After reading a lot of the posts here on trusts I felt someone needed to clarify a myth or two about asset protection, or at least open it up for some feedback and outline some risks with the average trust set up.
Here is a common trust example:
Mr and Mrs Jones buy a property for 500k and decide on a family / discretionary trust. They set up a new trust with a company as trustee. The trust buys the property and borrows 80% from a bank. The other 200k and say 20k costs are paid for by Mr and Mrs Jones.
The problem is that the balance sheet of the trust shows “beneficiaries loans” for 220k e.g. the amount of money the trust owes Mr and Mrs Jones. In the event Mr and Mrs Jones went bankrupt – a liquidator or court would look to collect the 220k from the trust.
Another Problem:
If a trust is profitable it may not be able to pay out its distributions e.g. if a trust profits 50k and needs to retain the money to pay down loans or pay non deductible costs such as stamp duty etc – it can not physically distribute the funds.
When this happens the funds are distributed for tax purposes e.g. visible in the tax returns. The money however stays in the trust and appears on the balance sheet as money owed to the beneficiaries.
I’m pretty sure that most people with family trusts would find that they don’t stand up in court for asset protection. The real benefit is income distribution – not asset protection.
I’m interested in your feedback???
What about if the company as trustee is successfully sued? The assets of the trust are then possibly at risk, but the family home and other assets held by the individuals are generally safe. Surely this is a major benefit of having the assets in a trust.
Your second problem is not really a problem at all. Most trusts are family trusts, where distributions may go to mum, dad, couple of kids and maybe a beneficiary company. The individuals realise that he trust needs some form of working capital, so the trust holds onto the distributions, and has a loan owing to the individuals. Once the trust is running successfully, regualr distributions can be made to the beneficiaries.
You need to think about who is going to sue you. If a company is trading – let’s say a builder. Trading through a family trust allows you to distribute your profits. If you buy assets in a seperate entity then the trust owns nothing and retains no income. This does protect assets but mainly due to distributing the profit away to different entities – if someone sues the building company / trust – it owns nothing…
But on this site you have general mum and dad investors where the trust does own something – the property. With my example of Mr and Mrs Jone – who on earth would sue the trust and not them? If the trust is sued – it holds the asset, if the individual is sued the asset is still at risk.
You mentioned above that the second point is not a risk however it leads to the first point of having the trust owe you money – e.g. If a trust owes you 200k it is an asset to you (Money owed to you is not actually held in trust – it is a debt the trust has to you).
Banks also vtake guarantees so a trust won’t protect you against them. The family law courts don’t pay to much attention to them either.
Sure, a trust won't protect you if a guarantee is taken by the bank. That is a given.
I disagree that the trust property is at risk if the individuals are sued, in most circumstances. If there has been some transfer of assets to the trust, for the main purpose of hiding the asset, then the trust structure probably won't work. This is the same situation as transferring an asset to the spouse to avoid creditors.
But if you are sued in the general course of business, having the investment assets separate from the personal assets will generally protect the personal assets.
Plan A – Mum and Dad hold all assets in their own name.
Mum and Dad are sued, they lose, and are ordered to pay damages to the 'winner'. All of their assets are at risk.Plan B – Mum and Dad own PPOR, Trust owns Business
Business is sued, they lose, damages payable. Personal assets would generally be safe, as it is the company as trustee that is liable for the damages, as a separate legal entity.There have been some examples recently of courts 'looking through' the trust, but those cases tend to be where assets are transferred for the specific purpose of hiding assets from creditors.
To expand on Plan B from above.
Company trust structure owns business assets. Dad is the sole director of the trustee company. Mum owns the house and all personal ssets in her name only.
Dad is sued as director of company, along with the company itself. Mum can't be sued, as she has no involvement in the business.
Let's say Dad loses. He has no assets in his own name. What court would force Mum, who has no involvement in the company, to sell her house to pay for Dad's damages?
Thanks guys for this thread it is really important that people understand what is going on with their structures.
The above is true regarding only one director of the company. That person carries the risk. The other person is then free and clear and can start up a new company or do whatever. Generally it is the person who already carries risk, highest earner, self employed person, etc.
I was told very clearly by my accountant that family courts can indeed 'see through' the trusts etc. I wanted to know what would happen if my other half met a younger, blonder model and did a runner!
I think people need to be really clear on the structure and the strategy they use. Yeah it costs money to set up more entities but having separate entities for different strategies is important. If you are trading property have a trading company, if buy and hold have an entity to suit. I think people just assume that because they have assets in a trust they are safe. I also think they are worried about getting their money out.
