CONDUCTING A DISCRETIONARY TRUST

A discretionary trust is not a separate legal entity in the same way as an individual or a company, rather it is a relationship which exists whereby a person (Trustee) is compelled to hold property for the benefit of others (Beneficiaries).

The Trust is constituted by the payment to the Trustee of an amount called the Settled Sum which the Trustee agrees to hold, together with any other money paid or property transferred to it, in accordance with the terms and conditions of the Deed of Settlement executed by the person making the initial donation (the Settlor) and the Trustee at the time that donation is made. The Settled Sum together with any other money paid or property transferred to the Trustee, is called the Trust Fund.

The Deed provides that the Trust is to terminate on a day called the Vesting Day stipulated in the Deed or such earlier date as the Trustee may determine.

On the Vesting Day, the Beneficiaries appointed by the Trustee in accordance with the terms of the Deed are entitled to the whole of the Trust Fund.

The Trustee may, on that day, divide the whole of the Trust Fund between such of the General Beneficiaries in such proportions as it determines by an instrument in writing.  In the absence of the Trustee executing such an instrument on the Vesting Day the whole of the Trust Fund is divisible between the persons named as Remainder Beneficiaries (if any).

In the most unlikely event that on the Vesting Day the Trustee has not determined to appoint the Trust Fund to any General Beneficiary and there is no Remainder Beneficiary surviving, and the Trustee has not appointed additional Remainder Beneficiaries, then the whole of the Trust Fund is payable to or for such charitable purposes as the Trustee nominates.

The Trustee's powers of investment of the Trust Fund are specifically set out in the Deed, but basically, the Trustee is authorised to do all things which an individual or a company could do in respect of his or its own property.

Duties of the Trustee

The law imposes upon a Trustee a duty to act in good faith for the benefit of beneficiaries named in the Deed establishing the trust, and the Trustee must administer the trust in accordance with the terms, conditions and powers enumerated in the Deed and implied by law.

Where a trustee enters into a transaction, the trustee will be liable for that transaction as if the trustee had entered into the transaction on its own behalf.  If the trustee acts in accordance with the terms, conditions and powers contained in the trust deed and those implied by law, the trustee has the right to be indemnified from the trust fund for any liability the trustee incurs as a result of entering into the transaction.  It is important for a trustee to be cognisant of this because if the trust fund is insufficient to meet the liability the trustee will remain liable.

All decisions of the Trustee, if a company, in relation to the trust should be made at a meeting of the directors of the Trustee properly constituted in accordance with the provisions of the Trustee's articles of association.  Proper minutes of each such meeting of the directors of the Trustee should be kept.

Similarly, proper accounting records should be maintained by the Trustee.

Indeed, the Trustee, if a company, must maintain two sets of financial records - one in respect of its own affairs and the other in respect of its activities as Trustee of the Trust.

If the Trustee's sole purpose is to act as Trustee of the trust constituted by the Deed, and it will not be engaging in any business on its own account, the books of account and financial records in respect of its own affairs will be extremely simple and should not change from year to year.

It will be necessary for the company generally to comply with the provisions of The Corporations Law in relation to notification of changes in directors, holding of annual general meetings, etc. and to prepare and approve formal accounts each financial year.

The books of account to be maintained by the Trustee in respect of the trust must record all receipts and payments by the Trustee, all distributions of income, etc.  A formal balance sheet and profit and loss account should be prepared for the trust in respect of each financial year of its operation, and if the trust has earned income during the period, an income tax return must be lodged with the Commissioner of Taxation.

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Distribution of income

The Deed allows the Trustee various alternatives in relation to the net trust income earned in each financial year.  These  alternatives, and the taxation ramifications of each of them, are as follows:

(a)     The Trustee may distribute the net trust income amongst      the General Beneficiaries or any one or more of them in such proportions as it determines at a meeting of the directors of the Trustee.  All the trust income can be distributed to one General Beneficiary to the exclusion of others, the income can be distributed equally, or it can be distributed disproportionately.

If the whole of the trust income is distributed to adult General Beneficiaries, the amount received by each beneficiary is taxable in the hands of the recipient as an addition to the total income of that recipient.  Thus, if a particular General Beneficiary received a distribution of $1,000.00 from the Trustee and earned salary or wages resulting in a taxable income of $10,000.00, his total taxable income for the year in question would be $11,000.00 and the tax payable by him would be the amount of tax payable on a total taxable income of $11,000.00.

