Testamentary Discretionary Trusts – Essential Clauses

All families are different and all Wills are different to meet the needs of each unique group and asset structure.

Whether you are employed or own a business, if you are retired or accumulating money in your superannuation fund, are all questions that need to be addressed in the drafting of your tailored estate plan.

Asset protection

The asset protection of a testamentary trust is very important for at risk professionals that may be subject to claims for negligence or business creditors. If you have deliberately structured ownership of your main residence in the name of  a spouse then it is a problem if they die leaving it directly to you as sole beneficiary. It may be better for the family if the asset is held in a trust to protect it from those risks. Having the choice to receive a property in your name or held on trust is a key element to a well drafted Will. In the same way, shares and control of trusts that hold significant assets, must be considered carefully. If you have created “investment” trusts and “bucket companies” to hold assets away from your trading business entity, then you need to consider how those shares or the control of those trusts are owned. Perhaps the shares should be held “on trust” so that they are not exposed to these risks.

Choice to dispense with estate trust

It is a big question whether you leave the power to dispense with an estate trust in the hands of a beneficiary or knowing their circumstances you oblige them to create a trust that protects the capital and ensures an income stream for a longer term. Consider if they may need to access part of the capital for medical or other emergencies.

Future Control of estate trusts

It is crucial to look forward and think about what pressures will be faced by your beneficiaries to access the capital and if they are in any way vulnerable to external influences. They may have a history of financial risk, alcohol or drugs, gambling and just plain spendthrifts. It may be better to require a jointly controlled trust with a sibling or independent trustee, to ensure that they are not accessing the capital in a wasteful or speculative way. You might need to consider who can control the trusts if you want the capital to flow through to the next generation as part of your bloodline. Perhaps excluding spouses from controlling a trust, is a way to prevent loss of the trust capital and ensure the grandchildren get their share.

Powers of appointment

The key to protecting assets in an estate trust is by defining who is “eligible” to be a trustee and exercise power over the trust. If a person becomes insolvent, is subject to a matrimonial dispute or suffers a disability, then a default clause should deem them ineligible and the executors or a nominated person are then appointed. This removes the control of the capital away from the affected person and protects it for that person and the other beneficiaries. That control might be restricted to lineal family members and ultimate control might vest in the grandchildren.

Class of Beneficiaries

It is a crucial element of the estate trust to define the “class” or potential individuals that can receive distributions of capital or income from the trusts. The most common way is to include all descendants of a nominated test person usually the Will makers parents, as well as any companies or trusts in which any of those people have an interest. Consider if real property is involved whether foreign beneficiaries should be excluded if there are children who are non-resident taxpayers as a beneficiary and if a separate trust must be set up for them. This is because capital gains tax exemptions will not apply to non-residents and penalty rates of land tax may be incurred.

Assets to be held and ongoing management

It is very important to think about what type of assets are going to form part of the estate and how management of those assets will need to be addressed into the future. If it is a share in a trading company that owns a business perhaps a buy/sell agreement is required, so the cash is released from the asset and no further trading risk is incurred by your successor. This can be achieved by a special purpose life policy to ensure the proceeds are deemed to be the consideration for the share sale price. If it is a passive real estate investment then it may require a common trustee where there are several beneficiaries holding that property in their respective trust.

Administrative Requirements on establishing a trust

All estate trusts are created as at the moment of death and the assets are held by the executors until such time as the estate can be distributed. Probate or proving the Will by lodging an Application in the Supreme Court is usually required. This enables the assets to be sold, transferred or collected and all tax and expenses paid. Once a net amount is realised the executor can then transfer the share of the estate to the Primary Beneficiaries as trustee of their own trust. This is as simple as opening a bank account with a bank or finance institution in the name of the trustee for the trust as named in the Will.

It is crucial to remember that once money is taken out of a trust it cannot be put back in. For example if it is used to pay for part of the purchase price of a main residence, especially if held jointly with a souse. The capital is then out of the trust and at risk. It is better to “loan” the funds by a commercial loan document, so on sale of the property the money is returned to the estate trust.

You cannot add money or assets to an estate trust, otherwise it will lose its status as a trust that can distribute “excepted trust income”, to children under 18 years. The trust can sometimes “gear” its assets, or borrow to purchase an asset, subject to the restrictions set out in the Will.