Please keep this sort of information coming. It will at least make people question their accountants a bit more and make sure their structure is right.
D
DWolfe | www.homestagers.com.au
http://www.homestagers.com.au
Email MeDan42 wrote:Sure, a trust won't protect you if a guarantee is taken by the bank. That is a given.I disagree that the trust property is at risk if the individuals are sued, in most circumstances. If there has been some transfer of assets to the trust, for the main purpose of hiding the asset, then the trust structure probably won't work. This is the same situation as transferring an asset to the spouse to avoid creditors.
OK but trust assets are different to beneficiary loans. Beneficiary loans are an asset to the individual / debt to the trust. If the individual goes tits up the courts can seize their asset. Including reasignment of monies owed to them.
Plan B is different – as I outlined above with a builder. Trading companies have different benefits. I am questioning the protection for your average person buying an investment property in a trust.
Buy the way. Customers with strong assets can use property outside the trust to secured debt in the trust.
E.g. Loan in the trust name- guaranteed by people on title. Very different to lending money to your trust yourself
By giving the trust a large LOC say from NAB. It can draw from the LOC to pay distributions in full. This avoids beneficiary loans – therefore the trust owes the bank – not the beneficiaries money.
You need more assets to do this as you need the equity to give the trust a Line of Credit. You also want to make sure the trust borrows 100% from non beneficial sources e.g. Don’t put cash in your trust for a deposit – let it borrow from a bank and provide security / guarantee if you néed to.
Other trust structures that don’t work include: husband and wife as directors and 100% shareholders of trustee company when the only beneficiaries receiving distributions are husband and wife. In essance it can be argued that the trust is void as your are holding assets in trust for yourself.
Banker wrote:OK but trust assets are different to beneficiary loans. Beneficiary loans are an asset to the individual / debt to the trust. If the individual goes tits up the courts can seize their asset. Including reasignment of monies owed to them.Plan B is different – as I outlined above with a builder. Trading companies have different benefits. I am questioning the protection for your average person buying an investment property in a trust.
Firstly, Plan B is not different. It's a trust with a company as trustee. It is holding the business / investment assets.
Point one – sure, but if the money has been paid out, then the individual goes belly-up, then whats the difference? In the end, the individual is left with nothing, and the trust has paid the money out. What IS protected is any asset that the trust owns.
Dan42 wrote:Firstly, Plan B is not different. It's a trust with a company as trustee. It is holding the business / investment assets.Point one – sure, but if the money has been paid out, then the individual goes belly-up, then whats the difference? In the end, the individual is left with nothing, and the trust has paid the money out. What IS protected is any asset that the trust owns.
Hi Dan42. Firstly thanks for the feedback.
Re plan B I don't believe a trading trust e.g. one that conducts business activities e.g. builder, mortgage broker etc should also hold assets as they are more likely to be sued or run into problems of their own. I would always suggest if your trust trades in day to day business activities you should use another entity to hold property.
So if we look at trusts that purely hold assets e.g. investment property (not trading).Point 1: individual goes belly up. Bankrupt. The courts seize their assets and the balance sheet of the trust shows the trust owes the individual say 200k. A creditor, bank or liquidator can claim against that asset. This could be reassigned to the creditor. Now the trust owes the creditor 200k.
As mentioned above – this comes down to the way the asset is held. If the trust has 100% borrowed from non-beneficial sources it might not be an issue however unpaid distributions relate to money the trust owes the individual – therefore not held in trust.
Banker would you be able to draw a trust tree or something similar to show a generally good way of setting up a trust etc? If you can contrast with a way that most people have it set up then maybe that would create a clear picture. Thanks.
D
DWolfe | www.homestagers.com.au
http://www.homestagers.com.au
Email MeBanker wrote:Point 1: individual goes belly up. Bankrupt. The courts seize their assets and the balance sheet of the trust shows the trust owes the individual say 200k. A creditor, bank or liquidator can claim against that asset. This could be reassigned to the creditor. Now the trust owes the creditor 200k.
As mentioned above – this comes down to the way the asset is held. If the trust has 100% borrowed from non-beneficial sources it might not be an issue however unpaid distributions relate to money the trust owes the individual – therefore not held in trust.
I understand that point. My view of asset protection is a little different. Using your example above, the creditor is owed the $200,000, I agree. But if all the assets were held in the individuals name, the creditor would have access to ALL of the assets. In this case, where the asset is held in a trust, the asset is protected from the creditors.
eg, Asset book value $1.5m, bank borrowings of $1m, beneficiary loans to bankrupt $200k, non-bankrupt $300k.
