What is a Secret Trust?

I would like to tell you, but it is a secret.

These are trusts, usually set up under a will, where property is left to a person on an undisclosed trust for someone else.

Example

Homer dies and leaves $100,000 cash for his mate Barney, but leaves it to Ned on the understanding that Ned gives Barney $100 per week for the next 100 weeks (so Barney doesn’t waste it all in the first week).

Barney is not recorded as the beneficiary under the will.

Naturally there may be problems with enforcing these trusts as no one may know about them other than the trustee. The beneficiary may realise or find out though but even then they will probably have difficulty proving the trust if there is no written evidence. As such you really must trust your trustee when doing this.

There is also the half secret trust, and that is when the trust is partially disclosed in the will. For example the will might say that Ned is the trustee (using above example) but not who the beneficiary is or the terms of the trust. This might have a higher chance of being enforced as it is evident that there is a trust, but not who for and for how long and how much.

Discuss at

https://www.propertychat.com.au/community/threads/legal-tip-204-what-is-a-secret-trust.39248/

Written by Terryw who is a lawyer at www.StructuringLawyers.com.au

Transferring a Property from a Testamentary Trust to a Beneficiary Without CGT

Trusts are generally considered the greatest British invention, (the sandwich comes in second), and Testamentary Discretionary Trusts (TDTs) are the best of the best.

The main benefit of a TDT is the ability to get income into the hands of children and have them taxed as adults.

Another main benefit of TDTs is the ability to transfer a property owned by the trustee of the trust to that of a beneficiary of the trust without triggering CGT. This means an inspecie transfer of assets is possible without CGT.

Example

Homer dies and leaves his property portfolio indirectly to his children by establishing 3 separate TDTs in his will. Bart’s trust will hold 3 properties, as will 2 more trusts controlled by Bart’s sisters.

Bart has 5 children, so is able to distribute the $100,000 in rental income to the children tax free each year.

After a while the kids grow up and start working so any further distributions will result in tax being payable at high rates. Bart decides to reduce the tax by moving into the most expensive property and living there rent free. Then he realises that the property is subject to CGT as it is held by a trustee and the main residence exemption won’t apply.

Bart decides to use the ATO’s concession and transfer the property from the trustee to himself as a beneficiary under the will.

He gets a private ruling first and this confirms the Commissioner will not treat this as a disposal for CGT purposes because it is a transfer from a deceased estate to a beneficiary.

Note however that this is not law, but a concessional treatment by the Commissioner as stated in Paragraph 2 of PS LA 2003/12 https://www.ato.gov.au/law/view/document?docid=PSR/PS200312/NAT/ATO/00001

“… the Commissioner will not depart from the ATO’s long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997, in particular subsection 128-15(3).”

See also PBR 99991231235958 – Questions 1 and 2

also PBR 1012603789935

Discuss at

https://www.propertychat.com.au/community/threads/tax-tip-194-transferring-a-property-from-a-testamentary-trust-to-a-beneficiary-without-cgt.38844/

Discretionary Trusts distributing income to a SMSF and Tax

We have seen that it can be possible for a discretionary trust to distribute income to a SMSF if the SMSF is a beneficiary of the trust. See my legal tip
http://www.structuring.com.au/terry/super/can-a-discretionary-trust-distribute-income-to-a-smsf/

But just because it can be done doesn’t mean it should be done.

Any distribution from a related discretionary trust received by a SMSF will be classed as NALI or ‘Non Arms Length Income’.

NALI income will be taxed in a SMSF at the highest marginal tax rate.

Income from Fixed Trusts to a SMSF can be taxed at normal SMSF rates, 15% generally, but only where the income is genuine non-NALI income. For example a SMSF owning units in a Fixed Unit Trust which owns a factory. Genuine rent can flow through to the SMSF and be taxed at 15%. But if a discretionary trust distributes income to the unit trust this would flow through to the SMSF but be taxed at the top marginal tax rate.

