Legal Tip 273: Discretionary Trusts with Non-Family Members as beneficiaries

A discretionary trust can have beneficiaries other than members from the same family. A friend could be included as a beneficiary of the trust for a variety of reason such as wanting the friend to benefit now or wanting the ability to want to distribute to them at some point in the future potentially.

Example 1

Bart sets up the Simpson Family Trust with himself as the primary beneficiary and secondary beneficiaries including all possibly related family members. He has a good mate called Millhouse who has helped him over the years so has Millhouse named secondary beneficiary. He doesn’t tell Millhouse this, and nothing comes of it until 10 years later when Bart causes the trustee to distribute $10,000 to Millhouse.



Example 2

Bart talks his mate Krusty into doing what Bart calls a ‘joint venture’ with the ‘structure’ being a discretionary trust which Bart controls. The trust is set up so that Bart controls it and his family are the beneficiaries and Krusty is a named beneficiary as well. The trust does a development and Bart causes the trust to pay 50% of the profits to Krusty and the rest to Bart’s other family members.

This ‘structure’ is good for Bart but terrible for poor old Krusty because he is merely a discretionary object of a trust and has no right to any income or capital. Bart is in full control and if the trust paid nothing to Krusty there would be not much Krusty could do about it.

Krusty would also have major issues if Bart suddenly dropped dead or lost capacity.


Note there are some tax issues to consider if a Family Trust Election is Required.

 

There is also another way. A class discretionary trust. It contains fixed and non-fixed elements. That fixed element is often very important eg It may address the Krusty problem.

eg Stuart and Stephanie and close friends who look to buy a successful pizza franchise. They expect to split profit 50/50 but also want the flexibility of disc trusts to involve their adult uni kids and spouses. A class disc trust could be a option.

It comprises a trust that gives each CLASS (ie Stuart is one, Stephanie is another) a fixed share of trust income. So Stuarts family gets 50% and so does Stephanie's but they can then each as Trustee Directors meet and resolve how their respective shares are ultimately distributed.

An alternative to the CDT is to have a unit trust with a trustee company + 2 x Disc trusts with 2 trustee companies. This largely replicates that same structure at a far higher cost upfront and ongoing but it does have some differences. And changes to a Class Disc Trust may trigger a trust resettlement if they were to later bring in a third "partner" as a new class. However a company rollover may be effective at that time.

 

Where is the line in the sand when it comes to anti avoidance?
A DT without an FTE and distributing to low income friends or their spouses, who in turn "gift" the money to one of the DT's beneficiaries and they in turn gift it back to the DT or use it themselves. Surely this is a big no no.

 

Failing to have a FTE if one is required would be pretty silly but if its not required that doesnt mean a trust can distribute to anyone it wants. A DT cant distribute to friends or their spouses or the neighbour. The deed will likely limit the potential beneficiaries to a class of persons based on primary beneficiaries named in the schedule and clauses which expand that. A defective trust distribution to a friend would mean the trustee is ALSO assessed at the top marginal tax rate. It is also assessable to the friend. And the regift could also be considered income if the ATO found that trail. Its undocumented so how can one prove it was a gift ?

One of the problems we also see is the DIY trustee who decides to distribute to a older non-working parent for just $416 income. And then the Centrelink problem is evident as they consider all the trust income and all the trust assets count for income and assets tests with a deeming rate applied. Costly legal issues to exclude beneficiaries and backdating things make a problem worse.

 

This is not always the case, the Control and Source test are the key. As soon as Centerlink sees trust income they'll want to see a lot more information and if the parent(s) fail the above tests then some or all of the trust income and assets can be attributed to them.

I've seen a few people go through this, parents are not named beneficiaries and don't act in a capacity of a Trustee, Director of Corporate Trustee or more importantly the Appointer. They do get distributions from trust income and are still eligible for part pension. Centrelink only took the distributed income and not attributed income or assets for purpose of aged pension.

Agree with Paul, If not documented properly this could be quite disastrous but in genuine scenarios the requirements in paperwork to prove otherwise are not that onerous. Professional advice is highly recommended of course.

 

see s 1207 Social Security Act onwards. complex stuff.

 

If someone other than the beneficiary benefits s100A could cause some issues.
You would generally not want a testamentary trusts to receive gifts, other than from the deceased estates, as the income generated from gifts won't qualify as excepted trust income - it will also be difficult to keep track of.

Also like Paul said it is unlikely friends will be beneficiaries unless they were specifically incorporated as beneficiaries. There are legal issues with amending testamentary trusts.

 

Thanks Terry and Paul. Much appreciated.