The creditor has a claim on the $200k, nothing else, as it is an asset of bankrupt. Let's say the creditor is owed $800,000. If this asset was held in the name of bankrupt, the creditor would stake a claim over the asset, to clear the debt. As it is held in trust, all the creditor can get at is the $200,000.
Maybe later. I have to go to an appointment. But try this.
New Trust is established.
Balance Sheet of the Trust shows NIL assets and NIL Debt
Beneficiaries lend the trust 200k
Balance sheet now shows: Asset – Cash 200k. Debt to beneficiary 200k
In accounting a balance sheet gets its name because assets and liabilities always balanceNow the trust uses the 200k to buy a property and borrows and additional 500k from a bank (700k property)
Trust asset are now:
700k Asset (property)
700k Debt (200k to beneficiaries / 500k to the bank)Beneficiary goes bankrupt. The property is held in trust so might have some protection however the trust owes the beneficiary 200k therefore may have to sell the asset to repay the beneficiary so they can repay their debt.
Potential Solution:
Trust buys are property for 700k and borrows 700k from bank
Asset (property) 700k
Liability 700k – let’s say loan from NAB
As the LVR is 100% the beneficiary may also provide a guarantee supported by property outside of the trust to reduce the LVRNow the trust owes money to the bank – not the beneficiary. Problem is that a lot of accountants and solicitors set up a trust that is defunct from day 1 because the balance sheet shows money owed to beneficiaries.
You then have the problem again when the trust profits 100k however does not actually transfer the money to the beneficiaries. The get the distribution on their tax return however get no actual cash. The distribution goes on to the balance sheet as a debt to the beneficiary (money is retained by the trust).
This is why a trust needs a LOC to ensure it can always pay distributions.
Dan42 wrote:Banker wrote:Point 1: individual goes belly up. Bankrupt. The courts seize their assets and the balance sheet of the trust shows the trust owes the individual say 200k. A creditor, bank or liquidator can claim against that asset. This could be reassigned to the creditor. Now the trust owes the creditor 200k.
As mentioned above – this comes down to the way the asset is held. If the trust has 100% borrowed from non-beneficial sources it might not be an issue however unpaid distributions relate to money the trust owes the individual – therefore not held in trust.
I understand that point. My view of asset protection is a little different. Using your example above, the creditor is owed the $200,000, I agree. But if all the assets were held in the individuals name, the creditor would have access to ALL of the assets. In this case, where the asset is held in a trust, the asset is protected from the creditors.
eg, Asset book value $1.5m, bank borrowings of $1m, beneficiary loans to bankrupt $200k, non-bankrupt $300k.
The creditor has a claim on the $200k, nothing else, as it is an asset of bankrupt. Let's say the creditor is owed $800,000. If this asset was held in the name of bankrupt, the creditor would stake a claim over the asset, to clear the debt. As it is held in trust, all the creditor can get at is the $200,000.
so we are getting some common ground here. For the average punter with one or two properties in the trust, if the trust can not write a chq for 200k. It might have to sells it’s own assets – either way the door is open.
property held on trust for someone else is exempt property under the Bankruptcy Act, s 116(2) I think. So if you have opened a bank account with money in it for your kids and you go bankrupt, this money is not available to your bankruptcy trustee.
Same applies to real property.
But, where people can get into trouble is with lending or gifting to a trust. If you lend $100 to someone then that money is still yours. If you go bankrupt that money is still owed to you and will fall into the hands of the bankruptcy trustee who will then share it out to your creditors (or more likely keep it all for himself in fees!).
Gifting is also dangerous because if a person goes bankrupt gifts can be clawed back. I think the period is up to 5 years if there was no intention to defeat creditors or indefinetly if there was intention.
Planning is essential
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Ok so if you lend money to you trust you have a problem – this will effect the asset protection for most trusts for people on this site.
Have you read about the ASIC ruling on matter of Richstar?
Google it : it appears that if one ofthe beneficiaries is the trustee or director of the trustee – the assets of the trust ar no longer protected. Courts ruled against this trust… He problem revolves around beneficiaries having control of the trust.
Yes, the money loaned is still the personal asset of the lender so, like all other personal assets, it will be at risk. A way around this is to gift it – but any gift is subject to the claw back provisions in the Bankruptcy Act. Another way is for the trust to earn some money, somehow, but probably the best way is for the trust to borrow as much as possible.