The reasons for these laws are to stop people diverting income to SMSFs to save tax.

Discuss this at https://www.propertychat.com.au/community/threads/tax-tip-196-discretionary-trusts-distributing-income-to-a-smsf.38915/

Can a Discretionary Trust Distribute Income to a SMSF

A SMSF is a trust and a discretionary trust could potentially distribute to another trust. But, the Trustee of a Discretionary Trust can only distribute income to beneficiaries of that trust if the SMSF meets the definition of beneficiary as defined in the deed. If the SMSF is a beneficiary of the discretionary trust then it would be possible for it to receive income and/or capital from the discretionary trust.

BUT (and there is always a but) – just because it could be done doesn’t mean it should be done. See my tax tip for some of the tax consequences.

Discuss this topic at https://www.propertychat.com.au/community/threads/legal-tip-198-legal-tip-can-a-discretionary-trust-distribute-income-to-a-smsf.38916/

Multiple Bucket Companies as an Estate Planning Strategy

A Bucket company is a company set up to receive profits from another entity – usually a discretionary trust. The bucket company usually does nothing else, except receive money and make loans or directly invest perhaps. Over time the value of the bucket company will rise as money is coming in but not going out. Therefore, it will become increasingly important to consider in regards to estate planning and asset protection.

One estate planning strategy is to set up one separate bucket company for each child so that when the controller of the companies dies each company’s control can be passed on rather than having multiple people inherit the control of one company.

Example

Homer has 3 kids. He wants to leave them approximately the same amount of his assets 1/3.

Homer has decided to set up a discretionary trust to use to invest in shares. He seeks legal advice on the difficulties with leaving the control of the trust to more than one person so has that covered. But after a while the dividends of the share investments are building up so Homer sets up 3 bucket companies with 3 separate discretionary trusts with one trust holding the shares in each bucket company.

When the dividends come in, he causes the trustee of the share trust to distribute 1/3 to each company. Over a period of time the companies end up with large amounts of retained earnings which and then lent back to the share trust.

Homer dies.

Each of the bucket companies is then passed to each child – actually nothing is passed but the control of the bucket companies is arranged so that Child A controls Trust A and Bucket Company A.

This way things will be easy to divide. There is no more than one child involved in one company so if they want to cause the company to make loans, invest, pay dividends or close down they can do so without the need to effect or even consult with their siblings.

For a Discussion go to:

https://www.propertychat.com.au/community/threads/legal-tip-195-multiple-bucket-companies-as-an-estate-planning-strategy.38768/

Declarations of Trust and CGT

I have outlined what a declaration of trust is here http://www.structuring.com.au/terry/trusts/declaration-of-trust/ .

What are the CGT consequences of a person declaring that they now hold an asset as trustee? There is no change in title, so most people probably think there are no tax consequences, but there are.

CGT Event E1 (section 104-55(1) ITAA97) happens when someone declares a trust over existing property they own. This is because there is a change of beneficial ownership, even though the legal ownership remains the same.

Example

Homer holds 100 shares in CBA. He makes a declaration of trust that he now holds these shares on trust under the terms of the Simpson Family Trust deed. No change of ownership has happened, but this has triggered CGT just as if there was a sale of those shares to a 3rd party. If the cost base of the shares was $100,000 and the market value is now $200,000 that would mean a $100,000 capital gain is made (which may then get the 50% CGT discount etc).

(Homer should have sought legal advice as there are ‘better’ ways of doing this)

Declaration of Trust

A declaration of trust happens when the legal owner of an asset declares that they now hold that asset on trust for another person or persons.

A more technical definition is found in legislation, for example in section 8(3) of the Duties Act 1997 NSW which has:

“declaration of trust” means any declaration (other than by a will or testamentary instrument) that any identified property vested or to be vested in the person making the declaration is or is to be held in trust for the person or persons, or the purpose or purposes, mentioned in the declaration although the beneficial owner of the property, or the person entitled to appoint the property, may not have joined in or assented to the declaration.

