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Report: Family Businesses in Australia

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Report: Family Businesses in Australia Chapter 6 The role of family trusts 6.1 Family trusts are considered important for the operation of many family businesses. Used properly, trusts enable family businesses to use available resources strategically and optimally. However, the committee heard that the existing legislative frameworks across the Commonwealth, States and territories pose challenges for family businesses trading through a trust structure. 6.2 This chapter considers the following three challenges to the effective use of a family trust structure. • First, some have argued that the rule against perpetuities in State and Territory legislation undermines business longevity. • Second, concerns were raised with the effect of taxation requirements under Division 7A of the Income Tax Assessment Act 1936 (the 1936 Act), Division 6 of the 1936 Act, and the capital gains tax provisions. • Third, some submitters criticised the inclusion of family trusts in the pool of assets available for distribution as part of a family law property settlement. Trading trusts — overview 6.3 To understand these challenges, it is important firstly to understand the role that family trusts play in the family business sector. The following section provides: • an overview of the trust structure, and its capacity to be used to facilitate business transactions (paragraphs 6.4–6.11); • a summary of the use of trusts by family businesses (paragraphs 6.12–6.32); and • various aspects of current Australian trust law (6.33–6.122). 6.4 The Australian Taxation Office (ATO) defines a trust as 'an obligation 1 imposed on a person or other entity to hold property for the benefit of beneficiaries'. 2 Trusts are typically established by trust deed. 6.5 Trusts are administered by trustees, which may be individuals or 3 corporations. Trustees hold legal title in the trust property and associated income. 1 Australian Taxation Office, Guide to the taxation of trusts, http://www.ato.gov.au/businesses/PrintFriendly.aspx?ms=businesses&doc=/content/00245963. htm&page=3#P44_3570 (accessed 7 December 2012). 2 Harold AJ. Ford, Robert P. Austin and Ian M. Ramsay, Ford's Principles of Corporations Law, 12th edition, LexisNexis Butterworths, Chatswood, 2005, p. 24. Page 122 However, trustees are subject to two strict fiduciary duties. First, trustees must avoid a situation where their own interest may conflict with their duties as trustee. Second, trustees must not take an unauthorised profit from the trust.4 The trustee may also be a beneficiary, provided they are not the sole beneficiary.5 Unless otherwise specified in the trust deed, trustees are personally liable to third parties including creditors.6 Trustees are appointed by, and may be removed by, an 'appointer', which is 'normally the person who has the greatest immediate interest in the affairs of the trust'.7 6.6 For beneficiaries, a trust creates an equitable interest in the trust property and associated income.8 Their interest may be discretionary or clearly defined. Discretionary trusts do not provide beneficiaries definite rights to the income or capital generated by the trust. Their entitlements depend on the trustee electing to distribute income or capital.9 This contrasts with 'fixed trusts' in which beneficiaries' entitlements to property and/or income is established, in writing, as part of the trust deed. Accordingly, fixed trusts do not provide the trustee discretion to determine the beneficiaries' entitlements.10 While nominally entitled to the income generated by the trust property, beneficiaries may also be 'personally liable to the trustee to the extent of their interest in the trust'. Accordingly, it has been argued that where trust assets are 3 Australian Taxation Office, Guide to the taxation of trusts, http://www.ato.gov.au/businesses/PrintFriendly.aspx?ms=businesses&doc=/content/00245963. htm&page=3#P44_3570 (accessed 7 December 2012). 4 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 4th edition, Lawbook Co, Pyrmont, 2007, p. 570. 5 Harold AJ. Ford, Robert P. Austin and Ian M. Ramsay, Ford's Principles of Corporations Law, 12th edition, LexisNexis Butterworths, Chatswood, 2005, p. 24. 6 The Hon Justice Paul Brereton, A trustee's lot is not happy one: Address to the National Family Law Conference, 19 October 2010, p. 1, http://www.lawlink.nsw.gov.au/lawlink/Supreme_Court/ll_sc.nsf/vwFiles/brereton191010.pdf/ $file/brereton191010.pdf (accessed 7 December 2012). 7 The Hon Justice Peter Nygh and Andrew Cotter-Moroz, 'The Law of trusts in the Family Court', Australian Journal of Family Law, 1992, vol.6, pp 4 and 5, as cited in The Hon Justice Paul Brereton, A trustee's lot is not happy one: Address to the National family law conference, 19 October 2010, p. 2, http://www.lawlink.nsw.gov.au/lawlink/Supreme_Court/ll_sc.nsf/vwFiles/brereton191010.pdf/ $file/brereton191010.pdf (accessed 7 December 2012). 8 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, p. 49. 