One of the best ways to protect your assets is through a family trust. However, trusts are not a magical cure-all for every situation.

What is a trust?

A trust is a device that holds property for the benefit of someone else. The trustee of a trust manages the device. The trustee can be an individual or a company. For example, a business may earn income which is paid into a trust account in accordance with a trust deed, and is distributed by the trustee to certain people or entities in accordance with the trust deed.

Trusts have been around since the time of the Crusades, when lords and knights wanted to keep their castles out of the hands of the taxman or crooked relatives while they were away fighting.

Trusts, tax benefits and the family farm

One way of protecting the family farm is through a family trust – in legal language an inter vivos (literally "between the living") discretionary trust. It not only protects family assets, but can also divide farm income to minimise tax.

A trust "owns" your family assets such as the farm, investments, home, shares or business. The trustees, usually farmer mum and dad, manage the trust. The income the trust earns each year can be divided among family members, who are the beneficiaries of the trust.

Different tax rates apply to different people depending on their circumstances. The trust can be used to give income to family members in lower tax brackets, such as a student or farm worker. They pay income tax on that lesser income, instead of the farmer paying tax on the total income at higher rates.

Use of trusts for estate planning and asset protection

A family trust also protects the family farm if hard times hit and you go bankrupt. Where business income is paid directly into a trust account, and then distributed to beneficiaries, the business assets are owned by the trust, not the individuals.

Therefore, if the individuals running the business ever face financial problems, the business assets are protected by the trust. This means that the asset owned by the trust cannot be sold in order to satisfy the debts of the individuals.

Trusts can be used to deliver income during one's lifetime. The vesting date of the trust can then be set to a certain date. This can be effective where a beneficiary is bankrupt. The reason for this is that a beneficiary of a will who is bankrupt is unlikely to receive any distribution under the will, on the basis that the funds will vest in the trustee in bankruptcy.

However, if that person is a beneficiary of a family trust, he or she could still receive income in the form of distributions from the trust and the trustee in bankruptcy would not have access to those funds.

Reasons to tread carefully with trusts

Trusts and Family Provision Act claims

Where a family trust leaves an eligible person without sufficient provision in a will, the executors of the estate may be faced with lengthy legal proceedings. The family trust may even be considered to be a "notional estate" for the purposes of a family provision claim.

The concept of a notional estate hinges on a broader view of the assets of the deceased person than the assets which they actually owned in their own name at the time they died.

What happens with the trust in the case of a divorce?

In the case of a divorce, the court has a broad discretionary power to decide what the assets of a family are, including a trust. The court may relinquish someone's benefit under a trust, or amend the trust to suit a family situation upon separation.

Allegations of misconduct by a trustee

Perhaps the most widely publicised lesson provided to the Australian public in recent years in what can go wrong with a family trust was the bitter wrangling between Gina Rinehart and the members of her family over their family trust, where it was alleged that Mrs Rinehart had misused trust funds and/or changed the vesting date of the trust.

The result was a lengthy, acrimonious and very expensive court trial to have her replaced as trustee. It is hard to imagine that this was an ideal outcome for anyone involved in that dispute.

Getting advice from both your lawyer and your accountant about setting up a trust

It's a fact that lawyers and accountants look at trusts from different perspectives. As a lawyer, I don't give advice about the tax implications of a particular structure or transaction – that's something an accountant needs to do.

Conversely, accountants who are advising clients about setting up a trust are likely to consider only the tax implications – they are less likely to look at the legal ramifications. Factors like succession planning or what happens in the event of divorce or separation will probably not come up on an accountant's radar.

In my view, the best solution is for an accountant and lawyer to work together to set up the family trust. This approach is most likely to benefit the client in the long term.

Above all, bear in mind that courts and the taxman love trying to get hold of assets held by trusts, so it's vital that they are drafted correctly and kept up to date to comply with any changes in laws and regulations.

Anneka Frayne
Asset structuring and family trusts
Stacks Law Firm

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.