Our articled clerk, David Natenzon is pleased to present our very first newsletter of 2006.

Resettlement of Trusts - beware of the beast

Trusts are an extremely useful tool for both succession planning and wealth protection.

A discretionary or family trust, in particular, is one of the most widely used small business structures in Australia. This type of trust has an 80 year lifespan. Discretionary trusts can be utilised to benefit family members in a number of ways. Properly structured discretionary trusts provide an inherently flexible mechanism both for spreading the tax burden among family members and also for protecting family assets.

Families who hold capital growth or income-generating assets can derive a number of benefits from the successful implementation of a discretionary family trust.  Examples of such benefits include: 

• the ability to apportion income to family members who are on low tax rates
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• their relative ease and low-cost to implement
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• the ability to "stream" income: a particular type of income can be distributed to one person and another type of income can be distributed to another person
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• the ability to provide a significant measure of protection from insolvency and bankruptcy.

However occasionally, people may wish to alter the trust deed for a myriad of reasons.  For example, they may wish to add or remove beneficiaries or to change their entitlements. Unfortunately however, many are dangerously unaware of the severe potential tax consequences of such alterations.  For some, the capital gains tax liability that they may be slapped with in such circumstances will be nothing short of devastating.

Resettlement is where, for income tax purposes, the ATO deems that one trust is ended and another has replaced it.  This is also sometimes referred to as a "freshening up" of trust asset.

So what exactly do these devastating consequences entail?

In the event that it is deemed that a new trust has been created, the Capital Gains Tax and Stamp Duty implications can be very onerous. This is because when a resettlement occurs, the assets held in the original trust are considered to be transferred into the new trust. Depending on the assets held within the trust this can result in enormous capital gains tax liabilities.

Additionally, if a new trust in deemed to have come into existence, any carried forward tax benefits will also be lost. Such benefits will be unable to be claimed because in the view of the ATO the original trust will be deemed to have ended.

There are a multitude of ways for the unwary to get themselves into trouble and unwittingly create what will be deemed to be a "new trust." Inter alia, they include the following:

Changing the Trust terms

Changing the trust terms in a way that alters the relationship between the Trustee and the beneficiaries in respect of entitlements from trust property will, in the eyes of the ATO, amount to the deeming of a new trust. This is particularly important to keep in mind where family trusts are concerned. As family trusts fall into the category of what are known as discretionary trusts, any attempt to alter the trust so as to fix the entitlements of the beneficiaries from the trust would be changing the nature and character of the original trust relationship, and in the process would constitute a new trust.  

Addition or Removal of Beneficiaries
 

Lawyers would also be well advised to treat the intricacies of changes to beneficiaries with extreme caution.  The misinterpretation of fine legalistic distinctions between changing ‘a class of beneficiaries’ and changes ‘within a class of beneficiaries’ can mean the imposition of a whopping tax liability for the client.  Because the beneficiary is an essential element of the trust obligation and relationship, any changes made here could very easily trigger a resettlement by effectively terminating the original trust.

To get the ball rolling on setting up a discretionary trust and protecting your family's wealth while at the same time avoiding the many pitfalls associated with badly drafted trust deeds contact Alan Rosendorff of our office on 9011 8353.