Explaining how a Trust structure works to a client who does not have a legal or accounting background is difficult.  In fact, explaining a trust to someone who does have an accounting background can sometimes be difficult as well.  Trusts are complex beasts.  I spent a semester of my Masters degree intensely studying the topic of Trusts.  I have read many books and been to conferences specifically about Trusts, yet I definitely would consider myself an expert.  It is completely OK to think that Trusts are complicated because they are.

I want to share with you the way I explain Trusts to my clients.  This is an intentionally simple explanation.  I am aware that there is so much more to know, but I also feel that understanding the basic concept is a critical stepping stone in your journey to become the proud owner of a Trust.

Let’s go back to Ye Olde England

Trusts started back in 12th Century and relate to the King of England and The Crusaders, but I prefer to explain trusts as they would have been used in Jane Austin times.  I may be taking some creative liberty with this story, but I think it helps get the message across.

Back in those days, women were not able to own property in their own names.  This caused a dilemma for the wealthy landowner who only had daughters.  What would happen when he passed away?  How could he leave his property to his wife and daughters when they were not legally able to hold the title to the property?

Enter “Old Mate” down the road, the landowner’s trusted friend.  What if he left the property to “Old Mate” who could be the legal owner of the property, with an agreement (based on the landowner’s trust of the moral fortitude of “Old Mate”) that he would do the right thing by the women family members?  They could live in the property and benefit from any income the property would derive without any legal entitlement to do so. There is a distinct reason that the word “trust” is used!

Essentially a Trust is just a relationship.  The relationship between the Trustee (Old Mate) and the Beneficiaries (the wife and daughters).  The relationship between the legal owner and those who should reap the benefits of the assets of the trust.

In current time

Return from the times of Pride & Prejudice and think about your own trust structure and how it works.  The Trustee is likely to be a company (a Corporate Trustee) or it may be some individuals.  The rules that define the relationship between the Trustee and the Beneficiary are formalised in a document called the Trust Deed.  The Trust Deed names the beneficiaries of the Trust, explains the powers of the Trustee, and outlines the operating rules for the Trust.   If you do have a Trust, take half an hour to read your Trust Deed.  It will be riveting reading (I know), but it is a very important document.

Our court system has come a long way since the days of the Crusaders and now it is the legal obligation of the Trustee of a Trust to act in the best interests of the beneficiaries.  This is known as a fiduciary duty, the requirement to put another person’s interests in front of your own.

The Settlor

There are a few more concepts and roles that you need to be aware of so I will try to explain them as simply as I can.  A trust must be settled over a piece of property and the person who provides that property is known as the Settlor.

In our Ye Olde England example, the Settlor would have been the landowner who was giving the property to Old Mate to create the Trust.  I appreciate that may have been part of a will, but let’s just set that aside for this example and assume he created the trust prior to his death.

In today’s typical Trust set up the Settlor is often a lawyer, accountant or friend who is generous enough to give the trust a sum of money (usually $100 – $500) to start the trust.  Once this act of generosity has been performed, the Settlor has no further role in the Trust.  Most Trust Deeds specifically say this – so please don’t think your lawyer or accountant has somehow wormed their way into your family business or investments by being the Settlor.  In some states (eg NSW), stamp duty is payable on the trust property when the trust is settled, and that is why you keep the trust property amount low.  You don’t want to inadvertently settle a Trust on a large value and end up with a high stamp duty charge.

The Appointor (or Principal)

In your Trust Deed you will find reference to the Appointor or Principal of the Trust.  This is the person who has the power to replace the Trustee of the Trust.  Typically this role does nothing, but it does have the ultimate power.  If the Appointor is not happy with the Trustee – they can be replaced.

Vesting Date

Unlike a company that has an unlimited life (until you choose to wind up a company), a Trust has a limited life.  The termination of a Trust agreement is called the Vesting Date and this will typically be 80 years after the start of the Trust.  On that date the Trust should be “vesting” the assets to at least one of its beneficiaries.

What is a Discretionary Trust?

There are many variations on Trusts but I will discuss the two most common forms of Trust – the fixed Trust (Unit Trust) and the Discretionary Family Trust.

A Family Trust is considered “discretionary” because the distribution of the income of the Trust, or the assets of the Trust is as the “discretion” of the Trustee.

A Family Trust Deed will list some named beneficiaries, and then the family relationship to those named beneficiaries that will allow us to find potential beneficiaries.  Allowing additional beneficiaries based on a family relationship stops you from having to change the deed as the family dynamics change.  Potential beneficiaries can include parents, grandparents, children, grandchildren, siblings, aunts, uncles, nieces and nephews.  There is a large net that can be cast to find the potential beneficiaries.  You do not need to name your children in the deed as they will automatically be potential beneficiaries.

To some people this sounds scary.  What about that crazy cousin who may want to get their hands on your money?  The key to all of this is that although they can be beneficiaries to your trust, there is no entitlement to anything without the Trustee exercising their discretion to distribute to that beneficiary.  Your investments are safe from that crazy cousin.

If you have distributed income to someone and the money has not been paid to them, they do have a legal right to that money.  This is called an unpaid present entitlement.  The entitlement is limited to the amount you have distributed to a beneficiary.

The Fixed Trust

As a business owner you may want to use a Trust structure but you have a business partner who is not related to you.  You can’t use a Family Trust as you are not part of the same family.  You will also want some assurance of your share of the assets of the Trust.  In this instance you would have a Unit Trust.

As the name implies, the beneficiaries are issued Units and the number of units indicates the unit holder’s share of the assets and income of the Trust.  It is very similar to a company, except the income must be distributed to the unit holders each year.

Distribution of Income

The Trustee of a discretionery Trust does not have to distribute the income of the Trust, but any undistributed income is taxed at the highest marginal tax rate.  As such, it is usually in the best interests of the beneficiaries that the income is distributed to at least one beneficiary.

The distribution of taxable trust income will be taxed in the beneficiary’s tax return at whatever their marginal tax rate is.  Be cautious about distributing to children under the age of 18.  Tax rates on minors are much higher than the tax rates of a grown up to discourage parents from putting investments into their children’s names.

If a trust is running at a loss you cannot distribute the loss.  It will stay in the trust to be offset against future gains.

ABN’s and Trading Names

My final point in this simple explanation (which probably doesn’t seem so simple now that I have written it) is about the logistics of trading through a Trust.

The legal name of the Trust is the Trustee’s name, as Trustee for (which is abbreviated to ATF), the Trust name.  As an example, my trust is Jigsaw Accounting & Taxation Services Pty Ltd ATF Jigsaw Family Trust. Yes, it can be a tongue twister and it is not something you want to write 100 times a day.

While you will open your bank account with this name, you are entitled to use the Trustee name as your business name or trading name.   In my example, I trade under Jigsaw Accounting & Taxation Services Pty Ltd.

Your Trust will have its own Australian Business Number (ABN) if it is running a business, and its own Tax File Number.  When your supplier looks up your ABN it will refer to the Trust name, not the Trustee name.  Trusts are common structures and you are not trying to hide anything or do anything dodgy by using a Trust as your business entity.

Hopefully this has shed some light on something that is very complicated.  As I mentioned, there is a whole lot more information available and I could talk about Trusts for hours, but a simple understand is better than no understanding at all.  If you have questions, please speak to your accountant or lawyer.