Working with accountants – Family trusts and separation
“Family trusts” are a common structure through which people may operate a business or hold assets.
There are various reasons why people may choose to place assets within a trust structure, but how are these structures (and other trust structures) regarded in the event of separation, divorce and family law proceedings? Do they offer any protection from a claim by an ex-spouse with respect to assets held by the trust? And what issues arise in the family law context?
What is a family trust?
A family trust is typically a discretionary trust generally set up by a family member with other family members being the beneficiaries of the trust.
Primarily family trusts are established to achieve tax minimisation in the manner by which trust income and capital is distributed to the beneficiaries; and to provide protection to the assets of the trust. Protection of assets occurs because the legal interest in the assets is held by the trustee for the benefit of the beneficiaries.
Thus, trust asset protection can be achieved as assets are kept separate from the claims of the creditors of any individual beneficiary.
But do trusts protect trust property from a spouse of a person who may be a beneficiary or trustee of a trust?
What is property in the family law context?
For the purposes of the Family Law Act 1975 the term “property” has a very broad definition. The Full Court has said:
“The word “property” is the most comprehensive of all the terms which can be used, in as much as it is indicative and descriptive of every possible interest a party can have.”[i]
Property can be real or personal and has been held to encompass interests including shares in Pty Ltd companies, partnership interests, contractual rights, rights under trade licences, beneficial interests in administered estates and rights with respect to property held in trusts.
Therefore, in being called upon to determine whether trust assets ought to be regarded as property for family law purposes, Judges will take a broad approach to answering that question.
In determining whether the assets of a trust ought to be included as property of the parties available for distribution between them, Courts exercising jurisdiction pursuant to the Family Law Act 1975 will examine what “influence and control” a party may exert over the trust.
The types of factors that the Court will look for include:
- What position or role within the trust do the parties have within the trust structure? (i.e. settlor, appointer, trustee and beneficiary)
- What distributions have occurred in the past?
- Are there debit or credit loans/accounts?
- What benefits have the parties received in terms of payment of expenses or salaries etc?
The High Court has held that in a situation where neither the husband or wife is a beneficiary of the Trust, the assets of the trust can be available for the “matrimonial property pool” based on factors such as the assets having been built up by the contributions of the parties over a long period.[ii]
In Kelly and Kelly (No2) the husband had no interest in the trust however the Court determined control based on his relationship with those who had an interest and that he received indirect financial advances. In this case the directors of the corporate trustee were the husband’s accountant, brother and wife. The husband was not a settlor, appointer or beneficiary.
Where the Court does not consider that the assets of the trust ought to be treated as property of the parties (such as where a party has a beneficial interest in a discretionary trust), it may be still be relevant to consider whether the interest is a mere expectancy (and irrelevant) or a financial resource of a party leading to an adjustment of the percentages of the overall matrimonial property pool each party receives.[iii] This is a situation where the history of distributions will be important evidence in firstly determining whether there is a financial resource, and secondly the weight to be applied (i.e. the level of percentage adjustment).
Other issues for Gold Coast family law solicitors and accountants?
There are a number of practical issues that arise in terms of proving a party’s case with respect to the trust and its assets, and with respect to how property may be distributed from a trust to a party to the marriage.
Family Law Disclosure
To determine the question of control, determine what interests the parties hold, and/or gain an understanding of what assets the trust holds, documents and information will be required. Often these documents will be held by a party’s accountant, and it is not uncommon for a spouse to lack access to documents, information or an understanding as to how the family financial affairs are structured.
The Family Court and Federal Circuit Court Rules require parties make “full and frank” disclosure.[iv]
The types of documents family law solicitors will typically request from a party or their accountant are:
- Tax returns with attached financials to determine what is the financial position of the trust;
- Trust deeds (including deeds of variation) to determine the structure and issues of control;
- For any corporate trustee a copy of the corporate constitution;
- Bank statements and any credit card statements for trust accounts evidencing transactions;
- Minutes of trustee meetings relevant to control and history of dealings;
- Register of assets and/or register of distributions;
- Loan agreements with respect to loan accounts;
- If the trust is operating a business (as is commonly the case), disclosure of relevant business records to determine value, assets and financial dealings.
The above is not exhaustive, and disclosure will be required depending on the circumstances and relevance.
If a party refuses to disclose, it can impact negatively upon their case and cause the Court to draw adverse inferences in some situations.
Further, trustees have obligations under State and Territory legislation to maintain certain records which beneficiary have a right to inspect. Subpoenas are also an available remedy to compel a recalcitrant party (or a third party such as an accountant) to provide documents or give evidence.
Issues for family law settlements involving trusts and transfer of property from trusts to a spouse or former spouse
There are a number of issues that can arise in relation to transfer of trust assets and income at separation.
These types of issues include:
- Capital Gains Tax (“CGT”) – where an asset pregnant with CGT is transferred from the trust to a spouse (or de facto spouse). In this situation the spouse takes the asset pregnant with the CGT however the transfer from trust to spouse attracts CGT rollover relief.[v]
- Tax issues from settlement distributions – If as part of a family law settlement a distribution from a trust is contemplated, it will be important to determine whether the intended recipient is still a beneficiary. A spouse who was a beneficiary may no longer be a beneficiary as at the date of settlement. For example, if the parties are divorced and the former spouse doesn’t fit the definition of a class of beneficiary pursuant to the deed after the marriage is dissolved. This can create issues as to how the ATO will regard and tax the payment.
- Tax issues from past distributions – If tax hasn’t been assessed on past financial years distributions, the tax needs to be considered in determining the overall pool available for distribution and whether the liable party will pay, or if the other party will be responsible for the tax. Sometimes it is an issue that tax on prior years distributions is payable, but that spouse party hasn’t received the distribution (income splitting between spouses). In this situation however, the beneficiary can enforce the actual payment of the distribution.
- Division 7A Income Tax Assessment Act 1936 – In some circumstances where distributions have been made to a private company, but not paid (present unpaid entitlements or UPE), Div 7A tax may be payable.
It is important for family lawyers drafting orders to consider all the potential issues arising from the proposed transfers, and where applicable, ensure that clients obtain accounting advice before finalising property settlement orders.
Family law advice
If you have any queries in relation to separation, divorce, de facto relationships, property settlement or child support payments, my firm Hooper Family Lawyers can assist you with practical advice.
We are family lawyers servicing all areas in Brisbane and on the Gold Coast.
[i] In the Marriage of Duff (1977) 29 FLR 46 – approving the statement by Lord Langdale MR in Jones v Skinner 5 LJ Ch. 87.
[ii] Kennon v Spry (2008) FLC 93-388 – in this case the trust was set up by an expert on the law of trusts likely for the purposes of placing assets beyond the reach of the wife.
[iii] Kelly and Kelly (No2) FLC 91-108.
[iv] Family Court Rules 2004 R13.04 and Federal Circuit Court Rules 2001 R20.04.
[v] S 126-5 Income Tax Assessment Act 1997.