Family Trusts - How to use for Asset Protection!

We have been discussing with a client recently about how to use their Family Trust for Asset Protection. There are some very important issues to be considered in relation to the use of Trusts in this area.

A Trust is started by someone “settling” an amount on the Trust. This amount can be any amount the settlor likes, but in practice it tends to be a notional amount (ie $10 – $100) that is settled on the trust by a family friend or professional advisor.

Under Section 102 of the Income Tax Assessment Act 1936 the settlor is not able to benefit under the trust, otherwise the Commissioner can assess the trustee of the trust on the income earnt during the year at the applicable tax rate that the settlor would incur in his own hands. The reason for this is to stop people effectively setting up a “revocable trust” where they divert income from property they settle on the trust (including cash), to other beneficiaries while still retaining the ability to call the capital back to themselves at a later date.

Consequently, if someone wants to settle a significant amount on a trust (so it is no longer seen as one of their assets and so is not exposed in bankruptcy or legal actions against them), they will need to understand that they have lost control of that asset from that point on and they can’t benefit from the trust by way of income distribution or receiving the assets back at the termination of the trust. This is an important consideration. What is most important to you – asset protection or future control over those assets?

What normally happens in practice, if there are no worries about the asset being exposed to bankruptcy or legal action risks, is that the asset holder will set up the trust with a family friend or professional advisor settling a notional amount on the trust. Then the asset holder will lend the significant funds to the trust to invest and derive income from, which is then distributed amongst the family group (including to him or herself). By loaning the funds to the trust it remains their asset so is exposed to the risks mentioned above.

So what could be done if you wanted to have your cake and eat it to? That is, to be able to benefit from the trust through income distribution each year and access to capital at the end of the trust, but still have asset protection on those assets.

Section 102 only applies when a person has created a trust by originally settling the property on the trustee. From a legal viewpoint a later gift or contribution should not fall within the definition of ‘creating a trust’ as the trust is already in existence. To back this view up it is important that the trust deed is worded in a way to support this. It should be clear that, where the trust deed excludes the original settlor from benefiting from the trust (as most trust deeds tend to), the clause in the deed does not go further and exclude later settlors from benefiting from the trust. This can extend to the situation where you forgive a loan to a trust thus gifting the amount to the trust.

We are not lawyers, but this area is an important part of your asset protection and structuring planning so we always take this into account when reviewing your affairs and involve lawyers if need be. In amongst all of this is also the consideration of ensuring any asset protection (including gifting property to a trust) is not done with the specific intention of defeating creditors, in which case it could be clawed back into your assets pool at any time.

If you want to use your family trust to protect your assets it is important that all of the above is taken into account and you work out what the most important priority is to you – asset protection or control over, and access to the assets? Further to this, any attempt to protect your assets as discussed above will need to be done with a proper consideration of what your trust deed says, to ensure it is worded correctly to support what you are trying to do.

As always, thank you very much for your time in reading our blog and please contact us if you need any guidance regarding any of the matters noted above.

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