(b)     Tax on income held on trust for or applied for the benefit of   beneficiaries under the age of 18 is in effect paid by the Trustee on behalf of the beneficiary as if it were the income of an individual.  Special provisions apply where the infant beneficiary has income from other sources.  Special rates of tax apply to income held, applied or distributed to beneficiaries under the age of 18.  In general, $416.00 in total may be safely distributed to an infant beneficiary without attracting the special rates.

(c)     The Trustee may determine in a particular year not to        distribute any proportion of the net income of the trust but to accumulate that income as an addition to the Trust Fund.  In these circumstances, the Trustee is liable to pay tax on the net income of the trust at the highest personal rate.

In exceptional circumstances, the Commissioner has a discretion not to apply the highest rate to accumulated trust income.  Where his discretion is so exercised the tax rate applicable to an individual earning salary or wages of an identical amount to that of the trust income is applicable.

Income accumulated by the Trustee in this nature from then forms capital of the Trust Fund, and when distributed to the beneficiaries on the Vesting Day is not taxable in the hands of those beneficiaries.

(d)     The Trustee may decide to distribute part of the net trust      income and to accumulate the balance of that income.  In these circumstances, the amounts received by beneficiaries would be taxable in their hands in the manner set forth in  paragraph (a) or (b) and the balance retained by the Trustee and accumulated would be taxable in the Trustee's hands in the manner set forth in paragraph (c).

(e)     In the absence of any written determination by the Trustee   to distribute or accumulate the net trust income in a particular year, that income is accumulated automatically as an addition to the Trust Fund and the tax consequences outlined in paragraph (c) apply.

(f)    With the introduction of capital gains tax, careful       consideration will need to be given to the consequences for the Trust of various types of transactions which may give rise to a taxable capital gain.

If the Trustee sells a trust asset to an arm's length person and realises a gain on the disposal, the gain will be included in the assessable income of the Trust to be distributed or accumulated as any other income.  Capital losses may be subtracted from the gain before a net amount is included as assessable income of the Trust.

Other situations may give rise to deemed capital gains and require careful consideration.  For example, if trust assets are appointed or distributed to any specific beneficiary, the Trustee is regarded as having sold the asset to the beneficiary at its then market value and a capital gain may arise (depending on the cost base of the asset adjusted to take account of inflation).  Consideration needs to be given to whether the capital gain should be allocated to the same beneficiary (usually the most appropriate person in the circumstances) or some other beneficiary.  The taxable capital gain will thus form part of the income of the beneficiary to whom it is allocated.

A decision in relation to the income of the trust should be made before 30th June in each and every year by the directors of the Trustee, and recorded in a written resolution of the directors of the Trustee on or before that date.

Until accounts for the trust for the financial year have been prepared, it may well be impossible to estimate with accuracy the amount of the income of the trust.  This difficulty can be overcome by the Trustee resolving to distribute the income in proportions, for example:    

Alternatively, if it is desired to set aside a specific sum for a beneficiary or beneficiaries, it is possible for the distribution to be as follows:

To v - the first $5,000.00 of the trust income.

To w - the next $2,000.00 of the trust income.

As to the balance of the trust income to the following  beneficiaries in the following proportions:  

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After the exact amount of the trust income is known and the proportion to which each beneficiary is entitled has been calculated, those specific amounts should be recorded in minutes of a further meeting of the directors of the Trustee.

A distribution to a beneficiary need not entail a physical payment of the amount distributed to the beneficiary.  If the Trustee wishes to retain the money which it has decided to distribute to a particular adult beneficiary it may, with the consent of the beneficiary, establish a loan account in the books of the trust in the name of that beneficiary and credit the amount of the distribution to that loan account.  The Trustee can deal with the amount of the loan in accordance with the powers given to it by the Trust Deed, but in the absence of any arrangement to the contrary, the beneficiary can call for payment of the amount credited to his account at any time.  It should be noted that the amount credited to the new account is taxable income of the beneficiary.

