When it comes to tax planning and asset protection, trusts are one of the many structures available to any businesses or property investors. For families, a family trust has been a popular vehicle to protect the family’s assets and manage or take advantage of any tax privileges.
If you’re on the fence about setting up a family trust or just want to know more about it, then this guide can help fill in some gaps and raise better awareness.
- A Family Trust is a great option for distributing income to beneficiaries without transferring asset ownership.
- A Family Trust is a form of a discretionary trust where the distribution is based on the discretion of the trustee.
- It is also a common option for property investing and tax planning
What is a Family Trust?
There are some misconception people make in assuming that a trust is a person or a corporation.
While a trust is considered an entity in the eyes of the Australian Taxation Office (ATO), it is not a legal structure without a trustee. In fact, it is an obligation or a fiduciary relationship where a person or a legal entity holds valuable assets in favour of a person or a group, otherwise known as beneficiaries.
There are multiple types of trusts depending on how it is to be managed. For example, a fixed trust is set up when the intention is for the beneficiaries to have a fixed entitlement to either the assets or the income of the trust.
Another example is a unit trust where beneficiaries own “units” to signify ownership or rights over the trust fund.
Then there is a discretionary trust. A discretionary trust is a trust put up for the benefit of the beneficiaries, but to which the trustee has overall control of how the funds are to be managed and how the assets, and the income thereto, are to be distributed.
The most common type of discretionary trust is a family trust which is used to manage a family business or to hold family assets. The capital and interest thereof are then distributed to family members or beneficiaries of the trust.
How do family trusts work?
Family trusts usually start with a family member setting a pool of assets for his or her descendants or for other family members. The trust deed, a legal document, contains the terms of how the assets and the income are to be managed and distributed.
Unlike a Will, where the distribution of assets takes place upon the death of the owner, a Family Trust takes effect immediately or after hitting a certain milestone, and while the trustee still lives.
When a family trust is created, any assets transferred to the trust belong to the trust. Similarly, assets purchased by the trust are owned by the trust.
Being a separate entity, assets held in trust are protected from any family member’s creditors. Similarly, beneficiaries cannot claim assets from the trust as long as they receive what is due to them.
How to Set Up a Family Trust in Australia
Setting up a family trust in Australia is somewhat similar to setting up a company; you need parties to the transactions and a document of how the trust is to be managed. Below are the step-by-step guide to setting up a trust fund.
#1 Identify your Trustee
A trustee is someone who manages your trust fund and has the power to make decisions over the assets of the trust. Therefore, this position is considered to be of most importance and should be assigned to a party (whether personal or juridical) that you trust.
A trustee can be a:
- Family member
- Professional individual – such as a lawyer, tax accountant, or investment firm, or
- Corporate Trustee – such as a family run company.
Choosing a trustee is a matter of preference. Being a trustee is a big responsibility. As the legal owner of the trust assets, a trustee can make decisions, implement changes, sell assets, and engage in trade or any other activities as long as it is part of the trust deed.
Additionally, the trustee is responsible for the overall tax administration of the fund, including lodging tax returns, and is responsible for any liabilities incurred by the trust fund.
What do I need to do if I want to change the trustee?
Part of a trust deed is setting an appointor. An appointor has the power to appoint, change or remove a trustee should it proves that the trustee fails to execute the terms and provision of the family trust deed.
#2 Identify your Beneficiaries
Beneficiaries are the ones who will benefit from the family trust and have legal claims to the income or property of the trust fund. As to who can be beneficiaries, usually family members are put as beneficiaries of a family trust.
When naming your beneficiaries, it is also encouraged to categorise family members or create a family group. Doing so ensures that capital and income distribution would best suit their respective tax rates.
Can a company be a beneficiary of a trust fund?
Yes, if the company is not also the trustee.
#3 Setting a trust deed
The next step is to set up a Discretionary Trust Deed, or in this case, a family trust deed.
A family trust deed is a legal document that sets out the objectives of the fund and establishes, identifies, and dictates how the asset and the corresponding income of the family trust are to be managed, operated and distributed.
The trust deed must appoint the trustee, the beneficiaries, and the appointor.
#4 Settling the family trust
The next step is the trust fund settlement where an independent person, who’s unrelated to the family, “settles” and signs the family trust deed. The settlor is also required to provide a gift sum as the trust’s settlement amount, for example $10 cash.
