Creating entitlements in discretionary trusts

A Matter of Trusts

Taxation in Australia

In Fischer v Nemeske Pty Ltd (Fischer),1 the High Court considered the effect of a resolution of a trustee of a discretionary trust that purported to make a capital distribution.
By a majority of three to two, the High Court upheld the decisions of the Supreme Court of New South Wales and Court of Appeal (unanimous) that the resolution of a trustee of a discretionary trust to distribute an amount equal to the value of shares owned by the trustee to a beneficiary (Nemes) was an effective exercise of the trustee’s power and created a debtor/creditor relationship between the trustee and beneficiary. Consequently, after Nemes’ death, the executor of Nemes’ will was entitled to demand payment of the debt and enforce their claim for payment against the trustee. The strategy adopted by Nemes enabled Nemes as testator to access trust assets to pay gifts under his will.
There are many circumstances where use of such a strategy may be recommended. For example, a testator may wish to access some trust assets to provide for a minor child while vesting control of the remaining trust assets in adult children. A credit entitlement or loan created in favour of a testator as beneficiary of a discretionary trust they control may be called up after death by the testator’s executors as a debt due to the testator’s estate. Advantages of this strategy include:

  • trust distributions to a minor from a deceased estate are taxed at adult marginal rates whereas those from inter vivos discretionary trusts are subject to penalty tax; and  
  • adult children could benefit from and control the trust assets. This is an especially important consideration when the trust operates a business or holds business property and at least one of the adult children is engaged in the business.

    Another example is when the testator wishes to benefit, after their death, persons who are not beneficiaries of the discretionary trust they control and the testator has insufficient personal wealth to make gifts to those persons.