Richstar & Bamford

Two good reasons to look closely at your family trusts

The Richstar [1] and Bamford [2] decisions may have significant consequences for many family (discretionary) trusts. Set out below is a summary of the issues considered by these cases and the changes to your discretionary trust that you should consider making in light of these cases.

Bamford

The High Court in Bamford clarified the concept of 'income of the trust estate' for the purposes of section 97[3] and how a beneficiary's share of the 'net income of the trust estate' is calculated for the purposes of section 97. Set out below is a summary of the conclusions reached by the High Court:

'Income of the trust estate' - what does this mean?

The High Court held that 'income of the trust estate' refers to the distributable income of the trust ascertained by the trustee according to accounting principles and importantly, the trust deed. Accordingly, a provision in the trust deed that provides the trustee with a discretionary power to determine whether amounts should be regarded as income or capital for the purposes of the trust will be effective.

How is a beneficiary's share of the 'net income of the trust estate' calculated?

The High Court held that the 'proportionate view' (rather than the 'quantum view') is to be adopted to determine a beneficiary's share of the net income when the taxable income of the trust exceeds its distributable income. This means that the amount that each beneficiary must include in their assessable income will be determined by reference to the percentage of the taxable income of the trust they receive rather than the actual dollar amount of the distributable income of the trust.

How should your discretionary trust be changed?

So as to maximise the tax benefits of a discretionary trust, your trust deed should be amended so that it provides the trustee with the power to:

1. determine whether an amount should be treated as capital or income; and
2. define the distributable income for the purposes of section 97 as taxable income in accordance with section 95.

Richstar

Richstar is a Federal Court case which was heard by Justice French, who is now the Chief Justice of the High Court. Richstar raised the possibility that assets in a discretionary trust over which an individual has de facto control can be applied to pay creditors, even though the individual is neither the trustee nor a direct beneficiary. 

Ordinarily, a beneficiary of a discretionary trust does not have an interest in the trust income or property which would fall within the definition of property in the Corporations Act or the Bankruptcy Act. This is one of the main benefits of a trust holding assets rather than an individual.

However, in Richstar, the 'ordinary' was distinguished from the case where a beneficiary of a trust effectively controls the trustee and therefore the trustee's powers.  In such a case, the trustee may be considered to be the alter-ego of the beneficiary and the beneficiary may be considered to have a contingent interest in the trust income or property in the sense that it would be as good as certain that the beneficiary will receive the benefits of distributions of either income or capital or both.

An example of the case where a beneficiary would be considered to have a contingent interest in the trust income or property is if a beneficiary was also the appointor or the guardian and therefore had the power to dismiss and/or appoint a trustee or control the exercise of the trustee's powers. 

How should your discretionary trust be changed?

Every trust is set up differently so it is not possible to specify global changes that should be made to your trust in light of Richstar. However, consideration needs to be given to protection of assets of a discretionary trust from the risk of attack by creditors of an at-risk discretionary beneficiary. It is often not possible to eliminate the risk completely, but it is important that risk minimization measures be taken. 

Please contact us if you would like to discuss these cases further and the implications that they may have for your trust. 

[1] Australian Securities and Investment Commission, re Richstar Enterprises Pty Ltd v Carey(No. 6)

    (2006) 153 CLR 509

[2] Bamford and Anor v FCT [2010] HCA 10

[3] All section references are to the Income Tax Assessment Act 1936 unless otherwise expressly indicated.