What is a trust
- What is a trust
- How do you form a trust
- What are the benefits of forming a trust
- What are the disadvantages of a trust
- How do I transfer assets to a trust
- So what do I need to do next
- Where to from here
an equitable obligation, binding a person (who is called a trustee) to deal with property over which he/she has control (the trust property) … for the benefit of persons (the beneficiaries) who may enforce that obligation
A trust is a method of separating the legal ownership of assets from the beneficial enjoyment of those assets. In other words, the trustees have the legal ownership of the assets but they do not own the assets in their own right, rather they are holding those assets on trust for the benefit of the beneficiaries.
A trust is not a separate legal entity from its trustee(s). To the outside world it appears that the trustee(s) is the absolute owner of the property. For tax purposes however, a trust is recognised as a distinct identity, which is taxed separately from the settlor/ testator, trustees and beneficiaries.
. . . a trust can be created orally or by conduct. In order to create a trust in this way the person wishing to declare the trust must use language clear enough to show an intention to create a trust.
The most common way to form a trust is for a person (known as the settlor) to enter into a Deed of Trust. The Deed of Trust specifies who will be responsible for administering and managing the trust assets and funds (the trustees) and who will benefit from the trust (the beneficiaries).
Once the Deed of Trust has been executed, the settlor transfers to the trustees (usually by way of sale) the assets the settlor wishes to be held on trust. The trustees then hold those assets on the terms specified in the Deed of Trust. Trusts created by Deed are known as intervivos trusts.
A trust can also be formed under the provisions of a persons will. This is done by the testator declaring certain assets or items are to be held on trusts for the benefit of named persons or entities after the testator’s death. Trusts created by Will are known as testamentary trusts.
Finally, a trust can be created orally or by conduct. In order to create a trust in this way the person wishing to declare the trust must use language clear enough to show an intention to create a trust.
In all cases, to create a valid trust the following three elements (know as certainties) must be present. Firstly, there must be an intention by the settlor to create a trust. Secondly, there must be subject matter (i.e assets) which the settlor directs or declares are to be held on trust. And lastly, there must be objects of the trust. That is, persons, entities or charitable purposes for whose benefit the trust has been created.
a way of ensuring future generations are provided for in a managed and controlled way.
Every person who considers setting up a trust will have a different set of reasons or purposes for creating a trust. Prior to establishing a trust it is important to spend time talking with your advisor about your reasons and intentions for setting up a trust. It is important that your advisor is aware of what you would like to achieve so they can explain to you the benefits (and potential downsides) of establishing a trust.
It is important to note that in all cases, in order to maintain the benefits a trust structure can offer, the trust must be administered and managed in accordance with the terms of the Deed of Trust and the law.
Some of the more common reasons for forming a trust include:
Business or professional persons who are at risk from professional liability, have high risk occupations or are involved in speculative development may choose to hold their personal assets in a trust in order to separate those assets from their business assets.
A trust (whether an intervivos trust or testamentary trust) provides a way of ensuring future generations (e.g. children and grandchildren) are provided for in a managed and controlled way. This may be ensuring certain assets are retained within the family by having them held in trust or controlling the way in which accumulated wealth is distributed in the future.
In some cases, when a person considers that a claim may be made against their estate, they may chose to move their property into a trust during their lifetime. Property held in a trust no longer belongs to you therefore on death it does not form part of your estate.
Relationship Property Claims
When a person has been in a relationship for a period of 3 years or more and they have not entered into an agreement contracting out of the provisions of the Property (Relationships) Act 1976, their assets and income become vulnerable to a claim from their partners, should the relationship come to an end.
It is possible to protect your assets (and income from income generating assets or investments) from potential Relationship Property claims if you have taken steps to transfer your assets into a trust prior to the commencement of a relationship. If the relationship has already commenced, it may be possible to transfer assets to a trust however this would generally require both parties to enter into a Contracting Out Agreement.
It is important to understand how a trust can operate to protect your assets from potential claims and what steps need to be taken and when to ensure your assets are properly protected. As with all things, timing is important and you should not assume just because you have transferred property to a trust automatic protection prevails.
Setting up a trust for the benefit of your children may also provide them with protection from potential relationship property claims in the future. This is because the assets would be held on trust for the child rather than by the child directly.
