LexisNexis Practical Guidance®

A testamentary trust is a trust that is established within the framework of a will. It only becomes operative on the death of the will maker (“the testator”) and the transfer of property to the trustee by the estate administrator.

A testamentary trust normally contains wide discretions similar to those contained in an inter vivos trust. However, care must be taken to ensure the will maker exercises his obligation to choose beneficiaries. There must be compliance with:

• •the rule against delegation of testamentary power, if relevant; and
• •the rules regarding certainty of objects.

The rule against delegation of testamentary power has now been abolished in New South Wales (s 44, Succession Act 2006 (NSW)), Victoria (s 48, Wills Act 1997 (Vic)), Queensland (s 33R, Succession Act 1981 (Qld)), Tasmania (s 58, Wills Act 2008 (Tas)) and the Northern Territory: s 43, Wills Act 2000 (NT).

Some of the advantages of trusts created by will are:

• •income distribution to minor beneficiaries where the minor is taxed on “unearned” income in the same way as an adult person;
• •the possibility of having undistributed income taxed at ordinary marginal rates applying to an individual rather than at maximum rates;
• •the flexibility of distributing income on a discretionary basis among different family members;
• •asset protection based on the law that no discretionary beneficiary has an interest in any particular trust asset;
• •some limited family law asset protection; and
• •the ability to shield assets from certain problem beneficiaries.

Capital Gains Tax rollover is possible through a testamentary trust to a beneficiary. Care must be taken when dealing with the main residence of the deceased.

Superannuation can be paid to and form part of the assets of a deceased estate. If paid to or exclusively for beneficiaries who would be tax advantaged if paid directly, then those tax advantages will normally flow through.

See Testamentary trusts.

Matters to note:

• •what is “charitable” in popular parlance may not be “charitable” in the legal sense;
• •charitable trusts are concerned with purposes not with persons;
• •raising funds for charities through a commercial enterprise may itself be a charitable purpose;
• •a trust established for charitable and non-charitable purposes is void at general law (subject to certain statutory provisions); and
• •there must normally be a benefit to the public at large or a section of the public.

Charitable trusts are classified under four main categories:

• •the relief of poverty;
• •the advancement of education;
• •the advancement of religion; and
• •other purposes beneficial to the community.

There are also extended meaning conferred by statutes in different jurisdictions, such as the provision of child care services on a not for profit basis.

The advantages of a charitable trust are:

• •rule against perpetuities does not apply;
• •more lenient legal construction;
• •income tax exemption; and
• •tax deductibility of gifts made to it.

The following are different types of funds:

• •public fund;
• •public benevolent institution; and
• •private ancillary fund.

See Charitable trusts.

A hybrid trust is simply a trust that possesses the characteristics of more than one of the simple forms of trust in varying degree and combination – fixed, discretionary and unit trusts.

The advantages of a hybrid trust are:

• •flexibility of control and distribution of capital and income;
• •negotiability - units can be redeemed and transferred;
• •CGT Event E4 may not apply;
• •CGT general 50% discount is accessible;
• •negative gearing may be available; and
• •asset protection advantages apply for non-fixed assets.

The disadvantages of hybrid trusts are:

• •difficulty in accessing small business tax concessions;
• •complicates valuation and stamp duty issues;
• •interest on borrowings may not be deductible;
• •cannot access trust loss provisions that are available to fixed trusts; and
• •cannot make a family trust election if more than one family is involved.

• •small business net asset value test;
• •requirement for CGT concession stakeholder;
• •requirement for significant individual;
• •fixed trust tests to access right to deduct current and prior year losses; and
• •the test individual in relation to a family group.

See Hybrid trusts.

A superannuation fund trust deed is little different from any inter vivos trust deed. Its purpose is to provide retirement benefits to the members of the fund (the beneficiaries). It will receive concessional tax treatment if:

• •it complies with the legislative requirements to bring it within the definition of a complying superannuation fund; and
• •it complies with the investment and administration requirements to maintain that status.

A complying fund that is a self-managed superannuation fund must have fewer than five members and must observe formal requirements that include:

• •who can be trustees of the fund;
• •who can be directors of a trustee company;
• •no remuneration to trustees; and
• •an investment strategy.