9 Australian Taxation Office, Guide to the taxation of trusts, http://www.ato.gov.au/businesses/PrintFriendly.aspx?ms=businesses&doc=/content/00245963. htm&page=3#P44_3570 (accessed 6 December 2012). 10 Australian Taxation Office, Guide to the taxation of trusts, http://www.ato.gov.au/businesses/PrintFriendly.aspx?ms=businesses&doc=/content/00245963. htm&page=3#P44_3570 (accessed 6 December 2012). Page 123 insufficient to repay creditors, beneficiaries may be personally liable to address any shortfall.11 6.7 Figure 6.1 shows the basic relationship between a trustee and beneficiaries. Figure 6.1: The trust structure Trustee Appointer - Holds legal title in the property (appoints the trustee) - Obligated to administer property for the benefit of the beneficiaries Property Beneficiaries - Hold equitable interest in the property - May receive payments from the trust (Terms differ between fixed and discretionary trusts) The use of trusts to facilitate commercial transactions 6.8 Historically, trusts were used for private arrangements. Their origins lie in medieval English property and succession law. Trusts, or 'uses', were primarily used for estate planning purposes to transfer property to heirs and descendants.12 However, Trusts were also used to 'circumvent the payment of [feudal] dues'.13 There was a decline in the use of trusts following the introduction of legislation in 1535 which sought to disrupt the effect of the trust by recognising beneficiaries as the property 11 Philip Lipton and Abe Herzberg, Understanding Company Law, 12th edition, Lawbook Co, Pyrmont, 2004, p. 43. 12 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, pp 432–433. 13 Treasury, Consultation paper: Modernising the taxation of trust income—options for reform, November 2011, p. 4. Page 124 owners for the purposes of levying duties. This legislation prompted the further development of the trust structure.14 6.9 The 20th century witnessed a marked expansion in the use of trusts. Trusts 'expanded from being principally a landholding device to instruments of commercial activity'.15 Accordingly, as academic commentators have noted: companies, partnerships and unincorporated non-profit associations do not represent all the structures available for collective action towards a common goal. A commercial enterprise requiring contributions of capital from a number of contributors can be organised as a trust.16 6.10 Trusts have retained their traditional role in estate and succession planning, while expanding into other commercial settings. They are, for example, used as investment vehicles (typically known as 'unit trusts'), for charitable purposes, and to prioritise payments to certain creditors.17 Trusts established for trading purposes, also known as 'trading trusts', hold property for the purpose of conducting business. Trading trusts typically consist of a limited liability corporate trustee holding the business on a discretionary trust for beneficiaries or in a fixed trust for unit holders.18 Ultimately, businesses that operate through a trust structure will be subject to trust law requirements. 6.11 The legal implications for businesses operating through a trust structure differ to those that operate as a corporation. Unlike a company, a trust is not a legal entity –– this means that the trust cannot sue or be sued.19 Trustees therefore may be personally liable for debts incurred in administering the trust. Beneficiaries, unlike members of a company, have no power to direct the trustee on the administration of the trust unless this power is specified in the trust deed. Trustees of a trust, unlike directors of a 20 corporation, cannot personally guarantee a trust liability. 14 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, p. 434. 15 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, p. 434. 16 Harold AJ. Ford, Robert P. Austin and Ian M. Ramsay, Ford's Principles of Corporations Law, 12th edition, LexisNexis Butterworths, Chatswood, 2005, p. 20. 17 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, pp 434–435. 18 Gino E. Dal Pont and Donald RC. Chalmers, Equity and Trusts in Australia, 2007, p. 435. 19 Australian Taxation Office, Guide to the taxation of trusts, http://www.ato.gov.au/businesses/PrintFriendly.aspx?ms=businesses&doc=/content/00245963. htm&page=3#P44_3570 (accessed 7 December 2012). 20 Harold AJ. Ford, Robert P. Austin and Ian M. Ramsay, Ford's Principles of Corporations Law, 12th edition, LexisNexis Butterworths, Chatswood, 2005, pp 23–24. Page 125 Family trusts in Australia 6.12 Estimates vary as to the number of family businesses that operate through a trust structure. MGI Australasia found in its 2010 Australian Family and Private Sector Survey that only 12.2 per cent of family businesses operate as family trusts. The vast majority, 80 per cent, are structured as private companies; 5.1 per cent trade as partnerships; and the remaining 1.2 per cent operate as public companies.21 6.13 Treasury officials estimated that of the 700,000 discretionary trusts operating in Australia in 2009–10, approximately 225,000 were family trusts.
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