The trustee can then apply for a tax file number and open an investment account just like any individual to purchase shares, managed funds or other assets. Real property is then transferred into the name of the trustee and they can start to receive the rent and will need to pay the outgoings such as rates and utilities for the property. Each year before 30 June the trustee must sign a resolution declaring how the income and capital gains are to be distributed to the “class” of beneficiaries. This enables the person to allocate income to children in the family under 18 years of age and they take it as “excepted trust income”, which is taxed at adult rates. This can minimise the tax burden on a family group over many years and will most likely pay for the costs of setting up the trust many times over.

Vesting the Trust

It is important to remember that the estate trust once established can run for up to 80 years from the date of death of the person from whose estate it is derived. This means that a family group over many generations can create a means of investing the capital and they can all share income from the trust each year. The capital can grow and be used at important stages of their lives such as deposits for homes, cars, study and overseas travel. If the capital is reduced and the tax advantages are limited, it may be within the discretion of the trustee to wind up the trust and distribute the balance of the cash. A Will maker can restrict the access to the capital until specific age requirements are met. For example access to capital might be limited to 25% at age 25 years, 25% at 30 years and the balance 50% at age 40 years, if it is a substantial amount. This staged control, can achieve the long term goals of the willmaker to ensure a secure income stream for the beneficiaries and capital protection for as long as possible. The appointment of joint trustees can assist in achieving these goals.

So you can see there are many aspects to estate trusts and thousands of ways to draft the Will to cover all family circumstances. We recommend a very detailed discussion with your financial planner and accountant to ensure the best possible outcomes and benefits for all family members. Ask us how. Go to our website www.perspectivelaw.com and click “Start My Estate Plan Now”.

Super and Family Might Not Mix!

A Super argument.

It is incredible the sheer number of self-managed super funds (SMSF) being established in Australia and the rate does not seem to be abating any time soon. I guess people feel that they can do just as well at investing their money as some fund managers. We see a very strong trend for money in super to intermingle because they are in a new relationship, are family or it is a business partner. This can be a result of a joint venture approach into a property investment or an attempt at keeping the family money together.

The problems arise when people with different financial needs and estate plans get together. All members must be individual trustees of the fund unless a company is used. All members must be Directors of a trustee company and most are shareholders as well. That means they all have to sign off on compliance documents including investment strategies and binding nominations where a member dies.

The choice of trustee can be critical as we can see from the case of  Notaras v Notaras in the Supreme Court NSW. This is an unfortunate dispute between brothers – Brinos and Basil. The two brothers were the sole trustees and only members of their SMSF. Relations between the two had broken down due to a separate property dispute in the Supreme Court, the outcome for which  was decided in favour of Basil. Not a lot of brotherly love at that point.

In December 2010, Brinos had made withdrawals of over $220,000 from the SMSF’s bank accounts. This was $57,839 more than Brinos was entitled to as a member. Subsequent to the withdrawals, the SMSF’s accountant (who was also Basil’s wife) sent a letter to Brinos, including tax returns and member statements that needed signing. Brinos returned the documents without signing them. While the judge in the case did not explicitly find that Brinos refused to sign them (partly because Brinos had not been expressly asked to do so in the letter), his Honour found that the ‘net effect…was that no further steps were taken… with a consequence that the trustees of the Fund [had] put themselves in breach of the Act’.   Basil sought an order that Brinos be removed as a trustee and replaced with a company. The company, Bazport Pty Ltd , had Basil as the sole director and shareholder. Brinos was not a happy camper.  Surprisingly, the order to remove Brinos was granted. This was an strange result in that it contemplated the trustees of the fund becoming both Basil, as well as his company Bazport. Because the judge still considered Brinos to be a member despite having only a ‘nominal interest’, the judge noted that Basil and Bazport would be seeking permission from the ATO to have the SMSF exempt from the relevant requirements of the Superannuation Industry (Supervision) Act. That is, an exemption would be sought from the requirement that each member be a trustee or a director of the corporate trustee.(thereby excluding Brinos)  The eventual result of Basil’s request to the ATO will probably not be made public. What is quite certain, however, is that the exercise of resolving the dispute via the Supreme Court was likely to have been time-consuming and very costly.

The case shows that clients must consider very carefully before establishing an SMSF and pooling  investments with a family member, especially where there are shared business interests. There are other relationships which may represent a higher degree of risk that a dispute will arise. These include: parent–child SMSFs, SMSFs with in-laws and SMSFs shared between business associates. What about making decisions? Does it have to be unanimous?  Following on from the issues raised by Notaras  the topic of trustee decision making is intriguing.  Remember that Self managed super funds are private trusts and as such disputes about the control of the trustee are a matter for the relevant state court. People should be more aware, that there is a general legal principle , where joint trustees are appointed, they must act unanimously.

