Trustees need to manage beneficiaries' expectations on what they are entitled to from the trust and how and when they will receive it.
Trusts can make income distributions, capital distributions or loans to beneficiaries.
Income distributions to beneficiaries
Income distributions are distributions of current year earnings. They are usually paid in cash during the year or by crediting the beneficiary's loan account at the end of the year.
Capital distributions to beneficiaries
Capital distributions are distributions from the capital of the trust. They can be paid in cash or by crediting the beneficiary's loan account. They can also be paid by the transfer of an asset or assets from the trust. For example, a house may be transferred to a beneficiary as a capital distribution from a trust.
Loans to beneficiaries
The beneficiary will have an obligation to repay the loan on terms agreed between the trustees and the beneficiary.
Every situation is different.
Trustees should consider the circumstances of the trust, the needs of beneficiaries and what makes the best sense at the time. For example:
- The trustees are helping a beneficiary and the beneficiary's spouse with their house deposit. If the trustees distribute the deposit money to the beneficiary, the beneficiary's spouse could become entitled to keep half of this if the relationship ends. It may be better if the trustees make a loan to the couple and secure it over the title of the house. Both the beneficiary and spouse would be required to repay their shares of the loan if the relationship ends.
- The trustees decide to pay university fees for a beneficiary. If the trustees do not require repayment, the payments should be distributions instead of a loan.
Questions trustees should ask themselves:
- Should the payment be a distribution or loan?
- Does the trust deed entitle the beneficiary to income while the trust is running? The beneficiary may be a final beneficiary who is only entitled to a share of what's left at the end of the trust.
- Does the trust deed have limits on what you can pay beneficiaries each year?
- Should we do this? Is it sensible?
- Is there enough money to make the payment?
- When is the right time to make the distribution?
- What are the tax consequences of the distribution?
- If a loan, what are the interest and repayment terms? What documents are required to record the loan? If charging interest, what are the tax consequences?
It's important to keep a record of loans and distributions. Trustees may want to equalise what each beneficiary receives at a future date. Some trust deeds have a hotchpot clause allowing for an equalisation adjustment. For example, if one beneficiary has received $50,000, one has received $60,000 and one has received $100,000, the trustees may decide to top up the first two beneficiaries so that each beneficiary eventually receives $100,000 from the trust.
Timing of Distributions
Trustees need to be careful of the timing of their decisions to distribute trust income. The Income Tax Act now allows trustees twelve months after the end of the tax year to decide to distribute income. However, many old trusts have a clause in the trust deed saying that the trustees must make their decision within six months after balance date.
As a trustee you need to know what your trust deed says and whether you have six or twelve months to make your distribution decision. If the resolution is not signed within the allowed time, the income for that year will be trustees' income and taxed at 33%.
If the trust has a six month limit for distributions, the trustees should ask the trust's lawyer to prepare a variation of the trust deed to give the trustees the full twelve months to make their decision for the distribution of trust income.
Every situation is different. Trustees should consider the specific circumstances of the trust and the needs of all beneficiaries.
Trustees must keep good trust and financial records, including:
- Minute book containing written resolutions signed by all the trustees for each decision they make
- Annual financial statements so the trustees can track and be very clear about what money's been treated as loans and what money or assets have been distributed outright to beneficiaries.
Trustees must know and understand their trust deed. They should go back to it regularly and know what they are allowed to do. They should get professional advice if there is something they don't understand.
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