The overriding principle is that the fund is established and maintained to provide benefits for a member's retirement or for the dependants of a deceased member. A non-complying fund is subject to substantial tax penalties, including being subject to tax at the top marginal tax rate, ie a 45% tax rate, from the start of the income year in which the fund becomes non-complying.

Control resides in the members but when a member dies it is critical to have a procedure in place to ensure that the assets of the fund pass to the intended persons. This can be achieved by:

• •provision in the deed itself;
• •a binding death benefit nomination; and
• •ensuring effective change of control of the trustee.

There is a general prohibition on transferring assets from a member to a fund. The major exception is business real property.

Benefits to consider include:

• •income will thereafter be taxed at the superannuation concessional rate of 15%;
• •CGT will be at a concessional rate or tax free after retirement; and
• •the property transferred will obtain some asset protection status if the business itself gets into financial difficulty.

A superannuation trustee may borrow money to purchase an asset in certain limited circumstances. Restrictions include:

• •a particular borrowing must be for a single asset;
• •the asset must be held on trust by a trustee, not being the superannuation trustee;
• •third party rights against the trustee are limited to the asset only; and
• •no other charge or encumbrance against the asset is permitted.

Payment of benefits is limited by the sole purpose test and the relevant legislation. In general terms these are:

• •the deceased member’s estate;
• •a spouse;
• •children; and
• •persons in an interdependency relationship with the deceased member.

See Superannuation.

The settlor:

• •provides the initial settled sum to establish the trust;
• •has no other role;
• •must not be a beneficiary; and
• •must not gift or transfer any other property to the trust.

The trustee:

• •is the legal owner of the trust assets;
• •is bound by the trust deed;
• •is subject to the relevant state or territory trustee legislation;
• •holds the assets for the beneficiaries; and
• •can be an individual or a corporation.

A corporate trustee has the following advantages:

• •it continues to exist despite the death of any person;
• •it has limited liability (subject to certain exceptions such as s 197 of the Corporations Act 2001 (Cth)); and
• •it removes individuals from direct control of the trust property.

The appointor:

• •can generally remove the trustee and appoint a new trustee;
• •generally must be consulted before major decisions are made by the trustee; and
• •is sometimes called “the guardian”, or the “the protector”, or may have division of powers with such persons; and
• •exercises at least some degree of indirect control over the trust.

Beneficiaries of a discretionary trust:

• •are for a family discretionary trust generally defined as widely as possible within a family group;
• •generally include corporations and other trusts connected to individual beneficiaries; and
• •have no proprietary interest in the assets of the trust generally or in any individual trust asset.

See Parties to a discretionary trust deed.

Powers and duties of trustees are found in:

• •the general law relating to trusts;
• •the various state and territory trustee legislation; and
• •the trust instrument.

Many discretionary trusts have a similar structure. Some of the more important aspects of the trust deed are:

• •definitions, including in particular:
• • ◦the vesting date;
• • ◦the beneficiaries;
• • ◦the trust assets;
• • ◦income; and
• • ◦income categories;
• •the formal declaration of the trust;
• •the duration of the trust and the ability to appoint an earlier date;
• •power to distribute income;
• •power to distribute capital;
• •power to stream income and capital gains;
• •power to deal with the trust assets, including investment, carrying on business, raising capital, etc;
• •mechanisms for appointment and removal of trustees;
• •powers of the appointor;
• •the right of indemnity of the trustee against the trust assets; and
• •power to amend the trust deed.

See Standard discretionary trust clauses.

Taxation of trust income is governed by Pt III of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) as supplemented by Div 6E and Subdiv 115C of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) for capital gains and Div 207 for imputation credits. The main provisions are:

The main provisions of the relevant income tax provisions for trusts that are contained in Pt III of the ITAA 1936 are:

• •ss 95–102, which are the main taxing provisions;
• •ss 102AA–102AGA, which cover tax treatment of children in certain circumstances;
• •ss 102AAA–102AAZG, which cover non-resident trust estates;
• •ss 102M–102T, which cover income of certain public trading trusts;
• •ss 102UA–102UV, which cover income of certain closely held trusts;
• •ss 95AAA–95AAC, relating to the new tax treatment of trust capital gains and franked dividends; and
• •ss 102UW–102UY, being a new Div 6E, relating to the new tax treatment of trust capital gains and franked dividends.

