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Gotta Have Faith: Trusts as a Business Structure

Apr 2021

The final article from our business structure series explores one of the most common yet misunderstood legal relationships: Trusts.

Trusts are widely used in Australia for a range of investment and business uses. As a structure they can be intimidating but are nonetheless a mainstay in the Australian commercial scene for their high adaptability to a variety of commercial needs, asset protection benefits, and flexibility in distributing income to beneficiaries.

Trust Types

The most common types of Trusts are Discretionary Trusts and Fixed Trusts.

1. Fixed Trusts

Fixed Trusts pre-determine the identity of all Beneficiaries, in a business context often through the issue of ‘units’ to Beneficiaries (although this is not necessary to the creation of a fixed Trust). In comparison to Discretionary Trusts, Fixed Trusts usually grant less power to the Trustees, who must distribute the assets in accordance with the terms of the Trust Deed.

Unit Trusts (e.g. managed funds, registered schemes, managed investment schemes) are a type of Fixed Trust where ‘unitholders’ hold units in the Trust, with units generally equal in size, value and the number of units held reflecting a unitholder’s overall interest in the Trust assets. Units are similar to the concept of shares in a company, and the number of units held by a Unitholder (Beneficiary) generally determines the holders’ share of the annual distribution of the Trust income and/or assets. Because units are also transferable, this right to receive benefits in proportion to a unitholder’s share in the Trust makes units in a Unit Trust comparable to shares in a company. However unlike companies, Trustees typically distribute all of their profits each year. These features make Unit Trusts well suited to business. Disadvantages of the Unit Trust structure include that the unitholder can be jointly and personally liable under Trust law to indemnify the Trust for any shortfall in the assets on liquidation (unless the Trust instrument provides otherwise).

2. Discretionary Trusts

Discretionary Trusts are useful where there are a broader or no fixed class of Beneficiaries, or for non-commercial interests, where enhanced flexibility is required. Although less common for business or investment purposes, they are often used for family Trusts or as vehicles for charities. These Trusts are simple to establish and operate and offer some tax advantages. What makes a Trust discretionary is that the identity of either the assets or the Beneficiaries are not determined definitively at the creation of the Trust- for example, a Discretionary Trust might allow all of the family assets to be distributed amongst the family members, but the Trustee has total discretion over which family members (or beneficiaries) receive which assets.

Some other less common Trust sub-types in commercial settings not covered in this article include:
a) Bare Trusts (e.g. nominee shareholdings);
b) Hybrid Trusts (a mix between a Discretionary Trust and a fixed Unit Trust);
c) Testamentary Trusts (e.g. Trusts set up by wills or gifts);
d) Charitable Trusts (e.g. charitable foundations); and
e) Superannuation Trusts (e.g. super funds regulated by the Superannuation Act).

Advantages

Trusts are a highly flexible and adaptable business structure due to the wide range of sub-types that are available. Beneficiaries of Trusts are also better protected than shareholders in companies, as they have more rights and stronger entitlements to the Trust assets. Except in the case of managed investment schemes (Registered Schemes) registered under Chapter 5C of the Corporations Act 2001 (Cth) (Corporations Act), Trusts generally have much less of a regulatory burden than companies, and are generally easier to wind up as the process can be set out in the Trust instrument as opposed to being dictated by legislation.

Disadvantages

On the other hand, the formal requirements for the creation of a Trust can be challenging and Trust structures can become extremely complex. Another consideration is the heavy role of common law in regulating Trusts. Unlike companies which are managed clearly and extensively by legislation like the Corporations Act, Trusts (with the exception of Registered Schemes) are mostly regulated by common law, which can be a source of uncertainty for business operators.
Another disadvantage is that Trustees hold a high degree of responsibility to the beneficiaries of the Trust. Trustees that do not act in the best interests of Beneficiaries may be exposed to far greater liability than directors of companies by virtue of the fiduciary relationship with the Beneficiaries.

Additional duties of Trustees include:
a) not to make an unauthorised profit from their position as Trustee,
b) to act in conflict with the interests of the Beneficiaries.

Trustees must also act in confidence and in good faith.

Winding Down

Cessation of a Trust varies, with three main methods used to wind down a Trust. These methods may be used separately or in conjunction with one another and include distribution, release/variation and via transfer.

Conclusion

As this introductory article has explored, Trusts as a business and investment structure encompasses a wide range of sub-types ranging from complex and sophisticated vehicles to relatively simple structures, making Trusts a highly adaptable structure for your needs.

If you have any questions about Trusts as an option for your business or would like to better understand your business structure options, please contact the team at Hazelbrook Legal.

Material in this article is available for information purposes only and is a high-level summary of the subject matter. It is not, and is not intended to be, legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this article. This article is copyright. For permission to reproduce this article please email Hazelbrook Legal: enquiry@hazelbrooklegal.com

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