If you already have a discretionary trust (also called a “family trust”) or are considering establishing one, it is important that you be aware of some of the more fundamental aspects of these entities and their operation.
The comments set out below are of a general nature only and it is emphasised that they are intended to be preliminary to obtaining professional legal advice in conference regarding your particular circumstances and the possible use of a discretionary trust within those circumstances.
Understanding the structure
Although technically complex, the general principles of trust structures generally, and discretionary trusts in particular, are quite straight forward. It is important to understand from the outset just how flexible a discretionary trust can be when used in business or family affairs.
It is also important to be aware of the limitations of the structure and the impact which its introduction can have on other aspects of family dealings and on your taxation and estate planning issues.
Once you have a basic understanding of the structure, you will be in a position to seek advice from your legal and accounting professionals from time to time to identify circumstances where the trust may be used to advantage or where a proposed use may require more careful consideration.
The nature of trusts generally
There are a number of forms which trusts can take. A discretionary trust is merely one adaptation of a structural concept which is centuries old and nowadays includes unit trusts, trusts established under Wills, nominees and custodians.
The various types of trust differ in sophistication, but all trusts embody a common conceptual basis – a person, (one or more individuals or a company – the trustee), agrees to be bound to hold certain assets (the trust fund) in its name for the benefit of one or more other persons (the beneficiaries) on certain terms and with certain powers.
Those terms and powers are usually set out in a document (the trust deed).
The assets which comprise the trust fund are legally owned by the trustee (and, where necessary, are registered in the trustee’s name). However the trustee is under a strict duty enforceable by a court to hold those assets (and the income arising from those assets) for the benefit of the beneficiaries.
The relationship of trustee and beneficiary is often simplified for explanatory purposes by saying that the trustee holds the “legal” title to the trust fund assets, while the beneficiary or beneficiaries hold the “beneficial” or “equitable” title to those assets. It is the beneficial or equitable title which is of value when one is considering asset ownership and which is usually relevant for taxation purposes.
The nature of a discretionary trust
A discretionary trust applies the above elements of the trust relationship in a more sophisticated manner than, say, a trust involving a mere nominee who holds assets on a fixed and inflexible trust.
A discretionary trust is usually established between an individual (called a “settlor”) and the intending trustee by both parties signing a deed (a “deed of settlement”). Three principal distinguishing features of a deed of settlement of a discretionary trust are:
- the wide number of beneficiaries who are potentially capable of receiving income and capital (assets) under the trust
- the breadth of the discretion given to the trustee as to which of those beneficiaries can receive capital and income from time to time and in what proportions or amounts
- the fact that no beneficiary has any valuable right in income or capital of the trust fund until the trustee’s discretion has been exercised in that beneficiary’s favour.