WHAT IS A TRUST?
A Trust is a separate legal entity which has a life of its own. A Trust has three participants:
The Settlor: The person who initially transfers property into a trust in order to create the Trust.
The Trustees: The Trustees of a trust hold the property of the Trust and are responsible for dealing with that property in accordance with the Trust Deed. It does not matter legally who the Trustees are, so long as they have the legal capacity to act as Trustees.
It is usual however for the Trustees to be the persons who set up the Trust together with an independent third party such as a solicitor, accountant or close family member.
The Beneficiaries: These are the people who are entitled to receive a benefit under the Trust. The beneficiaries normally comprise the husband and wife, children and their descendants. Depending on circumstances, other family members or relatives may also be included.
A trust is created by a document called a Trust Deed.
The Trust Deed: The Deed identifies the Settlor, Trustees and Beneficiaries, sets out the powers of the Trustees and provides rules for the Trust.
A Trust may well exist for a long period of time and it is vital that the Trust Deed is well prepared, so that it is specific in its provisions yet flexible enough to cover changing situations. Most trusts used today are called discretionary trusts.
Discretionary Trusts: This term is used to describe the Trust because although the Trust Deed nominates a number of beneficiaries, the Trustees have a discretion as to which of the named beneficiaries will receive a benefit under the Trust.
The Trustees not only have a discretion as to which of the named beneficiaries benefit, but also as to when any distributions are made from the Trust.
The maximum period that a trust usually exists for is 80 years due to a legal requirement called the Perpetuities Rule.
HOW IS PROPERTY TRANSFERRED INTO THE OWNERSHIP OF A TRUST?
The execution of a Trust Deed and the creation of a trust does not achieve anything on its own.
Transfer: To have any impact a trust has to obtain assets which it then deals with in terms of the Trust Deed. A common example of the way this occurs is where a husband and wife form a family trust and then transfer to the Trust assets such as their family home, investment property, holiday home, shares, investments or cash.
Because a trust has no assets or income when it is formed it has to acquire the assets from the person or persons who form the Trust.
Sale: This is normally done by way of a sale and purchase at the current market value. The sale and purchase is made at current market value to avoid any gift duty assessment.
It is not possible to immediately load a trust up with all of a person’s assets without that person incurring very substantial gift duty if the assets are more than $27,000.00.
The assets are usually transferred at current market value but because the Trust has no funds there is a debt left owing by the Trust to the original owners, equivalent to the sale price.
That debt is then gifted off over a period of time at a rate which avoids any gift duty assessment.
Currently every person can gift up to $27,000.00 free of gift duty in any 12 month period. In that way the individuals over time completely divest themselves of the ownership of the assets, and also the debts, which at the start directly represent the value of the assets transferred.
Gift: A husband and wife can currently gift $54,000.00 per annum jointly.
WHAT CAN SETTING UP A TRUST ACHIEVE?
Discretionary Trust: Under discretionary trusts the property is legally owned by the Trustees, but because they are Trustees for other beneficiaries, the Trust property must not provide a benefit to the Trustees in their own right.
Because the beneficiaries are discretionary beneficiaries, they do not have any rights of ownership in the Trust property prior to the final termination date, except to the extent that it may be specifically vested in them by virtue of decisions made by the Trustees.
The Trust property is, as a result, held in a state of limbo with the result that it does not form part of the estate or assets of any person.
This means that assets held by a family trust will normally be protected from a wide range of risks that an individual faces.
Limitation of Liability
Creditors: When people decide to embark on a business venture they usually allocate money towards that venture and in doing so they recognise that there is a calculated risk in that if the venture fails the money that they have put into it is at risk.
Sometimes business failures expose other assets to risk which an individual does not wish to have exposed. For example, the family home, holiday home, personal savings, investments and superannuation.
By having some or all of these assets held in a family trust they will not be lost if a business venture fails or if there is a claim against the individual due to a guarantee that an individual has entered into for bank borrowings or the personal guarantee of a lease.
The use of a Trust in these circumstances allows an individual to separate domestic or private assets (assets the individual does not want to place at risk), from business assets which an individual recognises as being part and parcel of the business venture and exposed to risk.
Asset Testing (Rest Home Subsidies)
A number of people, particularly the elderly are using trusts as a defence against asset testing. A government subsidy (Resthome Subsidy) is available to people over the age of 65 years who require long term resthome care. Eligibility for the subsidy is asset tested.
Assets held in a trust which has been set up properly are not currently taken into account when applying for a Resthome Subsidy, with one extremely important exception.
Any gifts made within five years of a subsidy application (e.g. those reducing debts owed by family trusts) can be “CLAWED BACK” into a person’s asset pool for the purposes of the asset test.
The setting up of a family trust may be too late as regards its usefulness to avoid asset testing. With annual resthome charges of approximately $30,000.00 it does not take long for assets to be dissipated.
