It is well known that a family trust has many benefits beyond tax. So, when a Perth business accountant discusses tax law structuring for family trusts, one of the first essential questions raised is: Who should be the trustee of my discretionary trust?
The choice of a trustee significantly impacts succession, tax efficiency, asset protection and ongoing costs.
Why is the choice of trustee important?
The trustee legally owns the trust property, but it is not necessarily the beneficial owner. The trustee plays a caretaker role on behalf of another person (or a group of people). The trustee is responsible for managing the trust fund, and as the legal owner, all transactions of the trust are conducted in the trustee’s name. The trustee is required to sign all documents on behalf of the trust in their capacity as trustee.
Since a trust is a relationship between the trustee and the beneficiaries, the trustee is responsible for the duties and obligations associated with the trust. So, the trustee is personally liable to creditors and accountable to beneficiaries.
TRUST TIP – Limiting Trustee’s Liability
A trustee can reduce their liability by only entering contracts where the assets of the trust exceed the commitment being made. Some documents, like a lease agreement, often contain clauses holding the trustee personally liable, so care should be taken when signing documents.
A trustee should clarify whether they are acting as the trustee or in a personal capacity and consider clauses in contracts to limit their personal liability.
Alternatively, the trustee should add the words “as trustee only, not otherwise” after their signature. While these steps are recommended, they may not offer complete protection for the trustee.
The trustee’s primary duty is to follow the trust deed. Typical legal obligations are:
- Trustees must execute the terms of the trust
- Trustees must act in good faith
- Trustees must safeguard the trust assets
- Trustees must exercise reasonable care in administering the trust
- Trustees must maintain accurate records and accounts
Many trustees will use cloud accounting program to help them with the last obligation.
EXAMPLE – Trustee Complies with Duties
Tom is the trustee of the Smith Discretionary Trust. The trust beneficiaries are Tim, Tam, Tony, and Tyron.
On 29 June, Tom decides to distribute the income of the Smith Discretionary Trust. Suppose Tom considers the interests of all four beneficiaries and the deed. In that case, he will not breach his obligations by distributing all the income to only Tam using his discretionary power.
TRUST WARNING – Trustee Must Act in Beneficiaries’ Best Interests
Unless explicitly permitted by the trust deed, Tom, as trustee, cannot exercise his powers for personal gain. However, many modern deeds allow a trustee to also be a beneficiary and to act even when they have a personal interest in the outcome. A family trust election properly drafted can even nominate the trustee to become the test individual, for tax purposes, of the discretionary trust. However, the trustee must still act in good faith and in the interests of the beneficiaries.
In addition to fulfilling their duties, trustees may also exercise certain powers granted by the trust deed. These powers often include the ability to acquire and dispose of assets, mortgage assets, and undertake borrowings.
The choice of a company as the trustee of your family discretionary trust will not impact your ability to enjoy the 50% capital gains tax discount.
Why should you consider a company trustee?
The humble family trust will often act as an investment centrepiece for many private CFO’s running the family investments. Most tax accountants in Perth will recommend a corporate trustee of a family discretionary trust for four main reasons:
Death of a Sole Trustee
When a sole individual trustee passes away, all trust assets are automatically vested with the Public Trustee. However, the deceased’s executor or another person can notify the Public Trustee in writing of their intention to take over as trustee. This individual must then ensure they are correctly appointed as the new trustee as provided for in the trust deed. They can then transfer trust assets to the new trustee – which can be time consuming and cumbersome.
A company remains as a trustee, even if the directors are deceased. A new director can be quickly appointed following the death of the previous directors, allowing the company to continue managing the trust without interruption.
This helps beneficiaries who depend on trust distributions of income or capital, as it significantly minimises delays in trust management and the distribution process.
If a trust generates and the trustee dies, the delay in appointing a new trustee after death and before year-end will often mean that the trust has not allocated its income and capital for the year. So, that income and capital are then taxed at the highest tax rate.
Incapacity of a Trustee
Significant challenges arise if an individual trustee can’t do their job. The trust deed might automatically remove a trustee loses capacity. However, many trust deeds do not include provisions for automatic removal.
In contrast, when a corporate trustee is appointed, the company remains the trustee if a director loses capacity. In such situations, the law and often the company’s constitution allow the shareholders to appoint a new director. If the incapacitated person is both the sole director and shareholder, their executor can appoint a new director.
It is sometimes better to have a different company shareholder to the director depending on the family.
The steps required to replace a director of a corporate trustee are easier compared to transferring the trustee through the deed. The company continues to serve as trustee, and the trust’s assets remain in the company’s name. In contrast, when an individual sole trustee becomes incapacitated, all trust assets must be transferred to the new trustee, which can be costly and time-consuming, particularly if the trust holds real property.
Protection of Personal Assets
Individual trustees are liable for any trust debts or trust liabilities. If the trust cannot cover these liabilities, the individual trustee must cover the shortfall. This responsibility can continue even after the individual retires as trustee, unless a new trustee is appointed who agrees to assume the trust’s liabilities.
A company limits liability of the trustee to the company itself. The company assets are often notional ($10 etc). The company offers protection through the corporate veil. Why not fool proof, it can reduce the personal exposure of a director.
Bankruptcy
Appointing a corporate trustee can offer significant protection for trust assets in the event of a director’s bankruptcy.
Recent legal cases have shown that if an individual trustee becomes bankrupt, their assets, including any interest in the trust assets, may be available to creditors. In contrast, corporate trustees do not typically receive personal benefits from the trust, so if a corporate trustee’s director becomes bankrupt, the trust assets remain protected.
Additionally, it can be challenging for individual trustees to clearly separate assets held on trust from those held personally. This confusion can result in trust assets being exposed during the trustee’s bankruptcy. A corporate trustee means all assets held by the company are held on behalf of the trust. This gives a clear separation if the director becomes bankrupt.
Conclusion
The tax law structuring of a family trust can be as diverse and as varied as families themselves are. So, getting strategy advice from a trusted advice firm is essential when starting the process. This is where Westcourt is a natural choice – we are entirely independent, focused only on tax strategy for business families, award-winning for our technical depth, and we have a deep international network of over 29,000 advisors – so why not give us a call?
