29/10/2014

Family trusts are most often thought of as vehicles to spread the tax burden throughout the family but, with both partners working these days, more and more the family trust's main role is being seen as the guard dog of the family's assets.

A family trust differs importantly from a unit trust.  A beneficiary/unitholder in a unit trust may be readily disentitled of their interest in the trust by creditors, bankruptcy or family separation.  Even though ownership of the property in a unit trust is indirect (the beneficiary's interest in the assets of the trust are not direct but rather indirect through the units in the trust) third parties can take over that interest by taking over the units, which are the property of the relevant beneficiary/unitholder.

Likewise, any income generated from the assets held in a unit trust is calculable from the proportion of units held and is therefore vulnerable to attack from third parties.

On the other hand, in a family trust the potential beneficiaries do not "own" a specific unit entitlement.  Potential beneficiaries generally have what is called a 'mere expectancy' – the right to be considered by the trustee each year when the trustee comes to decide who among the potential beneficiaries (if any) will receive a distribution of capital or income from the trust.  

The actual entitlement available to the potential beneficiaries is subject to the discretion of the trustee.  While this discretion is not unlimited, and is subject to fiduciary duties, the discretion enhances the protection of the assets.  If the entitlement is not immediately available to the potential beneficiary, it is by extension not available to third parties like creditors or trustees-in-bankruptcy.  

Likewise if the potential beneficiary does not have right to a particular portion of the income which the trust earns the result is that it is not possible to assign an indeterminate amount of income to creditors by garnishee orders.  

So if a potential beneficiary is attacked by creditors, in many circumstances the assets and income of the family trust should not be at risk.

In recent times the courts have tried to trim back this protection particularly in the family law context.  Whether this trimming process receives full judicial approval in the future remains to be seen but at present the situation appears to be that if a potential beneficiary of a family trust effectively controls the trust then the trust may be seen as property of that person and available to third parties in certain circumstances.

It is probably better to ensure that the family trust is controlled by a group of trustees, or a company with a number of directors, and to ensure the trust can show a history of exhibiting some autonomy in its dealings thereby negating the argument that the trust is controlled by the key person and is therefore part of their assets.

For further information regarding this article, please call Townsends Business & Corporate Lawyers on (02) 8296 6222.