Can Discretionary Trusts be attacked by creditors?


Many small businesses, farm holdings, and the families that operate them, have a discretionary trust, often called a family trust (although for tax purposes the two trusts are in fact different) .

These trusts own the family’s enterprise and the income from that enterprise is earned by the trustee which holds that income (and the capital wrapped up in the value of the enterprise) on trust for the various beneficiaries.

Each year the trustee decides whether any of the beneficiaries will be paid some of the income or capital.  Until the trustee makes that decision the beneficiaries may not be entitled to anything from the trust.  

The benefit of these trusts is that each year the income of the beneficiaries (most usually family members) can be balanced so that you avoid the situation where one person has a high taxable income and pays a high tax rate while the other is on a much lower income and pays a much lower rate.  Use of the trust levels out these rates.

Trusts were also seen as good vehicles to help protect the assets of the family because, with no family member actually owning anything until the trustee makes the necessary decision, there was no way that member’s creditors could demand the handing over of those assets.  That was until Carey’s Case.

ASIC was chasing the assets of Mr Carey and asked the Supreme Court to appoint a receiver to Carey’s discretionary trust.  In other words this was a court order appointing a receiver to the assets of a party who had nothing to do with Mr Carey’s allegedly wrongful behaviour (ie the trustee of his discretionary trust) and which would affect a number of other similarly innocent parties, namely the beneficiaries of this discretionary trust.

The Court found that normally a beneficiary in a discretionary trust does not have any interest in the property of that trust until the trustee exercises its discretion in favour of that beneficiary.  Before that time the beneficiary simply has a mere possibility of receiving a distribution and such a possibility is not ‘property’ in the legal sense.

But then the Court went on to say that the situation would be different if the trustee is in reality the ‘alter ego’ of a beneficiary.  In that case the beneficiary is “as good as certain” to receive a distribution and there is a significant property interest that can be made available to that beneficiary’s creditors.

The lesson is that if you want to use your discretionary trust to avoid creditors you must divorce yourself from control of the trust either directly (because you are the trustee or one of them or a director of the trustee company) or indirectly (because you are the appointor).

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