compliant with those laws, or so the trust can take advantage of law changes.
For example, a few years ago there was a tax law change that allowed trusts to split different classes of income – however, unless your trust deed also allows this, you can’t actually do it. Trusts created before this law change are unlikely to be able to take advantage of these changes.
You should regularly review all assets of the trust and ensure that where there is a registry for the asset (e.g. property, shares, motor vehicles), the trustees are the ones listed.
Assets owned by the trust need to be in the name of the trustee(s). If the trust has multiple trustees, then assets need to be in the names of all trustees. If the trustees change, then all assets need to be transferred to the new trustees.
Property is generally the biggest asset most trusts will own, and also the most problematic. Often people will sign a purchase contact “and or nominee” with the intention of putting it in a trust – however when they settle the property, they don’t update the name that the land is being registered to and instead of being in the name of the trustee, it is in the name of the person signing the contract.
When you subsequently sell that property, it can cause all sorts of issues. Firstly, the sale may be held up, particularly if there are any GST or CGT withholding obligations. Secondly, the ATO get copies of all land transfers, and if you have a property sale in your name but put it on the trust tax return, you may trigger an audit and in these circumstances it is quite possible the ATO will assess the property as never being owned by the trust.
Having a document that is signed and dated no later than 30 June with the distribution figures on it is a must. This needs to be done each year.
A trust is taxed at the top tax rate on all undistributed income. While not technically correct, this essentially means all income not on the tax return of a beneficiary.
What you may not know is that a trust must decide who to distribute its income to, and how much, BEFORE the end of the financial year (i.e. before it has been able to do its tax return and calculate how much income it has). Fail to do this and your trust is deemed to have not distributed its income taxed at the top tax rate. The only way you can prove to the ATO that you did make this decision is to have a signed document to that effect.
You should periodically review your unpaid distributions / loan accounts to assess the level of risk your trust is exposed to.
As outlined earlier, distributions that are not physically paid will sit in a loan account – showing how much each beneficiary is owed.
In the event of the beneficiary becoming bankrupt, going through a marriage breakdown, being sued, etc, that unpaid distribution is an asset of the beneficiary and the trust may be forced to find the money on relatively short notice, through no fault of its own, should a beneficiary need to call on those unpaid distributions.
You should highly consider ensuring that the people actually getting benefits from the trust are the ones paying tax on the trust’s income.
A common situation is for a trust to distribute its income to family members, but Mum and Dad use all the money personally. This occurs because those family members will be on a lower tax bracket that Mum and Dad and putting some income on their tax return will lower the overall tax burden of the family group. This has come under fire from the ATO who say that the person using the money is the one actually receiving the distribution, and therefore should be the one paying tax on it.
While the ATO’s view is largely untested in court, there is a piece of Law that supports the ATO’s view – so if your trust is having its income taxed in one persons name, with a different person getting paid, you may want to reconsider this strategy.
Failing to consider all possible beneficiaries when deciding who to distribute income to can land you in hot water.
A recent court case highlighted an issue that very few people consider – that trustees have a legal obligation to independently assess the needs of he beneficiaries of the trust and distribute its income in a fair and reasonable manner.
Most discretionary trusts are run by Mum and Dad for the benefit of Mum, Dad, and their kids – but their trust deed will allow it to distribute to pretty much any relative (at the discretion of Mum and Dad). Courts have recently rules that Mum and Dad are obliged to give genuine consideration to all potential beneficiaries – which may include all sorts of relatives that you may or may not speak to regularly.
While it would seem unlikely that a trust would be required to distribute to all potential beneficiaries, or even seriously consider all of those long-lost relatives – think of the immediate family at the very least.
Imagine this scenario: Mum and Dad have 2 kids, and historically the trust income is split evenly between all 4. Child 1 has a falling out with the rest of the family and Mum and Dad decide that they will now split this income 3 ways and exclude Child 1. It is likely, based on recent court decisions, that Child 1 could sue Mum and Dad and the trust on the grounds that they were not genuinely considered.
Genuine consideration extends beyond whether you like someone or talk to them, it requires considering their circumstances, their needs, and their financial status. Importantly, it also requires documenting this and the reasons why you decide not to distribute income to someone.
If your trust has a “settled sum”, ensure you have it documented where this money is, or where it went. If you don’t have that document, make it.
Discretionary trusts, and some unit trusts have a “settled sum” – an amount of money contributed to the trust by the “settlor” to start the trust. This would usually be $10 or another nominal amount. There are cases of the ATO deeming a trust to be invalid because the initial monies could not be identified.
Your trust should have documentation that it received that settled sum from the settlor in cash, and then shortly after, have a deposit in the bank account of the trust for that amount. Alternatively, the cash should be stapled to the trust deed and never lost.
Losing a $10 note could potentially undo years and years of tax benefits…
Do everything you can to not misplace your Trust Deed. If you do, replace it ASAP.
Once a trust is created, there are some fundamental parts of it that cannot be altered without triggering unwanted tax issues. If you lose your trust deed, how can you ever prove to the ATO that you haven’t done this? If you have a marriage breakdown or other family issues, how can you prove or disprove the opposing point of view?
Losing a trust deed also brings administrative headaches – if you ever want to borrow money, banks will want to see a copy of the deed. Same if you want to open a bank account, go through a marriage breakdown, purchase land, and so on.
There is a way of replacing a trust deed, but it is far from perfect and takes time to implement – so better you do it before you need it, and not wait until the bank informs you 2 days before you loan settles that you need to produce a deed or else they will not allow your property settlement to proceed.
Unless your trust will need to distribute to non-residents, consider specifically preventing it in the trust deed.
We mentioned earlier that you need to keep your trust deed updated to comply with Laws – here is an example. Some states charge additional stamp duty where the purchaser is a trust and the trust is able to distribute income to non-residents.
Most trust deeds will say something like “Mum and Dad are the primary beneficiaries, and anyone related to Mum and Dad are also able to be a beneficiary” (we’ve simplified the wording greatly). While you could argue that you only ever distribute to Mum and Dad and you are both in Australia at all times, legally, because the trust is able to distribute to relatives, and you no doubt don’t control whether your relatives would choose to live overseas or not, the trust would therefore be capable of distributing income to a non-resident and your trust would be liable for this additional stamp duty.
Whether they do or don’t live overseas, and whether you do or don’t distribute to them is irrelevant – what matters is that the trust could.