The term “trust” itself is not defined by the legislation but some of the more important terms are:

• •trustee (s 6, ITAA 1936);
• •net income (s 95, ITAA 1936);
• •present entitlement (s 97, ITAA 1936);
• •legal disability (s 98, ITAA 1936); and
• •specifically entitled: ss 115-228, ITAA 1997.

A beneficiary who is presently entitled and who is not under a legal disability is subject to tax on his or her “share of the net income of the trust estate”. Trust income of the taxpayer is aggregated with the other income of the taxpayer.

The tax definition of income and the concept of income as understood by the law relating to trusts can be quite different.

Where no beneficiary is presently entitled:

• •trust income is taxed in the hands of the trustee at the maximum rate of 45% plus medicare levy of 2% (s 99A, ITAA 1936); and
• •taxation at concessional rates is possible if the Commissioner of Taxation is prepared to exercise his discretion not to apply the higher rates: s 99, ITAA 1936.

Deceased estates are treated as trusts for tax purposes. Beneficiaries are not considered to be presently entitled to any of the assets of the deceased estate until estate liabilities have been discharged and the entitlement of the beneficiaries quantified.

See Income Tax.

Stamp duty is a state-based tax and varies in every state and territory. In most jurisdictions, the critical points for the levying of duty relating to trusts are:

• •on a declaration of trust over unspecified property, fixed rates of duty normally apply;
• •on a declaration of trust over specific property, ad valorem rates normally apply;
• •on a transfer of trust assets to a beneficiary, ad valorem rates normally apply but there are exemptions; and
• •on a transfer of trust property from the legal personal representative of a deceased estate to a beneficiary, nominal, fixed rates or an exemption normally apply.

Ad valorem stamp duty may be payable on any transaction which varies the terms of a trust by:

• •varying a beneficial interest; or
• •adding or removing a potential beneficiary.

This is often described as a "resettlement" of the trust.

A variation of trust may be dutiable as a transfer of trust property. This will occur if there is a “resettlement” of trust property. Some variations adding or deleting some categories of beneficiaries are not dutiable but may be treated as a resettlement for Federal capital gains tax purposes.

Care must be taken in contracts for sale of land if a trust is involved in the purchase. It is possible to be assessed for two heads of ad valorem duty. One is for the transfer of dutiable property and the second is for a declaration of trust over dutiable property.

In some jurisdictions, if a person has paid the whole of the purchase price and a property is vested in another entity, the person paying for the property is entitled to have it transferred to him for nominal duty utilising the concessional provisions of the relevant Act.

A transfer from a trustee to a beneficiary is dutiable unless a concession applies.

See Stamp duty.

There are defined terms and terms of art that must be understood in order to understand the taxation of capital gains.

The ITAA 1997 sets out nine CGT Events that specifically relate to trusts. These are:

• •creating a trust over a CGT asset —CGT Event E1;
• •transferring a CGT asset to a trust — CGT Event E2;
• •converting a trust to a unit trust — CGT Event E3;
• •capital payment for trust interest — CGT Event E4;
• •beneficiary becoming entitled to a trust asset — CGT Event E5;
• •disposal to beneficiary to end income right — CGT Event E6;
• •disposal to beneficiary to end capital right — CGT Event E7;
• •disposal by beneficiary of capital interest — CGT Event E8; and
• •creating a trust over future property — CGT Event E9.

Various CGT tax concessions are available to small businesses that satisfy the definition of “small business entity”. The threshold test is a $2 million aggregated turnover test.

Trusts that carry on business are entitled to the CGT concessions subject to satisfying some additional tests relating to ownership and control.

Important points to note:

• •death triggers a disposal for CGT purposes;
• •the legal personal representative or a beneficiary is taken to acquire the assets at the cost base of the deceased or, if there is no cost base, at market value; and
• •there is a deferral of CGT until there is a further disposal.

