Discretionary trusts are most commonly established under a trust deed and governed by the terms of the trust deed. Therefore, careful consideration and drafting of the terms of the trust deed followed by regular reviews and amendments are required to ensure their effectiveness and to accurately reflect the current requirements of the trust.

The followings are the 5 key issues that you should consider when establishing a trust or reviewing the trust deed of a trust.

1.Control and Succession

Most discretionary trusts include an ‘Appointor' role which generally has the power to appoint and remove trustees. Unlike the trustee, the role of an Appointor is a creature of the trust deed, and once created, it can have effective control of the trust depending on the terms of the trust deed. Therefore, it is critical that the trust deed has sufficient succession provisions to deal with both voluntary and involuntary vacation of the role, in particular, in the events of death and loss of capacity of the current Appointor. Also depending on the specific terms of the role, legal personal representatives such as executors of the estate or attorneys under powers of attorneys may not be able to act on behalf of Appointors unless specifically provided for under the trust deed.

2. Definition of trust income and income streaming

The definition of ‘income' in the trust deed should be reviewed in light of High Court decision in Bamford v. FCT [2010] HCA 10 as it can have undesired tax outcomes if not properly defined. ‘Trust income' generally will not include capital gains made by the trust or franking credits under its ordinary meaning and if not defined appropriately to be equal to ‘income' under tax laws, the trustee or certain beneficiaries may be liable to pay tax without actually receiving any income. Further, the trust deed should also provide the trustee with sufficient powers to stream a particular class of income to any one or more of beneficiaries at its discretion to best utilise the character of the particular class of income (such as distributing capital gains to offset capital losses of a particular beneficiary).

3. Takers in default

Takers in default are the beneficiaries of a trust who are specified to receive the distribution from the trust in the event that the trust fund is not wholly disposed of in a particular financial year or upon vesting. Having appropriate default distributions provisions in the trust deed ensures that the trustee is not taxed at the highest marginal tax rate if for any reason, the trust fund was not fully or validly distributed to beneficiaries.

4. Vesting day

Unlike companies, discretionary trusts have a limited life span under the rule against perpetuities, where trusts generally vest in 80 years from the date of establishment. However, this depends on the governing jurisdiction of the trust and also the terms of the trust deed. A shorter than maximum allowable vesting day in the trust deed can lead to significant CGT and other tax implications if overlooked. The trust deed should therefore have a mechanism not only to extend the vesting day within the perpetuity period but also to bring it forward if the trustee wishes to wind up the trust earlier than the predetermined vesting day.

5. Variation power

Given the rapidly changing nature of tax laws applying to trusts, it is critical that the trust deed provides a sufficiently broad power of variation to the trustee to amend the terms of the trust as and when appropriate or necessary. Narrower variation powers may lead to a trust resettlement and consequent CGT implications upon the trustee exercising such powers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.