Example

Homer owns 123 Smith Street. He is the legal and beneficial owner. One day he decides he wants to begin holding that property but for the benefit of his son Bart. Homer makes a declaration of trust that from this day forward he holds the property as trustee for Bart.

Homer is still the legal owner, but now Bart is the beneficial owner of the property. If Homer goes bankrupt the property is, at face value, not his property and not available to creditors (but…). If Homer dies this property is not one that can pass via his will. If the property is rented out the income will be taxed in the hands of Bart etc.

There are also various tax and duty consequences to making a declaration of trust and I will cover these in a future post.

Tax on Trust Income not Distributed

Where a trust has income and no one is presently entitled to it, the trustee of the trust will be taxed on this income at the top marginal tax rate because of s99A(4) ITAA36

http://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s99a.html

Note that the income doesn’t necessarily need to be distributed, it could be retained by the trust yet still be taxed in the hands of the beneficiary if they have been made presently entitled to it.

On present entitlements and trusts see this post I wrote a few years ago:

Legal Tip 87: Trusts and Unpaid Present Entitlements

https://propertychat.com.au/community/threads/legal-tip-87-trusts-and-unpaid-present-entitlements.4718/  

Example

Simpson family trust has $10,000 in income in year 1. The trustee makes Bart presently entitled to the income so Bart is the one that is taxed on this income. The trustee may not physical transfer the money, but if the is the case Bart will still be taxed (and he will have an unpaid present entitlement with the trust, which is similar to a loan). Bart has no other income and pays no tax.

In year 2 the trust has $10,000 in income, but the trustee doesn’t make anyone presently entitled – perhaps they forgot, or perhaps their resolutions were defective.

The trustee will pay the tax at the top tax 47%

Setting Up a Trust When You Have No Family

What is the point, you might ask, in setting up a discretionary trust to hold investment assets when you have no family?

A discretionary trust needs at least one beneficiary with the trustee having the option to retain income, or at least 2 beneficiaries where it doesn’t. However, most discretionary trusts will have hundreds of potential beneficiaries as they will be set up with one or two named persons as the primary beneficiary and then there will be secondary and, possibly, tertiary beneficiaries who are relations of the primary beneficiary.

So even though you are on your own now, you might have cousins or distant relatives who could be beneficiaries – this doesn’t mean they need to be recipients of trust income, but just that they could be. You never know when one of your cousins might invest in shares and lose the money and have carried forward income or capital losses.

There is also the issue that even though you may not have any family now, you may get a spouse at a future date. There may even be children and then grandchildren. All these people could and probably would be beneficiaries of the trust. This is generally the case even if they do not ‘exist’ at the time the trust was created.

Perhaps most importantly, a company could also be a beneficiary of the trust. This may allow for use of the bucket company strategy of diverting income to the company to cap the tax rate at 30%. Later on, the retained earnings in the company could be distributed to future family members (providing the shares of the bucket company are held by a different trust).

There are also the asset protection aspects to consider. Not having a spouse may mean holding all assets yourself and taking a risk of not ending up bankrupt. Where the assets are held on trust, the assets are generally much safer from attack should the controller of the trust become bankrupt at some point.

See the discussion at: https://www.propertychat.com.au/community/threads/legal-tip-190-setting-up-a-trust-when-you-have-no-family.36832/

Can a Trust Distribute Franking Credits to Someone Other than the Dividend Recipient?

No.

Franking credits are not income as defined in the tax acts nor are they assets of a trust. They therefore cannot be allocated to someone, but they must flow out as directed by Division 207 of the ITAA36.

It was previously thought that the franking credits could be distributed separately but this ‘bifurcation assumption’ was recently held be to be legally ineffective by the High Court in the case of Federal Commissioner of Taxation v Thomas [2018] HCA 31

Written by Terry Waugh, Solicitor at www.structuringlawyers.com.au