See Capital gains tax.

Land tax is a state-based tax. It is levied throughout all of the states and the Australian Capital Territory. It is not levied in the Northern Territory.

Except for the Australian Capital Territory, land tax is levied on the value of land over a certain threshold. Some trusts are not eligible for the threshold concession in some jurisdictions and in other jurisdictions different thresholds apply to trusts.

See Land tax.

In order to qualify for the payment of many of the benefits available under the Social Security Act 1991 (Cth) a person may have to satisfy an income test, an assets test, or both.

A person who is involved with a private trust may have some or all of the capital and income of the trust attributed to them if they satisfy certain tests of involvement with the trust.

The following are tests for attribution:

• •a control test; and
• •a source test.

To avoid the consequences of attribution a person may relinquish control of the trust and:

• •is then deemed to have made a gift of those assets held by the trustee; and
• •will be treated as the owner of those assets for a further 5 years.

The Centrelink attribution rules also apply to trusts created by will.

See Centrelink rules.

This guidance note summarises both the broad framework of most trusts and, specifically, the most common form of trust, which is a family discretionary trust.

Some of the other more common types of trusts are also considered.

See Business structures compared.

Using trusts can give a business owner access to the following business and tax advantages:

• •limited liability;
• •access to the 50% CGT general discount;
• •flow through taxation of income to beneficiaries; and
• •flexibility in distributing income.

See Advantages of a trust.

All choices of structure are compromises and each type of structure has disadvantages. Those applying to trusts include:

• •they can be complex;
• •they are more expensive to establish and maintain than some other structures, such as a partnership;
• •income must be distributed each year or maximum tax applies; and
• •losses remain within the structure and cannot be utilised by beneficiaries. This can be a disadvantage for a start-up business that generates initial losses.

See Disadvantages of a trust.

See Structuring for business.

Trust assets can be the property of a party to a marriage, if that party exercises such control that they can do with them as they please. A right of a party to a marriage to compel due administration of a discretionary trust controlled by the other party is itself property. Property still does not include a mere expectancy.

The High Court favours an expansive interpretation of the word “property”. Where a party is the director of the trustee and appointor of a trust, the court has held that the trust assets are assets of that party (other factors also play a part).

The law requires a trust to be wound up or “vested” in natural beneficiaries within a maximum period which in most states is 80 years. In South Australia the perpetuity period has been abolished.

Most discretionary trust deeds provide an internal mechanism to wind up the trust at any time. This varies from trust to trust so one should check the deed.

A trust will terminate:

• •when wound up in accordance with the deed;
• •when the perpetuity period expires; or
• •when there is no fund remaining under the control of the trustee.

See Vesting date.

In the Northern Territory, the law requires a trust to be wound up or "vested" in natural beneficiaries within a maximum period of a life in being plus 21 years or 80 years from the date on which settlement takes effect. The latter period is the default maximum period where a trust is required to be wound up or “vested” if this period is not specified in the trust instrument: s 187, Law of Property Act 2000 (NT)

Where all of the possible beneficiaries of a trust are of full legal age, they can together direct the trustee to terminate the trust and distribute the fund.

See Rule in Saunders v Vautier.

The following matters should be considered when winding up a trust:

• •the procedures prescribed by the trust deed;
• •consents that may be required – such as that of the appointor;
• •identifying all of the possible beneficiaries for discretionary consideration;
• •considering all possible creditors;
• •advertising for claimants in order to obtain any statutory releases from liability that may be available;
• •considering all possible tax consequences – particularly CGT arising from the sale of any trust assets or from in specie distribution to beneficiaries; and
• •choosing the beneficiaries with the best tax situations to receive distributions of streamed capital or income.

See Matters to be considered before winding up.

Where one of the steps to winding up a trust involves the sale of trust property, the trustee may be liable for capital gains tax (CGT). If the trustee is carrying on business, then it may have access to the small business CGT concessions when that business is sold.