Depending on your specific circumstances there may be some tax advantages to holding certain assets in a trust. It is always important to ensure you receive tax advice when considering entering into a trust arrangement. There are also likely to be tax ramifications associated with moving assets into a trust which need to be considered carefully before you decide to transfer them to a trust.
There can also be some advantages in making distributions of income to certain beneficiaries. Income derived by the trust can either be retained by the trustees as trustee income and tax paid on that income at 33%. Alternatively income can be distributed to chosen beneficiaries and tax paid on that distributed income (referred to as beneficiary income) at the beneficiaries marginal tax rate.
Special rules apply to the distribution of income to minor beneficiaries (persons under the age of 16). Distributions to minors are taxed at the trustee rate of 33% notwithstanding the child may have a lower marginal tax rate. However for adult beneficiaries who have a lower than 33% marginal tax rate it can, in certain circumstances be advantageous for a distribution of income to be made to that beneficiary, rather than the trustees paying tax at 33% and later distributing those funds as tax paid capital.
A Deed of Trust prepared in 1960 will differ greatly from a Deed of Trust prepared in 2013...
Lack of Control
The thing most people tend to struggle with when forming a trust is the relinquishing of control over the assets or money they subsequently transfer to the trust. Once the assets are transferred to the trust, the decisions relating to those assets and how money is invested distributed or spent falls in the hands of the trustees.
Commonly a trust will have more than one trustee of a trust, so in the majority of cases, all decisions relating to trust assets must be made by the trustees collectively. This can be a difficult adjustment for some people who are used to having control of their assets. However it is important to note that if you form a trust but continue to deal with the assets transferred to the trust as if they are still your own you will potentially defeat the purpose of the trust and run the risk of the trust structure being overturned by potential claimants.
Once you form a trust and transfer assets into the trust, those assets no longer belong to you. Even though you may hold title to them in your capacity as trustee, you are bound to deal with those assets in accordance with the provisions of the Deed of Trust and the law.
Cost is obviously an important factor to consider. There will be costs involved in the establishment of the trust including the preparation of the trust deed, transferring property to the trust and rearranging funding. There may also be some tax costs associated with the transfer (for example triggering depreciation recovery income on the transfer of depreciated property).
In addition to set up costs, there will also be ongoing annual administration costs. These include the cost of having an annual set of accounts prepared by your accountant as well as the preparation and filing of a trust tax return if the trust holds income generating assets.
In addition, it is important to ensure the trustees maintain a minute book which records their decisions as trustees. In some cases with proper guidance the trustees can maintain the minute book themselves. In other cases the trustees will engage a professional to prepare the resolutions/minutes and maintain the minute book for them.
Depending on whether or not there is a debt owing to you by the trustees for the sale or transfer of property from you to the trust (see “How do I transfer assets to a trust?”) you may also have annual costs associated with an ongoing gifting programme.
If you engage a professional trustee then there are likely to be costs associated with their time for attending to trustee’s duties and obligations.
A Deed of Trust prepared in 1960 will differ greatly from a Deed of Trust prepared in 2013 and what was drafted in 1960 to benefit future generations may no longer suit the circumstances of those family members in 2013.
Deeds of Trust can be difficult to change or vary once they are formed. Generally unless there has been a change in legislation which adversely impacts on the provisions of the Deed of Trust it is difficult to make variations to it without resettling the assets onto a new trust (assuming the Deed of Trust in question allows for resettlement) or an application for variation is made to the Court. In either case, detailed legal advice and sometimes significant expense can be incurred.
While it is impossible to provide for every possible eventuality or scenario, your trust advisor can only work with the legislation and facts applicable at the time they form the trust. Therefore it is important you give full consideration to a number of possible eventualities to ensure your Deed of Trust is as flexible as possible.
it is important to seek tax advice prior to making a decision to sell an asset to the trust.
Assets can be transferred to a trust by way of gift or by way of sale and purchase.
Gift duty was abolished from 1 October 2011; therefore it is now possible to give assets to a trust or another person without triggering a liability to pay gift duty. Notwithstanding there is no longer a liability to pay gift duty on the transfer of assets by way of gift, it is important to get advice about making a gift of property or money prior to making the gift. This is because there are various circumstances where a gift can be overturned (for example if the gift was made with the intention of defeating a claim by a creditor or made when the donor of the gift is insolvent). There can also be income tax and GST ramifications which are triggered by the disposal of an asset by way of gift.
