The family trust or the discretionary trust is a great vehicle for the first generation who set it up. It provides tax planning and asset protection advantages. Those advantages arise largely from the fact that nobody “owns” a share or interest in the trust. However, those very advantages can create serious succession planning problems.
The following are typical problems that can arise in a transfer of a family trust from one generation to another:
1. Mum and Dad believe that they have treated their three adult children equally by appointing them jointly as Guardians and Appointors of the family trust after the parents’ deaths. However, two children “gang up” on the third (a Collingwood supporter) and distribute all of the income and capital of the trust to their own benefit to the exclusion of the third by using their majority control in the corporate trustee. Just because one child has a one-third share in the corporate trustee does not mean that that child is entitled to be a director and even if the child was a director, he or she could be out voted.
2. Mum and Dad appoint their son and daughter jointly to be Guardians and Appointors. The daughter dies a few years after Mum and Dad leaving her brother as the sole Guardian and Appointor. The brother, who has just lost big time on a blue chip investment in a Nigerian oil project, uses his power to apply the income and capital of the trust for his sole benefit, to the exclusion of the children of the deceased daughter.
3. Mum and Dad do not appoint a Guardian or Appointor on their deaths and under the trust deed, the personal legal representative of the last to die of Mum and Dad becomes the Guardian and Appointor. Uncle Fred is the parents’ executor. Uncle Fred, who dislikes one of the two children, uses his position as Guardian and Appointor to distribute the income and capital of the trust to the favourite child and to Uncle Fred’s wife who, Uncle Fred, is pleasantly surprised to find, comes within the broad definition of general beneficiaries.
The usual method of passing control of a family trust to the succeeding generation includes appointing them as Guardians and Appointors of the trust. However, this in itself can be insufficient as it is often necessary to also amend the trust deed to ensure, for example, the equal distribution of capital and income between the children, unless all of the persons who are Guardians and Appointors agree otherwise.
Because of the potential Capital Gains Tax and Stamp Duty problems, it is important to consider whether an amendment to a trust deed amounts to a resettlement. The Commissioner of Taxation has issued a Statement of Principles indicating the changes to trust deeds that, in his view, amount to resettlements. This Statement of Principles is, in some significant aspects, an attempt to recast the law in favour of the Commissioner. In the most recent case on resettlement of trusts (Clarke v Commissioner of Taxation), the full Federal Court found in favour of the taxpayer and against the Commissioner’s argument for a potentially broader concept of resettlement.
The one method of achieving equality within the succeeding generation that is often overlooked in relation to family trusts is that of structuring the corporate trustee in a manner to give effect to this. The constitution could be amended to provide, for example, the following:-
1. the right of each shareholder to nominate a director;
2. that important decisions can only be made by the unanimous vote of the directors, such as decisions in respect of income and capital distributions, amendments to the trust deed and changes in the nature of the business or undertaking of the trust.
After a lifetime’s work, many people have millions of dollars’ worth of assets in family trusts. It would be a tragedy if, after their deaths, those assets did not go to the beneficiaries they thought that they were leaving them to.