CGT issues will also arise where assets are transferred in specie to a beneficiary. The specific CGT events are set out in Subdiv 104-E of the Income Tax assessment Act 1997 (Cth). Particularly consider:

• •payment attributable to small business concessions;
• •payment to beneficiary in respect of unit or interest in a trust;
• •a beneficiary becomes absolutely entitled to a trust asset;
• •distribution of a trust asset to end a beneficiary’s income right; and
• •distribution of a trust asset to end a beneficiary’s capital interest.

See Capital gains tax.

When a unit trust is wound up the payment to the unitholder is first applied against the cost base of the units. Once this has been reduced to nil any excess is treated as a capital gain.

If the units were acquired as a pre-CGT asset then CGT may still be payable if the value of the post CGT assets is more than 75% of the total trust assets.

See Unit trusts.

In New South Wales stamp duty at ad valorem rates is usually chargeable on trust property transferred to a beneficiary on the winding up of a trust. Concessions are available where a transfer is made under and in conformity with the trusts contained in a declaration of trusts. The conditions set out in the concession must be strictly met.

In Victoria, there are exemptions from duty in circumstances where:

• •property passes to beneficiaries of fixed trusts;
• •property passes to beneficiaries of discretionary trusts;
• •property passes to beneficiaries of unit trusts; and
• •property passes, not for valuable consideration, from the legal personal representative of a deceased person to a beneficiary.

In Queensland, stamp duty at ad valorem rates is usually chargeable on trust property transferred to a beneficiary on the winding up of a trust. Concessions are available where a transfer is made under and in conformity with the trusts contained in a declaration of trusts. The conditions set out in the concession must be strictly met.

To obtain the concession stamp duty must have been paid on the transaction that resulted in the property becoming subject to the trust and the beneficiary must have been a beneficiary at that time.

In Western Australia, duty is payable in relation to dutiable transactions, which include, among other things, a transfer of dutiable property, a declaration of trust over dutiable property and a trust acquisition or a trust surrender: ss 11(1)(b), 11(1)(c), 11(1)(h), Duties Act 2008 (WA); ss 53–62 and 63–69, Duties Act 2008 (WA).

Property passing to beneficiaries of a unit trust scheme is generally not dutiable, unless the ‘landholder’ provisions in Ch 3 of the Duties Act 2008 (WA) are met: s 29, Duties Act 2008 (WA).

Nominal duty is chargeable in relation to certain transactions involving trusts but the conditions set out in the relevant sections must be met: ss 114–119, Duties Act 2008 (WA).

In South Australia, there are limited exemptions from duty for transfers to:

• •beneficiaries of fixed trusts (where the relevant property was acquired under an instrument on which ad valorem duty has already been paid); and
• •beneficiaries under a family discretionary trust.

Each of these exemptions is subject to conditions which must be strictly met.

In Tasmania, there are various concessions from duty where property passes to beneficiaries of trusts and for changes relating to trustees.

In the Northern Territory, there are exemptions from duty for the transfer of property from trustee to beneficiary. Those exemptions are found in Item 6 of Sch 2 of the Stamp Duty Act and apply in the following circumstances:

• •property is transferred by the trustee to a beneficiary of a fixed trust; and
• •property is transferred by the trustee to a beneficiary of a discretionary trust;

To obtain the exemption:

• •the property must be transferred in accordance with the terms of the trust and must not be made for valuable consideration; and
• •stamp duty must have been paid on the transaction that resulted in the property becoming subject to the trust, unless duty was not otherwise payable on the transaction, the beneficiary must have been a beneficiary at that time.

In the case of a discretionary trust, there is an additional requirement that the beneficiary must be an individual and must hold the property both legally and beneficially.

A duty of $20 is chargeable on transfers of dutiable property from trustee to beneficiary if there was no consideration and the transfer was made in conformity with the declaration of trust: s 58(1), Duties Act 1999 (ACT).

See Stamp duty issues.

It is common in many trust deeds to find that, where a corporate trustee is wound up, the appointment of the corporate trustee is automatically terminated and this affects whether or not the liquidator of the corporate trustee is then able to dispose of trust assets.

See Trusts and liquidation.