• Home
  • /
  • Estate Group update: Discretionary Trusts, Unit Trusts and Hybrid Unit Trusts…

Estate Group update: Discretionary Trusts, Unit Trusts and Hybrid Unit Trusts…

Jan 30, 2013

General description

A trust is the obligation under which a person or company holding property (the trustee) is required to deal with that property in certain defined ways for the benefit of other persons (the beneficiaries). The most commonly used trusts in family and small businesses are Discretionary Trusts (sometimes called ‘Family Trusts’ or ‘Family Discretionary Trusts’) and Unit Trusts. Many enterprises use a combination of discretionary trusts and unit trusts. A recent development with growing popularity has been the formation of a Hybrid Unit Trust.

A discretionary trust is one where the trustee has the power to decide which of the beneficiaries will benefit from the capital and income of the trust.

A unit trust is one where the beneficiaries’ rights to capital and income are defined by the number and type of units held by them in the trust.

A ‘hybrid’ unit trust is a unit trust as described in this pamphlet but where the trustee has additional flexible powers to pay income or capital to beneficiaries other than the unit holders as and when the trustee decides.

Discretionary trusts and unit trusts are usually created by a settlor or founder giving property to a trustee to hold in favour of the beneficiaries. This gift (called a ‘settlement’) is recorded in a trust deed which sets out the powers that the trustee has to deal with the trust property and many of the rights of the beneficiaries.

Discretionary Trusts

The income and capital of a discretionary trust is held for the beneficiaries as selected by the trustee from time to time at its discretion from the list of potential beneficiaries named in the trust deed. No one beneficiary has an absolute right or interest in either trust income or capital before the trustee makes its selection.

Unit Trusts

There are different forms of unit trusts, but a common basic element is that the capital and income entitlements of beneficiaries are normally determined according to unit holdings. Under the hybrid form of unit trust the trustee, usually with the prior consent of unit holders, may decide to give income or capital of the trust to persons other than the unit holders in the trust. In other words the typical flexibility enjoyed by the trustee of a discretionary trust may be triggered in a hybrid unit trust.

Basic elements of a Trust

Trustee

The trustee is the legal representative of the trust and is responsible to administer the trust in accordance with the terms of the trust deed and laws governing trustees. The trustee of a discretionary trust or unit trust could be an individual or a corporation. Most commonly a corporation is chosen as trustee of discretionary trusts and unit trusts for the following reasons:

  • Corporations are immortal and individuals are not.
  • Through a corporation’s directors the management tasks of the trust can be shared.
  • Corporate trustees can have limited liability if the assets of the trust are insufficient to satisfy creditors.

A corporate trustee is controlled by its board of directors. A corporation’s board of directors is chosen by the corporation’s shareholders, subject to the corporation’s Articles of Association. Ultimate control of the trust may, however, rest with those persons who have the ability to remove and replace the trustee or from whom the trustee is required, under the trust deed, to obtain consent before carrying out certain actions.

Settlor/founder

Discretionary trusts have a settlor or founder who is the person who establishes the trust by way of a gift of property (money) to be held by the trustee in accordance with the settlor/founder’s intentions which are recorded in the trust deed. After making the gift and signing the trust deed, the settlor/founder has no further involvement in the operation and management of the trust. The settlor/founder should not be a beneficiary or potential beneficiary, trustee or director of a corporate trustee.

Unit trusts can be established in a similar way to discretionary trusts by a settlor/founder. Alternatively they may be established by the original beneficiaries (unit holders) buying (subscribing for) units issued in the unit trust.

Beneficiaries

Beneficiaries are the persons who are to benefit from the trust.

