Succession strategies for family trusts
Australia is experiencing a significant generational transfer of wealth, much of it tied to family businesses held in discretionary trusts. Ensuring a smooth, tax-effective succession of these trusts is crucial for preserving family wealth and business continuity. Here’s a practical overview of the main strategies and considerations for transitioning a family business held in a discretionary trust to the next generation.
Understanding Interests in Discretionary Trusts
Nature of Beneficiary Interests:
Beneficiaries in a discretionary trust generally have only an expectancy, not a vested interest, until the trustee exercises discretion in their favor.
Implication for Succession:
No proprietary interest passes to the next generation unless the trustee creates a specific interest for a beneficiary as per the trust deed.
Three Key Succession Methods
Continuing with the Trust Structure
How It Works: The trust remains intact, and the trustee continues to distribute income or capital at their discretion.
Facilitating Exits: Exiting beneficiaries can receive a capital distribution and formally disclaim their interest. However, this does not automatically shift entitlements to others, so alternative methods (like asset sales to new entities) may be needed.
Control Considerations: Succession planning must address who will control the trust, especially the role of the appointor, who has the power to remove and appoint trustees. Consider appointor succession and asset protection.
Planning Tips: Ensure disclaimers are valid, timely, and properly documented. Review the structure for multiple trusts and potential disclaimers.
2. Trust Splitting
What Is It? The trust is functionally split so different family branches control and benefit from separate assets.
Tax Implications: If the split is not carefully structured, it may trigger capital gains tax (CGT) events. Therefore, critical to CGT consequences being triggered (CGT Event E1) is the trustee’s right to be indemnified from the assets of the trust.
State Duties: Changing trustees or splitting assets may also trigger state-based duties. Review trust deeds and seek legal advice before proceeding.
Best Practice: Seek a private binding ruling (PBR) from the ATO to confirm tax outcomes before implementing a split.
3. Conversion to a Unit Trust
How It Works: The discretionary trust is converted to a unit trust, with specific persons or entities holding units that represent their rights to income, capital, and voting.
Benefits: Units can be transferred or bequeathed, providing clarity and flexibility for succession.Tax and Duty
Risks: Significant changes may be treated as a resettlement, triggering CGT or state duties. The trust deed must allow for such conversion, and beneficiaries should remain substantially the same.
Recommendation: Obtain a PBR to confirm tax treatment and review state duty implications before proceeding.
Final Thoughts
A high volume of matters involving the succession of family businesses which operate via discretionary trusts is occurring. It is expected that this will continue in the coming years and at an accelerated rate as further transfers of wealth occur.
Every family and business situation is unique. Effective succession planning for discretionary trusts requires careful legal and tax analysis, clear documentation, and a focus on both control and tax outcomes. Engaging professional advisers and seeking ATO guidance where needed can help ensure a smooth and tax-effective transition to the next generation
