Legal Tip 275: The Rights of Beneficiaries Under a Discretionary Trust

Discussion in 'Legal Issues' started by Terry_w, 6th Mar, 2020.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Generally, discretionary beneficiaries under a trust have only one right, and that is the right to be considered when the trustee distributes income and/or capital of the trust. This is caselaw from over 50 years ago now – the English case of Gartside.


    This is actually what gives discretionary trust their strength in Asset Protection – the beneficiaries are not entitled to any assets held by the trustee, until the trustee has made them presently entitled to those assets or income.


    Gartside v IRC [1968] AC 553


    Example

    Homer is a discretionary beneficiary of the Homer Trust. The trust deed is worded so that Homer is just one of possibly hundreds of beneficiaries. Homer becomes bankrupt.

    A trustee in bankruptcy is appointed to take over Homer’s assets. Homer is still a beneficiary of the trust and if the trustee distributes income to him this will be taken by creditors. So the trustee doesn’t distribute to Homer but gives the trust income to others. Homer’s interest in the trust is essentially worthless to his creditors.


    Compare this to that of a unit trust. Under a unit trust unit holders would generally have an entitlement to the income of the trust in proportion to the percentage of units that they owned. So if Homer owned 20% of the units in a unit trust 20% of the trust income would be distributed to him each year and if he was bankrupt this income would fall into the hands of creditors.


    Note that the wording of deeds varies and the asset protection strength can vary depending on the wording so legal advice should be sought before a trust deed is settled.

    Also, note that there are many other ways a discretionary trust can be attacked. Having a trust in the mix does not necessarily mean asset protection.
     
  2. Paul@PAS

    [email protected] Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Some apparent rights under a deed may be illusionary too. eg a fixed trust deed that allows a trustee a right to decline a request of a unitholder or do something other than what is assumed. Plenty of unit trusts give the trustee a right to consider and refuse a request to redeem for example. It may not give a unitholder any entitlement to have a redemption made at the present market value. And there may be very sound reasons not to have that right or JV partners could bail on you. All issues for sound legal advice.
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  4. Hamish Blair

    Hamish Blair Well-Known Member

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    Can a beneficiary decline / alienate themselves from a distribution? For example additional income might trigger a uni HELP repayment, cause loss of Centrelink income etc
     
  5. SatayKing

    SatayKing Well-Known Member

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    Isn't there an assumption the beneficiary knows what the distribution will be before the Trustee decides the level, if any, to be allocated?

    At one stage when I was involved the tax return for the TT and individual tax returns were done by the same accountancy firm and some juggling took place but I, as Trustee, didn't know of the tax situation of the individual beneficiaries.
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes they can.
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    In most cases beneficiaries will know about the income before they become entitled to it. But no all and there are many cases about whether a disclaimer of income was effective. Generally it will only be effective if disclaimer as soon as they know about it.
     
  8. Paul@PAS

    [email protected] Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Taxation could be imposed on the trustee as it would be impossible for a trustee to make a valid resolution to distribute and not know about to whom a distribution was made. This ineffective resolution problem could impact all beneficiaries and tax at the top marginal rate.
    Resolutions checklist

    Reference to a testamentary trust (TT) above may limit a beneficiary disclaiming income. If a beneficicary has a testamentary entitlement then it may be difficult to disclaim on the basis of not wanting to pay more tax than was desired which is different to disclaiming entitlements. However a beneficiary who didnt know they had a potential entitlement who for any reasons does not seek any trust income (or capital) may disclaim the income given. The terms of the deed may also be important for clauses relating to disclaiming or removing a beneficiary. This comes up with centrelink recipients like older parents who wish to stop any entitlement. A $1 distribution from a trust in 2019 with $1m of assets can see the pension cease as the $1m may count to assets and all the trust future income count to the income test.

    Depending on the deed, the resolutions could be better formulated prior to 30 June and greater effort to know individual incomes to avoid this problem.
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    When disclaiming I believe it has to be in full. You cannot disclaim part of a distribution - i want the dividends but not the capital gains sort of thing and you cannot receive a future distribution from the trust either.
     
  10. SatayKing

    SatayKing Well-Known Member

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    @[email protected] and @Terry_w thank you for your responses.

    Very educational and appreciate both of you taking the time to post.
     
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  11. Paul@PAS

    [email protected] Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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