Discretionary trusts

A discretionary trust (commonly referred to as a family trust) is the most common trust used by small to medium size business owners and passive investors in Australia, particularly where the interest in the underlying assets of the trust represent the interest of one family only and not multiple families.

A discretionary trust has a limited life. In Victoria the maximum life span of a trust  is 80 years from the date of its establishment. They are generally set up to hold a family’s passive assets and/or business assets for the benefit of providing asset protection and succession planning for family members for which the trust was established.

The single most powerful element of a discretionary trust comes from the fact that it is at the complete discretion of the trustee of the trust as to how the income and capital proceeds received by the trust are to be distributed to the eligible beneficiaries of the trust. The trustee could even determine not to distribute any of the income or capital of the trust but to accumulate it in the trust for the future benefit of the beneficiaries. Given that the entitlements of the beneficiaries are at the complete discretion of the trustee in a discretionary trust arrangement,  the beneficiaries do not have a fixed interest in the the trust fund until such time as the trustee  determines to distribute either the income or capital of the trust fund to the beneficiaries. Therefore it can be said that, at best, the beneficiary of a discretionary trust only has a mere expectation to be considered by the trustee of the trust fund to receive either a distribution of capital or income of the trust fund. Until such time that the trustee makes that determination, the assets of the trust fund do not vest in the beneficiaries. To that end, the beneficiary can only stake a claim on that much of the trust fund as has been allocated for his or her benefit by the trustee .

What follows from this concept is the unique element of the typical discretionary trust structure; the concept of being able to control an asset or group of assets but not have a beneficial interest in the asset until such time as it is determined that the assets of the trust should vest in the beneficiaries personally. This concept brings about a varied range of possibilities and opportunities from both an asset protection and succession planning perspective. Generally, from an asset protection perspective, provided the trust is well constructed, the  assets held in a discretionary trust cannot be attacked and should be well out of reach of unsecured creditors seeking to make a claim on the assets of the individual beneficiary who may find him or herself under attack or from the general commercial exposure that a person in business can find themselves under. Click here to read more about the role of a discretionary for asset protection purposes. Or click here for the role of a discretionary trust for succession planning purposes.

This concept of having the ability to control the assets of the trust whilst retaining the ability to not have an interest in the trust assets is achieved by careful construction of the trust. The following are the critical persons who form a discretionary trust relationship. Understanding the interrelationship and the roles that each of these  play in a discretionary trust relationship  is the key to achieving the ultimate result for all of those concerned from an asset protection, succession planning and income tax perspective.

Settlor Trustee Appointor Primary Beneficiaries General Beneficiaries


Key features and benefits of a discretionary trust

Flexibility

Because the trustee has a complete discretion as to which beneficiary may benefit from a particular source of income or capital that the trust fund may receive, the trustee in it’s complete discretion has complete flexibility from year to year as to which beneficiaries may benefit from the particular source of income or capital of the trust fund, provided the beneficiaries are within the class of eligible  beneficiaries listed in the trust deed that the trust fund was established for the benefit of.

Asset Protection

One of the most powerful mechanism’s that a discretionary trust provides, stems from the fact that it is at the trustee’s discretion as to who of the eligible beneficiaries in the trust becomes entitled to receive the income or the capital of the trust or both. Until such time that the trustee makes that determination none of the beneficiaries that may be eligible to receive an entitlement have a fixed interest in the trust. Because the beneficiaries do not have a fixed interest in the trust assets, should one of the eligible beneficiaries become exposed to an involuntary claim brought against them by either a secured or unsecured creditor, the creditor does not have a claim over the trust assets that the beneficiary may stand to benefit  from, out of the trust fund, at some point in time.

Whilst this is the principal mechanism of a discretionary trust the level of protection is not automatic and very much depends upon how the trust affairs are administered and upon how the trust is constructed. That is were the skill set of the team at BPC kicks in.

Estate and Succession planning

Understanding the key roles and the interrelationship of the various parties to a discretionary trust is the beginning to understanding the mechanism’s required to insuring that the assets of the trust safely transition to the next generation of beneficiaries should the trustee want that to be the outcome.

In this regard we believe that a well established, structured  and administered discretionary trust is a powerful tool for a family to be able to transition the control of the assets to their loved ones, whilst at the same time keeping the assets out of reach of those unwanted parties such as unsecured creditors or potential claims from a family law dispute.     

In short a well constructed discretionary trust can provide the stakeholders with the ability to control the assets of the trust but not own them. This is a very powerful mechanism from both an asset protection, estate and succession planning perspective.

You need to know what levers to pull before you can pull them to achieve the desired outcome.

This is a very important aspect of estate and succession planning where the substantial assets  of a family group or individual are during their lifetime accumulated in an inter vivo’s trust structure.

The succession of those assets are not dealt with by the individuals Will alone. In fact there is less reliance upon the individuals Will as the Will can only deal with the assets that the individual owns in their own personal name. The key to a successful transitioning of the assets in the trust becomes about getting the interrelationship between the individuals Will and the relationship of the parties that control the trust in sync with each other.

Where the trustee of the trust is a corporate entity, this also means having an understanding of how the corporate provisions work and how the respective powers of each of the parties including the shareholders and directors of the trustee company (relative to who are the appointor’s of the trust) each play out to achieve the effective control and transition of the assets of the trust.

It also requires a clear understanding of were the respective risk’s of all of the parties in the trust structure sit to insure that the right parties are placed in the correct positions to achieve the desired outcome. The principal is not to dissimilar to the players on a footy field. The strategic positioning of the players is what ultimately determines whether the team scores goals.  Getting the positions wrong can spell disaster and result in such things as potentially having the assets of the trust end up in the hands of the wrongful owner.

Taxation

From a tax perspective the main benefit that a discretionary trust arrangement  provides is flexibility. Because it is at the discretion of the trustee to determine which of the beneficiaries in the trust arrangement that is eligible to receive either an income or capital distribution from the trust fund, the trustee can, each financial year, determine which beneficiary is most suited to receive that particular years income or capital distribution from the trust fund. In the alternative the trustee at it’s unfettered discretion may also determine to not distribute any of the income or capital of the trust fund but accumulate it instead.

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