Trusts – Tax and related considerations

A trust is used to manage the assets of a person, called a settlor. The settlor creates the trust to ensure assets that are transferred into the trust are distributed and managed according to his wishes.

A private trust, for example, is a legal instrument that takes effect during the lifetime of the settlor. It contains the settlor’s instructions to the trustees on the distribution of assets that form part of the trust to the beneficiaries.

While the legal ownership of the asset rests with the trust i.e. the settlor no longer owns the assets once they are transferred into the trust, the settlor controls the assets by his instructions in the trust deed.

The settlors would want to ensure that their assets will be distributed to their beneficiaries of choice with total confidentiality and privacy when the terms of the trust deed are met. These terms could be death of the settlor, coming of age of a beneficiary, completion of housing loans etc.

Some of the benefits of trusts are:

> Assets in the trust are not frozen on the death of the settlor. The assets would be available for distribution per the terms of the trust deed.

> Ownership of shares can be redistributed to remaining shareholders per the trust deed, on the death of a shareholder.

> Confidentiality of beneficiaries – the trust deed is a confidential document whereby beneficiaries will not know who the other beneficiaries are. A trusted trustee keeps all information confidential, per the terms of the trust deed.

> Tax benefits, for example, assets are transferred from a high taxed settlor to a beneficiary that is taxed at a lower tax bracket. However, the tax benefits of settlement schemes that are regarded as being tax avoidance in nature would be negated by specific provisions of the Malaysian Income Tax Act, 1967.

There are several types of trusts in Malaysia, for example:

> Family trusts.

> Business continuity trusts. > Special-purpose trusts.

A family trust is set up to distribute assets to family members. Family feuds over assets or the squandering of inheritances can be avoided if there are trusts in place.

When young children receive large amounts of money, having a trust in place can protect them from unwanted influences by making sure the payouts are made in instalments.

Family trusts would include:

> Annuity trusts – These are used to distribute income from rental properties to beneficiaries. The unencumbered properties are owned by the trust and are governed by the trust deed.

> Declaration trust – This trust is a declaration of intent of asset distribution. On a particular event, for example, when the settlor goes missing, being disabled or on death, the assets enter into the ownership of the trustee and are governed by the trust deed.

> Insurance trust – A trust created to assign life insurance policies to a trustee to manage the insurance proceeds per the trust deed.

Business continuity trusts ensure that the surviving shareholders take over a deceased shareholder’s shares. The trust could buy the shares of the deceased shareholder and distribute them to the existing shareholders. The trust then pays the beneficiaries the money from the sale of the shares.

Special-purpose trusts could be created for immediate distribution. The beneficiary could be anyone or anything. It could be a charity, a relative, a friend or anything that will benefit from the proceeds of the trust.

From a taxation standpoint, a trust is subject to income tax in respect of its taxable income. The income distributed by the trust to beneficiaries is taxable in the hands of the beneficiaries.

However, the tax paid by the trust would be available as a credit to the beneficiary i.e. there should be no double taxation.

A trust settlement may at times be used as a vehicle through which a settlor diverts either his income or capital to the beneficiary whose tax liability is at a lower rate as compared to that of the settlor.

Although a settlement is created, the beneficiary of the settlement is not automatically taxed on the income arising from the settlement as the income could be deemed as income of the settlor.

This would be the case where the settlor retains the power to revoke the settlement or holds a significant measure of control or accessibility to the said income.

Further, where a settlement is created for the benefit of a minor or a relative of the settlor, any income arising under the settlement would be deemed to settlor’s income provided that at the beginning of the basis period of the year of assessment, the relative is unmarried and has not attained the age of 21 years.

Finally, where a settlor, relative or company controlled by the settlor or relative makes use of any income arising from a settlement to which he is not entitled, such income of the settlement would be deemed to be the settlor’s income and not the beneficiary’s for the relevant year of assessment.