Trusts have become an extremely popular tool in business and personal asset protection and tax minimisation strategies.
A common misconception with a Trust is that it is a legal entity in the same mould as a person or a company. People will often say “my trust owns this” or “my business is a trust”. Whilst such statements are harmless in general conversation, the lack of understanding of a trust can cause significant consequences to parties. A trust is not an entity but simply a contract. It is a contract between a Settlor, a Trustee and Beneficiaries. The Settlor agrees to put in an initial settlement sum into the trust account (usually a nominal amount such as $10) and the Trustee agrees to hold all legal interest in property acquired or income generated by the trust for the benefit of the beneficiaries.
The Trustee must distribute trust income to the beneficiaries at the end of each financial year. The Trustee and Beneficiaries are legal entities, the “Trust” is not.
Most people use a “set and forget” strategy when it comes to establishing their Trusts, however it is important to review them from time to time in light of changes to law and individual circumstances.
Errors at Creation – Wrong Information
We’ve seen a remarkable example recently where a person put themselves down as Settlor, Trustee and Beneficiary in an online form. For a trust to properly exist there needs to be a distinction between those parties. The result (only noticed after many years) is that a trust does not exist and all of the income-splitting that had been done during that time was not legitimate for tax purposes. Every bit of income (millions) that had been created through the trust is re-assessable by the ATO at the highest marginal tax rate of 45%. You do the math.
Errors at Creation – Formality compliance
A common risk that also occurs is the failure to tidy up formalities such as:
(a) proper execution; or
(b) actual provision of a settlement sum (not just writing it in the deed).
The Settlor must physically provide the Trustee with the settlement sum (whether by cash or bank deposit) before a trust can come into existence. This also flows to another common error which is ensuring that the trust always holds some form of property (which can include cash).
If this process is not conducted properly, the consequence can be that a trust will be deemed not to exist and all tax conducted through the trust thereafter will be capable of being re-assessed at the highest marginal tax rate by the ATO.
Lack of Understanding of its Terms
In another example a person didn’t understand how the standard “Appointor” clause contained in their Trust Deed worked. He listed three appointors on the presumption that all three appointors needed to agree before a Trustee could be removed (a unanimous decision as a safety mechanism). However, the standard clause allowed for any one of the Appointor’s to act on their own in exercising that power. After a falling out with a beneficiary, a rogue Appointor decided to replace the trustee with himself and took control of the Trust.
Changes to Law
A number of Trust Deeds were overhauled in light of the decision in Bamford in 2011. The need for flexibility in the definition of Income in trust deeds was required to ensure the standard practice of accountants (which is distributing sometime after the financial year) could be conducted legitimately. Without the correct amendment, the ATO can decide that unless distribution occurs by midnight 30 June, all income goes straight to the default beneficiary (or trustee at the highest marginal tax rate). Despite extensive coverage of this, I would suggest a significant number of trust deeds on foot still have not had the appropriate Deed of Variation drafted to be protected from this risk.
Review Your Trust Now
The ATO are on a warpath at the moment in the aggressive collection of tax, audits and re-assessments. We strongly recommend you have any trust deed reviewed by your lawyer immediately for any irregularities and that you ensure any new trust deeds into the future are prepared by a law firm.