The Richstar matter is not an ASIC ruling but a court case by ASIC v Richstar. There are several matters between ASIC and Richstar, but the one you are probably referring to is Richstar Enterprises Pty Ltd v Carey (No.6) [2006] FCA 814) see http://www.austlii.edu.au/au/cases/cth/federal_ct/2006/814.html. This is the one where ASIC claimed that the trust was the alter ego of the person behind it. This is the only case where this has happened, to my knowledge and it is not the average type of case that would apply to most people. It concerns Corporations Act offences rather than bankrupcty for starters.
Since Richstar there have been a number of cases where the sole person behind a trust was deemed not to be the true owners of the trust assets. One case in the NSW Supreme Court invovled a doctor who had her house held in a trust with her as sole director of the trustee and main beneficiary. She, mistakenly, left her house in the will to someone (even though it was a trust asset). The person who would have received it according to the will didn't get it as it stayed in the trust and so she sued the estate using the Richstar argument saying the doctor was the alter ego of the trust and therefore the house was the doctors. She lost. It was held that the trust assets were separate to the person's. see Public Trustee v Smith [2008] NSWSC 397 at http://www.lawlink.nsw.gov.au/scjudgments%5C2008nswsc.nsf/2008nswsc.nsf/WebView2/4DE829E369881E6FCA25743B0017D5DA?OpenDocument
See also Kawasaki (Australia) Pty Ltd v ARC Strang Pty Ltd [2008] FCA 461 where it was held that under a discretionary trust, no beneficiary under it has a vested interest.
Another one after Richstar, also involving ASIC is ASIC v Burnard [2007] NSWSC 1217. Here ASIC used the Richstar argument and lost. ASIC sought injunction restraining dealing with trust assets. Richstar was not followed, trust assets not property of Mr Burnard. http://www.lawlink.nsw.gov.au/scjudgments/2007nswsc.nsf/aef73009028d6777ca25673900081e8d/15560b0a474a6832ca2573830018e17e?OpenDocument
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Hi Terry,
Thanks for the info. I'd like to explore a bit more in to this though.
One of the links you provided relates to a case where a 'Dr Ward' left a property in her will to a women who would 'mind her cats'. The problem is the asset was not owned by Dr Ward but rather it was owned by a trust. Also note that Dr Ward was not listed as an income or capital beneficiary. The major difference here is that Dr Ward, although she controlled the trust; was not listed as a beneficiary.
The case of ASIC v Burnard relates to hundreds of millions of dollars and is far from relivant from the average punter on this site. The Richstar is also less than 12 months ago so far from dead and buried.
Above we appear to have agreed that if you lend or gift money to a trust, the funds can be clawed back if you went broke. We both agree that the best way around this is for the trust to borrow "as much as possible" – from a source not being a beneficiary.
Back to the mum and dad property investor. If they along with the kids are the other beneficiaries of the trust. They are also the only directors / shareholders of the trustee company : – would this protect them against receivers, liquidators, bankruptcy if the family business went bust?
I'm pretty sure the true level of asset protection for the average trust is a lot less than most readers think (especially going by other posts).If we break some of the areas of asset protection down – is the bold scenario protected or not?
I would say no…
Banker wrote:Back to the mum and dad property investor. If they along with the kids are the other beneficiaries of the trust. They are also the only directors / shareholders of the trustee company : – would this protect them against receivers, liquidators, bankruptcy if the family business went bust?If an individual went bankrupt then any assets held in trust don't belong to the individual – so are generally not at risk. The assets would be safe. There are exceptions such as if it was gifted or transferred into the trust from the person that went bankrupt. To make the trust even stronger, it would be probably better to have different people as appointor, director and named beneficiary.
In the Ward case the Dr Ward wasn't named as a beneficiary, but this was a mistake in the drafting and the court deemed that the trust be amended so that she was a beneficiary – see 77. The argument by the other party was that Ward controlled the trust and was the main beneficiary and therefore she held an interest in that property. But despite all this the court ruled otherwise – that the trust assets were not her personal assets.
Richstar was 3 years ago now. I don't know of any case since that has followed this ruling. There may be some that I am unaware of, but I haven't heard of any.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
I think the asset protection comes more when the property investor owns many properties in different trusts with not much debt.
If house one tenant trips over and sues house one trust then house two trust is not affected or house 50 trust account is not affected.
However setting up the trust early is what is being mentioned to protect the assets when the portfolio grows to 10 plus houses.as the stamp duty is chronic to swap over later.
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