Family trusts are part of the architecture of Australian wealth. Business owners use them to hold trading operations and investments; parents use them to hold family assets for the next generation; advisers recommend them for tax efficiency and asset protection. So it is no surprise that when a relationship ends, one of the most common questions we hear is: is the trust protected?
The short answer is that a trust is not a wall around family wealth. Depending on who controls it and how it has been used, its assets may be treated as a party's property and divided, or as a financial resource that shifts the division of other property. Understanding which, and why, is essential.
This article is general information, not legal advice.
What a discretionary trust is
A discretionary (or family) trust is a relationship, not an entity. A trustee (an individual or, commonly, a company) legally owns the trust assets and holds them for a class of beneficiaries. The trustee has discretion each year to decide which beneficiaries receive income or capital, and how much. No beneficiary has a fixed entitlement.
Most family trusts also have an appointor (sometimes called a principal or guardian), who can remove and replace the trustee. Because the appointor controls who the trustee is, the appointor is often the person who ultimately controls the trust.
Because no beneficiary owns the assets, it is tempting to think the assets belong to no one for family law purposes. The courts have rejected that view where the reality is otherwise.
Property or financial resource?
The Family Law Act allows the court to divide the parties' property and to take into account their financial resources. Trust assets can fall into either category.
When trust assets are treated as property
In Kennon v Spry (2008), the High Court considered a trust in which the husband had been trustee with power to distribute the trust fund to any beneficiary, including himself. The Court held that, in substance, the trust assets were his property for the purposes of the Family Law Act: he had the power to take them for himself at any time.
Since then, courts have treated trust assets as the property of a party where that party has effective control of the trust. Indicators include:
- the party (or a company they control) is the trustee;
- the party is the appointor, or can otherwise control who the trustee is;
- the party is a beneficiary, or can become one;
- the trust has in practice been used as the party's alter ego: paying their expenses, funding their lifestyle, or making distributions at their direction.
Where those features are present, the net assets of the trust can be added to the property pool and divided like any other asset.
When trust assets are a financial resource
Where the trust is genuinely controlled by someone else, commonly a parent or other relative, and the party is simply one of many beneficiaries, the trust is more likely to be treated as a financial resource. The court cannot divide it directly, but it can take it into account in assessing the parties' future circumstances. A party with a valuable financial resource may receive a smaller share of the property that can be divided.
The grey zone
Many trusts sit between these poles. A parent might be appointor but have always acted on a child's wishes. Control might be shared between siblings. The trustee company's shares might be held by several family members. In these cases, the history of how the trust has actually operated is critical: distributions, minutes, correspondence with accountants, and the use of trust funds for family expenses.
Common trust issues in a property settlement
Unpaid present entitlements
Where a trust has resolved to distribute income to a beneficiary but has not paid it, the beneficiary has an unpaid present entitlement: effectively a debt owed by the trust. That debt is usually property of the beneficiary. It may be significant, especially where distributions have been made on paper to minimise tax without cash changing hands.
Loans to and from the trust
Family trusts often lend to family members or related companies, and borrow from them. Each loan must be identified and characterised. A loan from the trust to a party is an asset of the trust and a liability of the party; if the trust is treated as that party's property, the two may cancel out.
Corporate trustees and related companies
Where the trustee is a company, the shares in the trustee company, and the constitution governing who can appoint its directors, are relevant to control. Trading trusts often sit alongside companies with their own loan accounts and Division 7A implications, which must be analysed together.
Distributions after separation
After separation, the party controlling the trust may stop making distributions to the other spouse, direct income elsewhere, or accumulate it. These decisions may be relevant to both the property pool and to interim spousal maintenance. Where there is a risk of assets being dissipated, the court can grant injunctions.
Changes to trust roles after separation
Parties sometimes resign as trustee or appointor after separation, or transfer the role to a relative, in the hope of moving the trust outside the court's reach. The court looks at the substance of control, and at why the change was made. Section 106B of the Family Law Act allows the court to set aside transactions made to defeat a claim, and courts have examined changes to trust roles on this basis.
Changes made long before any relationship difficulty, for genuine reasons, are treated very differently from those made on the eve of separation.
Can the court make orders against the trustee?
Yes, where the court's powers can reach the trustee. If a party to the proceedings is the trustee, orders can be directed to them in that capacity. Third-party trustees can be joined as parties to the proceedings, and the court has power to make orders binding third parties in certain circumstances.
In practice, most settlements involving trusts are resolved by agreement: one party retains control of the trust and pays the other a sum reflecting the value of the trust assets treated as property, or the trust transfers specific assets. Careful drafting is needed to ensure the trustee can lawfully do what the orders require, and to manage tax and duty.
Tax and stamp duty
Transfers of assets out of a trust as part of a family law settlement can trigger capital gains tax and duty. Rollover relief for relationship breakdown is available in some circumstances, including certain transfers by trustees under court orders or binding financial agreements, but the rules are technical. NSW transfer duty exemptions for family law transfers also have specific requirements. Early coordination between the family lawyer and the trust's accountant avoids expensive mistakes.
Protecting a trust in advance
For families who want trust wealth to stay in the family, the time to act is before a relationship is tested:
- Control
Consider who holds the roles of trustee and appointor, and whether succession provisions in the deed reflect the family's intentions. - Documentation
Record loans as loans, with written agreements. Minute distribution decisions properly. - Binding financial agreements
Adult children entering relationships can make agreements that expressly deal with their interests in family trusts. See binding financial agreements. - Estate planning
Testamentary trusts can protect inheritances from a beneficiary's later relationship breakdown. See wills and estate planning.
None of these measures is guaranteed to put assets beyond the court's reach, and none should be implemented after a relationship is in difficulty. But properly done, they substantially reduce risk.
Practical steps if a trust is involved in your separation
- Obtain a copy of the trust deed and all variations.
- Identify the trustee, appointor and beneficiaries, and any changes to those roles.
- Collect financial statements and tax returns for the trust for several years.
- Identify loans, unpaid present entitlements and related entities.
- Get advice before changing any trust roles or making unusual distributions.
How we can help
Our high net worth divorce team regularly advises on family trusts, both for the party who controls the trust and for the party who does not. We work with forensic accountants to analyse trust history and value, and we structure settlements that are tax-effective and practical to implement. For families planning ahead, see asset protection.
This article is general information about the law as at the date it was last reviewed. It is not legal advice and does not take your circumstances into account.