What happens to a family trust in a divorce?

It is common for families to set up a family trust during the course of their relationship, usually upon the advice of their accountant. It is especially common for people who own their own business and they are often used to legitimately split their income in order to reduce tax.

However, they can cause problems in the event of separation depending on how they are established and whether they involve third parties.

How do family trusts work?

There are various types of family trusts. The most common ones are:

I. Discretionary trusts

These are trusts where the trustee has the discretion about how the income and capital of the trust are to be distributed amongst the beneficiaries. The beneficiaries are usually family members.

II. Unit trusts

These are trusts composed of a pre-determined number of units. The income and capital of the trust are divided based on the number of units held by each owner.

Trusts have the following:

  1. A trust deed which sets out the details of the trust including the rights, obligations and entitlements. The trust deed has to comply with the necessary legislation;
  2. A settlor who is the person who establishes the trust;
  3. In some cases there is an Appointor who can appoint and remove the trustee;
  4. The trustee who is the person or persons or company who administers the capital and income of the trust in accordance with the trust deed. The trustee owns the trust assets but can only deal with them as permitted by the deed;
  5. The beneficiaries who are the people or companies or trusts who receive the capital and income from the trust.

Are the assets in the family trust included in the pool of available property in a divorce?

There have been several cases about this. The assets in the family trust can be considered one of the following:

  1. Property of the parties by virtue of the fact they control the assets in the trust (even if they don’t own them);
  2. A financial resource. If there is not the requisite level of control of the assets in the trust they will not be considered property but a court can have regard to them in dividing the property of the parties because they have value to one or both of the parties;
  3. A mere expectancy. If someone expects to receive assets from a trust but there is no level of control of when or how much they will receive it will be regarded as an expectancy.

In determining which category the assets of the trust fall, a court will have regard to the level of control the parties have over the assets in the trust. If one or both parties have a high degree of control the trust will be regarded as the “alter ego” of the parties. In most straight forward family trusts the parties or a company of which they are the directors will be the trustee. Therefore, they control the assets of the trust and those assets form part of the pool of matrimonial property available for distribution between the parties.

However, there are other cases where it isn’t so straight forward. If the trustees or beneficiaries include people other than the parties or the trustee is a company of which other people are directors then it is necessary to examine just how much control the parties have over the trust assets. Sometimes family trusts are established intentionally so that the control over the assets rests with people or companies other than the husband and wife.  In that case, the assets and trust are more likely to be regarded as a financial resource or mere expectancy.

To determine the issue of control it’s necessary to look at the terms of trust deed in each case.

What if assets are put into a trust to keep them away from the other?

The court has the power under the Family Law Act to set aside a transaction which is entered into to defeat a claim. In other words, if a person puts matrimonial property into a trust which is controlled by another person or company, that transaction can be set aside. But only where the transaction was entered into for the purpose of depriving the other of their lawful entitlement. If a transaction was entered into for other purposes, such as a genuine commercial transaction or to reduce tax, it might not be set aside.  The timing of the transaction is also relevant. A transaction late in the relationship or following separation is more likely to be set aside.

How does a trust get split up?

As part of the property settlement, there needs to be an order or agreement about what is going to happen with the trust and the assets in it.  One option is to wind up the trust and sell or distribute the assets in the trust and pay any tax and other liabilities associated with doing so.

More often one person will want to retain the trust. In this case, parties may agree or the court may order one person to relinquish their interest in the trust by resigning as the Appointor or trustee or a director of a corporate trustee and to sign a document to forgo their interest as a beneficiary of the trust.  As part of this process, the person who retains the trust can be required to transfer assets out of the trust to the other person or an entity they control.

What about loans?

It is common for there to be loans from the family trust to one of the parties and vice versa. If there is a loan to the parties from the trust there may be tax liabilities involved if the loans are not repaid within a specified period. These loans are sometimes referred to as “Division 7A loans” referring to the division of the Income Tax Assessment Act.  In general loans to and from the family trust will need to be repaid.

Whether establishing a family trust or contemplating separation or going through a separation it is a good idea to get advice from an experienced specialist lawyer. It is also a good idea to talk to your accountant at an early stage.

The Show Must Go On…

A Guide to Help Small Business Owners Better Understand & Navigate The Separation Process.

The Show Must Go On...

A Guide to Help Small Business Owners Better Understand & Navigate The Separation Process.
The guide includes:

  • An overview of the impacts a separation can have on your personal life & business.
  • A summary of the complexities small business owners will face when going through a separation.
  • An explanation of the family law process that small business owners will face.
  • Ways small business owners can limit the stress and impact that their separation has on their business.