#5 Signing the trust deed
After the settlor signs the trust deed, it now needs to be signed by all trustees. It is of the highest importance that the trustees understand and acknowledge the provisions of the trust deed before signing as all parties will be bound by this agreement.
Likewise, it is advisable to have a witness during the sign-off to ensure that all trustees agree and sign voluntarily.
#6 Stamping the Trust
Depending on where you are, the relevant revenue authority may require you to pay stamp duty on your family trust. Some States require it, some don’t, so it is always best to talk to a professional when setting up a family trust.
The following states require you to pay stamp duty upon settling:
- VIC: $200
- NSW: $500 + $10 for every additional stamp copy
- NT: $20 + $5 for every additional stamped copy
- TAS: $50
The following states do not require you to pay for stamp duty:
#7 Applying for an Australian Business Number (ABN) and Tax File Number (TFN)
While some trust funds are set up just for the sole purpose of holding the assets, most family trusts are established to engage in investment or business. As such, the trustee should apply for an Australian Business Number for operating the business, and a Tax File Number for tax purposes.
Does a trust need an ABN and a TFN?
If the family trust fund is to operate a business, the trust must have an ABN. In the meanwhile, as long as the trust earns income, it is required to have its own TFN and pay tax liabilities.
Is a family trust fund taxable? Do I need to pay Capital Gains Tax?
As a general rule, a trust’s net income is normally distributed to its beneficiaries who are then taxed on the distribution based on their individual tax rates.
If the trust sells investment assets such as shares or properties, it is required to declare it in the trust tax return and distribute any capital gains to beneficiaries.
#8 Setting up a Trust Bank Account
Once everything is in place, it is now the time to open a bank account in the name of the trustee. The trustee should deposit the initial settlement sum before any transactions can be made.
A bank account is mandatory to enable the trustee to transact business, pay obligations, distribute trust income and manage trust assets.
Advantages and Disadvantages of a Family Trust
Many families set up a family trust merely for the tax benefits it gives them. In particular, here are the benefits you can enjoy should you wish to open a family trust:
- You have some potential flexibility to optimise your tax obligations when distributing and redistributing income.
- When a trust asset or investment property is sold, you may be eligible for a CGT discount.
- It offers asset protection, especially if there are significant investment assets involved.
- It can restrict to only family members from becoming beneficiaries. Thus, assets and income do not form part of the descendent beneficiaries’ and the spouses’ joint assets.
Just like any vehicle, opening a family trust brings its own disadvantages:
- Capital or revenue losses cannot be distributed to the beneficiaries, Therefore, for income tax purposes, beneficiaries cannot offset losses against any other income they individually earn.
- Undistributed income and income of minors can be taxed at a higher rate.
- Family trusts require ongoing maintenance and trust deeds may need constant updating as necessary.
- You lose personal ownership once the asset is transferred to the trust
Frequently Asked Questions About Family Trusts
How much does it cost to set up a family trust?
The main costs of setting up a family trust are the stamp duty, if and when required, the cost of setting up a corporation, in case of a corporate trustee, and professional fees to help you with the structure design.
As costs vary depending on the State in which you plan to establish your trusts and the complexity involved, it is always best to consult with a professional. While costly at first, it ensures all bases are covered.
Can I set up a family trust to buy a property?
As a separate legal entity, a family trust can buy and claim beneficial ownership of investment properties. However, establishing a family trust for the sole purpose of avoiding or evading tax is a risky move. Always consult with a professional to ensure that you don’t break any state laws.
How to transfer assets into a family trust?
To transfer assets into a family trust account, you can either gift or sell the asset/s.
When gifting an asset, the owner needs to execute a gift deed to the family trust to execute the gift. Meanwhile, selling a property to a trust fund works the same way as selling to a company or a person. Either way, there may be Capital Gains Tax (CGT) and / or stamp duty involved.
Gifting or selling has merits on its own, so be sure to consult with a tax advisor to know which is more beneficial for you and your trust.
Are family trusts worth it?
Family trust funds are worth it if you plan to protect your assets from creditors, ensuring that family members are taken care of. What’s more, this legal agreement takes effect immediately. If you decide to open a family trust, note that this should not be used to avoid taxes or defraud creditors.
In the next blog, we’ll further discuss about Chan & Naylor’s Property Investors Trust (PIT™). It may avoid the limitations of negative gearing quarantine common to a family trust while still providing a certain level of asset protection.
To evaluate what type of trust suits you and your family better, contact us and a member of our team will be in touch with you and work out how we may best assist you.