It important to ensure that the gift is documented or recorded in some way. Documenting the gift provides evidence of the fact that the asset has left your ownership and is now owned by the trustees of the trust. It also provides a record of when the gift was made.
Sale and Purchase
When assets are sold to a trust, they are usually sold at their current market value. As most trusts will not have the cash available to pay the purchase price, the sale price is commonly left owing as a debt. The debt can be forgiven immediately or forgiven over a period of time. It is important that you get advice on what sort of gifting arrangement you should enter into. Where the debt is to be forgiven over a period of time, you will enter into a gifting programme which will normally be administered by your trust advisor who will prepare the necessary documentation for you.
As with a gift, the sale and purchase of an asset is a disposal which can trigger the requirement to pay income tax and GST (if the owner of the asset was GST registered and used that asset for making taxable supplies). Again it is important to seek tax advice prior to making a decision to sell an asset to the trust.
Beneficiaries may include family members, charities or another trust. If you are the settlor of the trust, you are not prohibited from also being a beneficiary
Before you embark on forming a trust there are a number of decisions you need to make. Some of the more common decisions you need to make are summarised below.
What is the purpose or objective of the trust?
In other words, why do you want to form a trust? What do you hope to achieve? Who and what do you wish to protect? For example it might be that you wish to keep your home and private assets separate from your business assets. It might be that you have received a significant inheritance that you would like to keep separate from your relationship property.
What ever your purpose or objective is, it is critical you discuss these matters openly with your advisor. They cannot help you fully if you do not disclose all of the facts.
Who will benefit from the trust?
As stated earlier in this article, to be a valid trust it must have beneficiaries or objects. Beneficiaries may include family members, charities or another trust. If you are the settlor of the trust, you are not prohibited from also being a beneficiary however in such case you would need to ensure the trust was created for the benefit of more than just yourself.
Typically in New Zealand, a majority of family trusts are created as discretionary family trusts meaning that the beneficiaries defined as discretionary beneficiaries, will not have an automatic entitlement or right to benefit from the trust, they only have the right to be considered. In such case, the pool of beneficiaries should be wide enough to include the persons you actually want to benefit but not so wide that the trustees have to consider the needs of a large disparate group.
Who will be the trustees
When choosing trustees it’s very important to consider people you trust and people who have a good working knowledge of your family and background. Generally, you would have more than one trustee. Trustees can consist of a mix of family members as well as an independent trustee, such as a professional person or someone who is not also a beneficiary of the trust.
It is possible for a beneficiary to also be a trustee however generally the Deed of Trust will contain a provision which prohibits that trustee from participating in decisions which are likely to benefit that trustee in their capacity as a beneficiary.
In all cases, the person you have chosen as a trustee must be asked if they wish to be a trustee and agree to being appointed. It is important that before undertaking that role, the proposed trustee has read and understood the Deed of Trust and understands clearly the duties, obligations and liabilities that will bee imposed on. It may be prudent for that person to seek their own independent advice before accepting a position as trustee.
What assets to transfer?
The answer to this question will depend largely on the purpose or objective of the trust. Look at the assets you wish to protect and the assets that have the greatest potential to increase in value. As stated above, it is important to discuss any tax implications (including GST) associated with transferring assets out of your name and into a trust, particularly if the assets are rental or commercial properties that have been depreciated, or you are a property developer or in the business of dealing in property. Equally if the assets consist of shares in a closely held company or an investment in a significant share portfolio there are likely to be tax consequence associated with the transfer of those assets.
If you are interested in forming a trust or would like to discuss whether a trust is right for you, please contact me for an initial discussion.
Meeting with your trust advisor will help clarify the answer to some of the above questions. Usually as part of working through the process of forming a trust, further issues will come to light. You should expect to have several meetings with your advisor so you are very clear that firstly a trust is right for you, and if so, what steps you need to take to form the trust and transfer assets to the trust. If you are interested in forming a trust or would like to discuss whether a trust is right for you, please contact me for an initial discussion.