This principle was affirmed by Kaye J in Beath v Kousal [2010]. This means that it is almost impossible to make decisions if joint trustees cannot agree.  However, this general legal rule can be displaced by the “governing rules” of the fund (usually attached to the trust deed) where they provide that decisions can be made in some other manner. One example is, the rules might state that where there are deadlocks between trustees in making their  decisions,  can be resolved on the basis that votes by each trustee, are weighted according to their account balance as a member of the fund. If you read the Deed carefully in many cases this provision does not exist and the deadlock will remain. A really important question to ask in the case of SMSFs where trustees cannot agree is: Can the trustee be removed, other than by a court?   In order to avoid a costly court process and likely time delays, a properly drafted trust deed and associated governing rules can provide for a procedure by which a trustee can be removed, and a new one appointed. An appropriate process may be that the member or members who have greater than half the total account balance are able to appoint a new trustee and remove an existing one. Not all governing rules are the same, and many will not provide for this as a solution.

It is very interesting that the case of  Notaras, did not contain any discussion about the trust deed or governing rules of the rights of Basil and Brinos’ as trustees and members of a shared SMSF. It appears that under the governing rules of Basil’s SMSF, he did not have adequate power to remove Brinos, despite Basil clearly being the member with the majority account balance.   In addition, the governing rules also determine whether the power to hire and fire a trustee (i.e., the appointor power) comes with extra duties or “fiduciary” obligations attached, such as the obligation to exercise the power in good faith (see for example Berger v Lysteron Pty Ltd [2012]). Unless the rules specifically provide that the power does not have to be exercised in good faith, the decision to remove and appoint a trustee will always be subject to attack on grounds that one party was not treated fairly. So a smart thing to do is review carefully the words in the trust deed and rules. You should ensure it will protect the interests of the members with the majority of benefits, by the governing rules stating that the power to appoint a new trustee, can be exercised without associated fiduciary duties (these duties would be similar to those of a trustee). Very few governing rules will provide for this so it is a very important process to check what they state.

What about forcibly removing a member? A trustee who cannot agree with fellow trustees is most likely to be a member of the SMSF, although it is possible they are not. One person on their own cannot act as a sole trustee (which is different from a family discretionary trust) Super funds require at least two individuals or a company to act as trustee. What happens if an individual trustee refuses to  reply to correspondence and generally refuses to participate in the management of the fund? Investments may be affected if no action is taken. Contracts might not be signed and opportunities lost. The question then arises, is it possible to forcibly remove by law the offending person as a member? The governing rules usually provide for a mechanism to remove a member. However, the bigger hurdles are the requirements under the regulations, where in broad terms, prior consent of the member to be removed, is required. Of course, this may be impossible to obtain where there is a dispute between them as is generally the case.

A strategy for SMSFs to consider to overcome this potential impasse is for the member with the larger account balance to obtain a signed consent up-front from the other member (in their capacity as both trustee and member) that, upon the occurrence of certain events (for example, disagreement about a material SMSF decision, relationship breakdown or legal dispute), the trustee can remove the other member from the fund and transfer their benefit to another complying superannuation fund.   Another option for a person ‘stuck’ in an SMSF with a trustee/member who will not cooperate is to remove their member benefits and account balance from that fund (and roll over funds into a new SMSF). However, legally and sometimes practically, this itself may require the consent of the other trustees (for example, authority to deal with the bank).

Some suggestions and conclusions.  The problem of a difficult trustee can prove extremely expensive and hard to resolve due to the law of trusts, as well as laws protecting the interest of members of superannuation funds. This can be made even more difficult by documents that do not confer strategic powers. In conclusion, a wise approach is to consider carefully who to share investments with by membership in a SMSF. Once you are together as members and trustees, you are bound by law to act according to the law and the trust deed. This includes situations where you have a very large difference elsewhere such as divorce from a spouse, a fight over an estate or an argument in relation to management of a business. The clear message from these cases is make sure the trust deed covers the possibility that a dispute might arise and has a means of breaking any deadlock. Further, strategically drafted trust deeds and governing rules, as well as good initial planning, can assist in curing problems, or more preferably, prevent them. As a final note, for those who are already members of a SMSF, it worthwhile getting the structure and terms of the trust deed reviewed and considering whether the current structure is prone to problems. It is never too late to agree on a change before a problem arises.