A trust is a legally recognised relationship by which someone (trustee) holds property for the benefit of another (beneficiary). A discretionary trust is a type of trust which gives the trustee the power to decide which of the beneficiaries are to benefit from the trust, and to what extent – essentially, they have power over how the trust assets are distributed.
A discretionary trust which is used to trade a business is a trust over the goodwill and assets of a business. The trustee company conducts business relating to the trust property in accordance with the terms of the trust instrument (deed). The company incurs debts personally, but it is entitled to indemnity from the trust assets.
A discretionary trust is one of the most popular vehicles for conducting a small to medium-sized enterprise (SME) in Australia. This blog post describes the steps and documentation required for an SME to set up a trading trust in Australia.
What is the typical structure of a trading trust for an SME?
- Two persons decide to create a business together (the owners)
- Trustee structure: Incorporate a company and call it ABC Pty Ltd
- Shareholding structure: Issue shares for nominal value to owner’s family trusts
- Directorship structure: Owners to become directors of the trustee company
- Trust to be declared with nominal working capital ($50)
- Working capital to be loaned to the trading trust by the owner’s family trusts
- Owners to become appointors of the trusts
- The trust is a discretionary trust with decision-making required to be unanimous or in accordance with a shareholder’s agreement (bespoke)
What is the checklist for establishing a trust structure?
- Set up a trustee company (utilising your professional adviser or a shelf company provider)
- Identify who will control the trust and be its appointor
- Identify who will be the beneficiaries of the trust
- Owners to seek advice from their respective tax accountants regarding streaming of trust distributions
- Owners seek advice from their respective solicitors regarding specific items of the trust deed:
a) Amendments to right to indemnity
b) Exclusion of liability provisions
c) The scope of power of a trustee to sell assets
d) Powers of trustee to borrow monies
e) Whether owners can demand a say in management and profit distribution
f) The power of the appointors to replace the trustee
- Owners to seek advice from their solicitors regarding whether a shareholders or quasi-partnership agreement is required
- Settle and sign the trust deed
- Pay stamp duty (where applicable)
- Apply for an Australian Business Number (ABN) and Tax File Number (TFN) for the trust as required by the Australian Tax Office (ATO)
- Open a bank account for trust operations
How do you incorporate the trustee company?
In Australia, private companies are solely incorporated by the Australian Securities and Investments Commission (ASIC) (www.asic.gov.au). However, most companies are incorporated through shelf company providers that deal with ASIC. The shelf company providers incorporate the company, provide a company constitution, and also provide documentation to lodge registrations of an ABN and TFN.
Our firm uses Patricia Holdings (www.patricia.com.au) for our shelf company registrations due to the quality. Their current price for a shelf company with full documentation is in the order of $800 AUD. Patricia Holdings will also prepare a trust document for a discretionary trust for approximately $300 AUD.
What documentation is required to create the trust?
A trust is a relationship that is created through the trust deed, and this document may need to be evidenced in the future. The ATO or a liquidator may deem that a trust is not in existence if the documentation below cannot be evidenced when called upon. It is a good idea to have the trust documentation witnessed by a solicitor so that the solicitor keeps copies of the documentation on file for future reference.
The documentation required to establish the trust is:
- A company constitution for the trust company: The shelf company provider will include this document in the incorporation package with detailed instructions on adoption and execution.
- A trust deed: The trust deed must be signed and the settlor must also pay a nominal sum to the trustee (i.e. $50). Copies of the trust deed should be retained by the owners and this document may also need to be stamped for tax (depending on the place of domicile and the assets held).
- Minutes of a meeting of the trustee company to accept the appointment as trustee: This will usually be provided by the shelf company but it may need to be bespoke (i.e. prepared by a solicitor).
It is advisable, but not essential, for persons participating in a trading trust business structure to enter into a comprehensive shareholders’ agreement (reminiscent of a partnership agreement) to cover matters not dealt with in the company constitution or various trust deeds, particularly in terms of planning for disputes, business failure, and trustee insolvency.
Asset protection and trading trusts
It is essential as a company director or business owner to design and implement personalised strategies to separate personal assets and wealth from business risks. This can be especially complex when trading via a discretionary trust.
A business operated through a discretionary trust does not enjoy ‘separate legal entity’ status. This means that the trustee is personally liable for any business conduct and the trade debts are deemed to be the trustee’s own, but this may be frustrated by changing trustees.
Further, unless excluded, trustees do maintain a ‘right of indemnity’ and an associated lien over trust assets to be able to settle debts incurred while lawfully conducting trust business.
To determine whether your current asset protection strategy for your trading trust is sufficient, you should make sure you are aware of and have accounted for the following points:
- Claw-back provisions: The Bankruptcy Act includes claw-back provisions which may operate to reverse pre-bankruptcy transactions (e.g. to spouses/family or superannuation)
- Personal guarantees: Do creditors have any personal guarantees for business debts?
- Discretionary trust provisions: Does your discretionary trust provide an alternative or management strategy in the case of bankruptcy of the appointor? Is the right to indemnity excluded by the trust deed?
- Loan security: Are loans from stakeholders appropriately secured? Have they been registered under the Personal Property Securities Act?
It is crucial that these points are considered at the earliest possible stage. If you attempt to make retrospective changes once the business is already in financial difficulty, you could be subject to civil penalties. If you are in doubt, it is best to consult a legal practitioner for advice before doing anything else.
Mistakes that could burn you later
The following are a list of things to look out for that could cause you financial loss at a later date:
- If you set up multiple trustee companies and multiple trust deeds (there should only be one trustee company and one trust deed)
- Financial records of the trust should be prepared by a qualified accountant
- The minutes of the trustee company should be prepared by a solicitor
- The trustee company should not conduct business separately to the trust because it may cause confusion about assets and income actually held in the trust
- When land is purchased you should inform your solicitor that the company is a trustee so they can ensure proper declarations are made
- To minimise risk husbands and wives should not both be company directors of the trustee company at the same time
Further reading about the trust-business structure
Sewell & Kettle blog posts: