A simple definition of a trust is: “A relationship in which one person (the trustee) holds assets (money, property, a business) for the benefit of another (the beneficiary).”
Other parties in a trust structure include a “settlor” who contributes the initial trust asset (which may be anything, including a nominal $10 cash or even a house) to bring the trust into existence, and an “appointor” who generally has rights to appoint, replace and remove trustees.
OK, that’s great but why would you set up a trust ?
Most importantly, trusts are an excellent structure for protecting assets. Property and assets can be moved into a trust for protection from creditors or to isolate the more valuable assets used by a trading company (e.g. land & buildings) from litigation.
A trust structure can help you legally minimise tax. In simple terms, opportunities for business or investment income splitting e.g. between husband & wife to take advantage of a partners lower tax rate is a often key motivator.
Distributions and tax
A trust calculates its annual taxable income under the usual tax laws and then the trustee distributes the income to the beneficiaries. The income distributed to beneficiaries is treated as though the beneficiaries earned it directly and is taxable at their personal tax rates.
When the trustee of a discretionary trust decides how much to distribute to each beneficiary, the trustee can take into account each beneficiary’s circumstances (personal tax rate) and distribute income in the way that best serves everyone (minimises the tax payable).
Types of trust
A discretionary trust provides the trustee with a “discretion” as to how much income each beneficiary receives in any year. For tax planning purposes, most “Family Trusts” are discretionary trusts.
In a fixed trust, the share that each beneficiary has is pre-determined and “fixed”, so the trustee cannot vary the income distribution. Unit trusts are an example of a fixed trust as each unit held in the trust represents an entitlement to a certain proportion of the income.
A hybrid trust has characteristics of both fixed and discretionary trusts and can be anything that is neither totally discretionary nor totally fixed.
There are many more variations not covered here, and much more regulation and specific considerations than can be covered in this brief article. The area of trusts is a complex one, and anyone considering setting up their own trust is well advised to seek expert advice, both accounting and legal.