Where the Trustee resolves to distribute part of the trust income to an infant beneficiary, most Trust Deeds provide for it to hold the amount of the distribution (and any future distributions to the same infant) in trust for the infant until the infant attains the age of 18 years.  This trust is separate to the discretionary trust from which the infant receives income.  The trustee has no discretion as to the persons entitled to the income of the separate trust - it is obliged to hold the trust fund for the particular infant concerned.  The whole of the capital and income of that trust belongs to the nominated infant beneficiary when the infant reaches 18 years.

The Trustee does have certain additional powers given to it in respect of separate Trust Funds for infant beneficiaries.  It may apply money held for an infant beneficiary in payment of education, clothing and other similar expenses which are for the maintenance, education or benefit of the beneficiary, reducing the actual amount due to the beneficiary.

Alternatively, it can pay the whole or any part of the money held to the parent or guardian of the infant.  The receipt of a parent or guardian for money paid to him on behalf of his child is a sufficient receipt for the Trustee, and the Trustee is not required to concern itself as to the way in which the parent or guardian then deals with the money paid to him.

The Trustee may loan the separate Trust Fund back to the main trust, or invest it in any investment authorised by the Deed but if any income is earned as a result of that investment, the income is taxable income of the infant beneficiary and tax is payable at higher rates than under normal circumstances (as mentioned above).

The situation could arise where an infant beneficiary approaching the age of 18 years is entitled to receive a substantial amount from the Trustee, the payment of which would be a matter of some difficulty.  If this situation arises, it is possible to avert the necessity for the Trustee to actually make a payment of the amount due, and discussions with professional advisers at the appropriate time would be necessary.

Distribution of capital

On the winding up of the trust on the Vesting Day, or at any time before the Trustee may exercise its discretion as to the manner in which the capital of the Trust Fund will be distributed to the various beneficiaries in accordance with the Deed.

From the Vesting Day, any assets belonging to the Trust or constituting the Trust Fund are held by the Trustee until payment or transfer specifically for the beneficiaries and in the proportions in which the Trustee has exercised its discretion, or failing the exercise of that discretion, in accordance with the default clauses (see page 1 of these notes).

The Trustee need not realise the assets of the Trust on the Vesting Day, but may transfer those assets to the beneficiaries in specie.

Entering into contracts

As previously indicated, a trust is represented by the Trustee, which enters into contracts and legal relationships with other persons in its own name.

It is not necessary for the Trustee to disclose to the other party to the dealing that it is acting in its capacity as Trustee of a trust.

Indeed, registers maintained by the Registrar General and company share registers cannot have recorded in them transactions which recognise that a person or company is acting in the capacity as Trustee.  However, it should be noted that companies do have the power, under the Corporations Law to obtain information as to the beneficial ownership of their shares.

Documents of transfer should only name the Trustee and should not refer to the capacity in which the Trustee is contracting.

In all circumstances where the Trustee is entering into contracts or dealing with property, it is essential that the decision of the Trustee to contract or deal with the property in its capacity as Trustee should be properly recorded in minutes of a meeting of the directors of the Trustee.

Conducting the Trust bank account

The Trustee should conduct a current account in its own name on behalf of the Trust if there are a sufficient number of transactions.  Alternatively, where only a small number of transactions will take place, a savings or building society account will suffice.

All payments to or by the Trustee should be effected through the Trustee's account.

Control and change of Trustees

Most Deeds empower the person named Appointor and after his death his legal personal representative or such person as he may nominate in writing or in his Will, to remove any trustee of the trust and appoint a new or additional trustee at any time by instrument in writing.  Additional control of the Trustee is usually vested in the Appointor to the extent that the Appointor is a shareholder and director of the Trustee company.

Memorandum of wishes

The assets of the trust will not form part of the estate of the "promoter" or "controller" of the Trust.  Such person should execute a memorandum of wishes addressed to his executor-elect, requesting that person to use his power as Appointor of the Trust in accordance with those wishes.

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WARNING
 

This memorandum has been prepared by Gadens Lawyers as a general guideline, and is not intended to be an exhaustive or complete statement concerning the operation of a trust.  There are many particular legal and accounting matters which have not been dealt with in this memorandum and clients are urged to discuss any aspect of the operation of the trust not discussed herein with their professional advisers.

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