A properly set up and well planned family trust can provide an effective protection for these assets. There is, however, a significant prospect of legislative change in this area and it is not possible to guarantee that the use of a trust is always going to provide effective protection against asset testing.
Estate Duty
Estate Duty was abolished for the estate of any person who died after 17 December 1992. Prior to that time estate duty was payable on the value of an estate valued in excess of $450,000.00. Prior to the abolition of estate duty family trusts were a common estate planning method to ensure that on death, estate duty was avoided or at least minimised.
Income Tax
In the past, marginal tax rates ranged from between 15% to 66%. The ability to split income by transferring income producing assets to a trust was extremely attractive and was a common technique for minimising tax. The incentive to use trusts in this way disappeared when the tax scale was flattened to rates between 19.5% and 33%.
Tax changes from 1 April 2000 have meant that there is a useful but not significant advantage in using trusts as an income splitting device.
Estate Planning: The use of trusts for estate planning is one of the less fashionable and often forgotten benefits of a family trust. Most people overlook the fact that when they die a trust is created. Under a Will property is left to trustees to distribute to beneficiaries named in the Will.
Use of a family trust can bring this process forward so that it occurs during a person’s lifetime rather than after their death when, for obvious reasons, they have little control over what is happening.
Use of a family trust can ensure that a person can see the orderly transfer of their wealth to the next generation during their lifetime while at the same time they can still exercise some control over the asset through the Trust.
In this way a person can avoid claims under the Family Protection Act 1955 and Matrimonial Property Act 1976. Most people will be aware that on a person’s death a disappointed family member can bring a claim under the Family Protection Act against whatever assets there are in a deceased estate.
If assets have been distributed to a beneficiary of a family trust then such claims may well be avoided or at least minimised. In a similar way a child who receives a benefit under a Will may find that a claim is made by the child’s spouse for a half share of the inheritance under the Matrimonial Property Act.
The use of a family trust can provide some protection against such claims if that is considered appropriate.
ARE THERE ANY DISADVANTAGES IN SETTING UP A TRUST?
It is important to realise that a trust is a separate legal entity. Once you transfer property to a trust it no longer belongs to you. This is the reason that it has the advantages which have already been outlined.
Because the property no longer belongs to you there are new and important considerations to take into account when dealing with the property.
Although you can be a beneficiary/trustee and thereby exercise substantial "de facto" control over the assets, you have a "fiduciary duty" to consider the requirements of all the trust beneficiaries in dealings with the trust property.
Making sure that these duties are met is essential to the Trust being able to stand up to any form of legal challenge.
Costs: There are costs involved with the creation of a family trust and the transferring of assets to it. These costs vary depending on the type and amount of assets being transferred.
We are very happy to discuss cost estimates for specific situations but generally it is important to understand that for a trust to be prepared and set up properly it needs to be done thoroughly.
WHAT IS INVOLVED IN SETTING UP A TRUST?
Advice: Anyone thinking about setting up a trust should seek professional advice. The advisors will usually be a person’s solicitor, accountant and, as appropriate, financial planner. Each of the advisors have special areas of expertise and their involvement will ensure that your objectives are met.
At Preston Russell Law we have taken care to keep up to date with current practical and legal considerations which need to be taken into account when looking at the possibility of setting up a family trust.
Because of our experience in setting up trusts for many different people in many different situations we are able to make sure all arrangements are made to suit our clients’ individual circumstances.
WHAT ARE THE ONGOING REQUIREMENTS FOR THE OPERATION OF A TRUST?
Once a trust is established it must be operated correctly otherwise the benefits can be lost.
You cannot set up a trust, transfer some property into it and then forget about it, keep no records and treat the property as if it was still your own.
Proper records must be kept about all transactions and the administration of the Trust. The trust is a separate legal entity.
The Trust may require its own IRD number and, where appropriate (depending on the level of taxable activity the Trust carries out), a GST number. Decisions made by the Trustees should be properly documented and a minute book maintained. Separate bank accounts should be established and a separate set of accounting records should be maintained for the Trust.
In most cases where the Trust is used to hold non-trading assets such as property or investments the record keeping will be simple.
Prudent Investment: All Trustees, in investing funds, must consider the provisions of the Trustee Act 1956.
An explanation of the role of Prudent Trustee can be found by clicking here.
As already stated, for those purposes advice must be sought from professional advisors, solicitor, accountant or financial planner.
Preston Russell Law is able to give professional advice in relation to all aspects of the trust administration.
IMPORTANT NOTE:
Every effort has been made to ensure the accuracy of the information in this presentation. Items have been prepared to highlight current issues. Professional advice should be sought in relation to any specific problem. Reproduction of the material is welcomed with the prior written consent of Preston Russell Law.