  • Discretionary Trust
    It is usual for trust deeds governing discretionary trusts to include in the list of potential beneficiaries a wide range of relatives of named individuals, any company in which any of the named individuals or relatives holds a share, and any other trust of which any of those persons is a beneficiary (potential or otherwise) if that trust meets certain criteria (eg. must come to an end [vest] earlier). The classes of potential beneficiaries can of course vary but generally they are designed to be wide and as flexible as possible. In some cases trust deeds expressly state that named individuals (or classes of individuals) can never be a beneficiary even if they would because they belong to a class of persons who are otherwise potential beneficiaries.
    The trustee of a discretionary trust can in its absolute discretion select from the potential beneficiaries listed in the trust deed those who will from time to time partake in income and/or capital of the trust and in what proportions.
  • Unit Trusts
    The beneficiaries of unit trusts are unit holders. Units are very similar to shares issued in a company because, subject to the provisions of the trust deed, they may be transferred from one person to another and may be issued in different classes each of which gives to the holders different rights to income and/or capital of the trust and/or different powers over the trustee. Unlike companies, the capital of unit trusts is usually readily redeemable by the trustee.
  • Hybrid Unit Trust
    The principal beneficiaries of a hybrid unit trust are the unit holders. However, the trust deed will also contain an extensive list of potential beneficiaries similar to those listed in a typical discretionary trust. In other words not only will the (say) corporate unit holders benefit under the hybrid unit trust but also family members and their interests have the potential to receive payments of income or capital.

Vesting Date

According to the laws of the State of Victoria, trusts must have a limited life, which is normally stated in trust deeds to be 80 years after the trust’s creation. Sometimes, to make sure that one trust is capable of being the beneficiary of another trust, a shorter life is chosen. When a trust is brought to an end its capital is given to its beneficiaries in accordance with the provisions of the trust deed and this is normally called the vesting date. Most trust deeds allow the trust’s vesting date to be brought forward by the trustee.

Change of Trustee

Discretionary Trust

In most trust deeds governing discretionary trusts a certain person (or several persons either acting jointly or one after the death of another) is nominated to be an appointor. The primary power granted by those trust deeds to appointors is the power to remove and appoint trustees. The position of appointor is obviously potentially one of considerable power and influence.

In some trust deeds governing discretionary trusts a person (or several persons either acting jointly or one after the death of another) is nominated as a guardian. The guardian usually acts as a watchdog and may have a power of veto over certain of the trustee’s actions. Sometimes the deed provides that after the death of the guardian (or last person nominated in the deed as Guardian) the trustee is unable to exercise certain of its powers.

Unit Trusts

In most trust deeds governing unit trusts (including hybrid unit trusts) the power to remove and replace trustees is given to the unit holders. The deed can provide that all unit holders must agree to removal and replacement of the trustee or that the relevant power is granted to a stated proportion of unit holders or is given to only a stated class or classes of unit holders.

Change of Trust Deed

Discretionary Trust

Most discretionary trust deeds provide that the trustee may change the trust deed if it believes that to do so would be in the interest of the beneficiaries. These powers of amendment usually do not allow the trustee to remove any benefits already declared in favour of a beneficiary or to make any amendment that results in any favour or benefit to the trustee or the settlor or founder. If the trust deed nominates a guardian he/she is often given a veto over the trustee’s powers to amend the trust deed.

Unit Trust

Most trust deeds governing unit trusts (including hybrid unit trusts) allow the trustee to change the trust deed if it believes that to do so would be in the interest of the beneficiaries and if a certain number or combination of unit holders agree. The trustee’s powers of amendment usually do not allow it to remove any benefits already declared in favour of unit holders or to make any amendment that results in any favour or benefit to the trustee or the settlor or founder.

Powers of Trustees

Most trust deeds governing discretionary trusts and unit trusts are designed to give the trustee the widest powers possible so that it can carry out all expected tasks. Those powers include powers to operate businesses of all types, to borrow, to give guarantees, to employ, to lend, to make gifts and to be indemnified out of trust assets.

Liabilities

Generally a trustee is liable for debts it incurs on behalf of the trust and has a right of indemnity (a right to be compensated) out of trust assets unless it has acted in breach of its obligations. Similarly, generally beneficiaries are not liable if there are insufficient assets of the trust to satisfy the liabilities incurred by the trustee and most trust deeds include specific provisions in this regard. These are very ‘general’ propositions to which there are many exceptions which cannot be properly covered in this pamphlet.

More information

For more information, please contact a member of our Estate Group on (03) 8600 8885.

Note: This update is a guide only and is not intended to constitute legal advice.