Wednesday, 4 April 2012

Duels for the family jewels

Duels for the family jewels
April 4, 2012

Melda Donnelly
Prepared ... Melda Donnelly has planned to provide for her family. Photo: Domino Postiglione
Trusts are designed to protect assets but it can be a bit rich when the kids want out, writes Barbara Drury.

Family trusts are a time-honoured way for successful individuals to put a fence around their wealth and protect it from outside threats and prying eyes. But it seems that such a trust can't protect a family from itself.

In recent months some of Australia's wealthiest families have been displaying their dirty laundry in full view of the neighbours. The mining magnate, Gina Rinehart, is resisting an attempt by her children to have her removed as trustee of the multibillion dollar family trust. And the billionaire retailer, Solomon Lew, is fighting legal attempts by the estranged spouses of two of his children to get a share of the $621 million family trust.

These fights over the hereditary silver are proof that the trusts are assailable (more on that later) but that does not mean they are not a valuable wealth-management tool.

<i>Illustration: Karl Hilzinger</i>
Close to the chest … increasingly, the Family Court is considering trusts as marital property. Illustration: Karl Hilzinger

In fact, Australians with far less wealth than Rinehart or Lew are embracing them in ever greater numbers. In 2009, 660,000 trusts lodged tax returns with the Australian Tax Office, a 50 per cent increase in less than a decade.

The main advantages of family trusts (see box) are to protect family and business assets, not just during a lifetime but beyond the grave, and to reduce tax, in that order.

A family trust specialist, Bernie O'Sullivan of Bernie O'Sullivan Lawyers, says many of his clients are professionals who set up family trusts to protect themselves from future litigation.

''In the event they are sued, money transferred into a family trust no longer belongs to them. Rather, it belongs to the trust so it is out of reach of potential creditors,'' he says.

But let's not forget the tax benefits.

One of the key ones is that the trustee can distribute income earned on assets inside the trust to other family members, taking full advantage of each member's tax status and $6000 tax-free threshold.

Capital gains generated by the trust are distributed to the beneficiaries as income. This might be from the sale of assets or distributions from managed investments inside the trust.

The beneficiaries pay tax on the income and can claim the normal 50 per cent discount if the asset was held for more than 12 months.

''Provided the trust deed allows, you can stream different types of income to different beneficiaries,'' O'Sullivan says.

For instance, you can distribute capital gains to a beneficiary who can offset them against existing capital losses, distribute income to beneficiaries on low marginal tax rates, or distribute income with franking credits to the family member who can benefit most from them.

''The trustee has full discretion whether to distribute income and capital, to whom and in what proportion,'' O'Sullivan says. ''If they choose not to distribute income, it will be taxed to the trustee [inside the trust] at the top marginal tax rate.''

This is rarely ideal, O'Sullivan says, as trusts would usually be better off distributing ''excess'' income to a corporate beneficiary, which pays tax at the company rate of 30 per cent.

Another benefit of family trusts is that they allow assets to be passed from one generation to the next and capital gains tax to be deferred for up to 80 years. But this can cause problems for beneficiaries when the ''vesting'' date arrives and the trust is pregnant with unrealised capital gains.

The HLB Mann Judd Sydney tax partner, Peter Bembrick, says when the trust vests, ''all assets have to be passed on to the beneficiaries''. ''Capital gains tax is more likely to be a problem if it has been holding assets for a very long time,'' he says.

Or if the trust is sitting on billions of dollars of iron ore assets. The dispute at the heart of the Rinehart family feud is Gina's unilateral decision, as trustee, to extend the life of the family trust by more than half a century from its original vesting date late last year. Three of her four children want their share of the trust's assets now but Rinehart argues the capital gains tax bill would bankrupt them.

In practice, many family trusts with more modest fortunes wind up early and by the second generation, family members will often go their own way.

''When you have three siblings, all with their own families or divorced, they often want to take their share and go their separate ways,'' Bembrick says. ''You have to balance the costs of taking assets out of the trust structure with the benefits of each person being able to control their own affairs.''


The vexed issue of the distribution of capital gains is one reason behind the federal government's planned reform of the taxation of trust income.

Bembrick says recent court decisions, including the Bamford versus Commissioner of Taxation case that went all the way to the High Court in 2010, have highlighted gaps between ancient trust law and modern tax law, especially where the distribution of capital gains is involved.

This, plus the recommendations of the Henry Tax Review, is behind the federal government's planned reform of the taxation of trust income.

A consultation paper was circulated last November with the aim of ''better aligning the concepts of distributable and taxable income''.

While the government stresses that it was not proposing a ''crackdown'' on family trusts and that trusts are still a legitimate structure to conduct personal and business affairs, Bembrick says the uncertainty has led some people to think that family trusts are not worth the risk.

''It is vital that the reforms lead to a system that is workable and provides certainty to beneficiaries and trustees of family trusts,'' Bembrick says.

''There's a popular perception that family trusts are just a way to rort the tax system but that does not appear to be the approach Treasury is taking.

''I don't think they are in danger of disappearing.''

But tax isn't the only area where trusts have not kept up with the times.

O'Sullivan says the protection offered by family trusts from a family law perspective is not as good as it once was. He says the Family Court is increasingly willing to consider treating an individual's interest in a family trust as being part of the property of their marriage.

''In recent times there have been more cases where people get divorced and there is very little marital property. In such cases, the Family Court might be more inclined to look to the family trust, if one exists. But there are ways of structuring a trust that offer greater protection,'' he says.


Family trusts are not necessarily expensive to set up but the experts agree that you need to be well off to make the most of them.

O'Sullivan says it costs in the order of $600 to set up a family trust, plus ongoing fees associated with lodging an annual return. Additional costs kick in if you decide to have a corporate trustee. ''In total, ongoing costs can amount to $1000 a year or more,'' he says.

''Rarely would someone establish a trust for assets of only $100,000 but it's not uncommon to get started with that if it is expected to grow quickly.''

Regardless, O'Sullivan says anyone thinking of establishing a family trust, streaming income or distributing to corporate beneficiaries should always seek advice from their accountant or lawyer before doing so, as complex tax and succession-planning issues can arise.

A senior adviser at Donnelly Wealth Management, Russell Lees, normally only recommends a family trust where assets exceed $400,000.

''If a client's capital is reasonably high, we would consider a family trust and self-managed super and shuffle assets from the trust into super,'' he says.

''If a client is in their 30s or 40s, perhaps with their own business, they can't get access to money in super so they can use a family trust as an entity to hold money outside super.

''Trusts are a complicated beast. The holdings are more long-term and it doesn't dissolve at death, as super does. Even with a testamentary trust, you have to ask, 'is it worth it to direct $300,000 to a beneficiary?'''

The advantages of setting up any trust needs to be weighed up against the added cost and complexity of using the structure. You need to be satisfied that a trust will have real financial benefits for your family and not just provide a rich seam of fees for your advisers.

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