How to determine if the trend is your friend


I was on the hunt for some interesting insights in to the current market and using momentum or contrarian strategies for clients .  Lawrence Lam of Lumenary Investment Management writes in this guest blog that it not always a case of either or but a combination.

At a recent lunch with another fund manager I found myself engaged in a discussion about the state of the current market.

‘From your perspective, are you seeing many good opportunities?’ I asked.

‘I’m seeing good companies, but prices are toppy,’ he said, wincing before continuing. ‘More than I’d like to pay. But we’ve recently deployed more anyway.’ He shrugged his shoulders, ‘Momentum in the market is strong – the fed is decreasing rates. Despite the high prices, we wouldn’t want to miss this momentum.’

I nodded as we both acknowledged this unique investment environment. Decreasing rates, high stock valuations, yet stock prices that have continued to climb steadily.

Walking back to my office I reflected. ‘Is now a good time to be a momentum investor? Or is it time to go against the herd?’

Harness the power of momentum or be a contrarian?

 It’s a dichotomy faced by all investors, but it isn’t a binary decision. Your portfolio can be made up of both momentum and contrarian investments. So the question becomes: how can we determine the optimal proportion of holdings between momentum and contrarian?

Are you seeing the full picture?

Momentum investors have much to gain if the wave of popularity is caught early. However, be the last one to the party and you will be left with all the cleaning up. The real question is: how much more of the wave is left to catch? The solution to this contradiction can be found by understanding the long-term context.

The ratio of a company’s stock price-to-intrinsic value tells us how much the market is willing to pay for the company. It’s a useful measurement of sentiment at one point in time. There’s a clear link between sentiment (the stock price) versus fundamental value (intrinsic value).

But it doesn’t give us the full picture. To understand this contradiction, we need to see how sentiment for the stock has changed over a significant period of time – over entire market cycles. Extend the ratio of stock price-to-intrinsic value over a 15 year horizon and you’ll now gain a multi-dimensional view of just how manic-depressive Mr Market is.

As an example, here is the change in sentiment for the founder-led aerospace electronics company HEICO Corporation.

 

During the GFC, Mr Market was very pessimistic. He was only willing to pay 1.8x the intrinsic value of HEICO. But alas Mr Market is as fickle as they come. More recently, he has been very bullish. He’s willing to pay 4.8x intrinsic value. A large proportion of the returns have been driven solely by the company’s increasing popularity with investors.

Now we have a better view of the context. Understanding the stock price and intrinsic value over a long time period equips us to answer the following question…

 

Is the party getting started or is it about to end?

There’s an interesting observation about parties. When do they end?

Answer? They end when the alcohol runs out. Rarely do they end immediately though. Good times roll on for a while longer before the sudden realisation hits the sobering crowd.

So when is the worst time to join a party?

As you’re pondering the answer, here is another view of HEICO to illustrate the point.

 

Although the intrinsic value of HEICO’s business has consistently increased over time, the increase in it’s price has far outpaced the fundamental growth of the company. HEICO is a solid and growing company, but its impressive performance has been driven primarily by sentiment and price, rather than actual business value. The price-to-intrinsic value ratio shows this.

Risk is heightened when a company’s stock price outpaces its intrinsic value for significant periods of time. As crazy as Mr Market is, one thing is certain – his enthusiasm and pessimism never last forever. The gravitational pull of a company’s fundamental value is unrelenting.

The best time to join a party is when there’s plenty of alcohol and not too many people. But tread carefully when there crowd is pumping and booze is running low. Whilst the fun may continue for a while longer yet, the risk of an abrupt ending is heightened.

A ‘reasonable’ price

Pure momentum investing focuses predominantly on the historical price movement and pays little attention to actual fundamental value. But if you want to understand if a trend is justified, the fundamentals are critical.

Armed with this insight, we can make a judgement call on what a ‘reasonable’ price would be and whether we should join the party. Some sectors run hot. Today, technology is a classic example. But a strong trend shouldn’t be a deterrent. Prices may seem exorbitant, but in the context of the company’s historical sentiment, sometimes the high price is worth paying. What may seem expensive on an absolute basis may be reasonable in the context of history. For example, the price-to-intrinsic value of Facebook was high on an absolute basis in late 2018, but was reasonable when compared to its history. It has proven to be a good entry point so far.

But there’s more for enterprising investors – the picture is still not yet complete.

A deeper level of analysis

Competition

You may have noticed my focus on individual company analysis rather than broad-based economic generalisations. We are buying slices of companies after all. Whilst we can understand the sentiment in our target company, it is also important to have context across other comparable companies. The same price-to-intrinsic value historical ratio across a few companies will give us a sense of sentiment across the sector. We’ll be able to see if there are any other reasonably priced companies.

Potential growth

So far the focus has been on gaining historical context. Sometimes the momentum is justified if there are tangible growth prospects. In other words, intrinsic value is expected to grow significantly with price. In those situations, the trend may be your friend. For those that heard me speak at the AIA National Conference, I outlined my framework to assess the potential growth of a company.

Intrinsic value

Speculators focus on stock price movements only. Investors focus on the underlying true worth of a company.

As Warren Buffett says “Price is what you pay, value is what you get”.

The fundamentals of a company’s value is reflected in its Intrinsic value. Importantly, in determining a company’s intrinsic value, I’ve stripped out accounting distortions that may hide a company’s true worth.

Closing remarks

Is the trend your friend?

If the fundamentals of a company are sound and the price is reasonable in the context of its history and other competitors, then the trend may indeed be an ally. Ride the wave and enjoy the party.

Price and intrinsic value may deviate for many years but price will eventually move towards intrinsic value over the long-term. Seeing the full picture is key to capturing sensible opportunities. In every party, everyone sobers eventually.

Happy compounding.

Note:

Stocks mentioned have been used as examples only. They are not recommendations to buy or sell.

About me

Lawrence Lam is the Managing Director & Founder of Lumenary, a fund that uncovers the best founder-led companies in the world. We invest in unique, overlooked companies in markets and industries beyond most managers’ reach. We are a different type of global fund – for more articles and information about us, visit www.lumenaryinvest.com

 

The SMSF Coach is in no way connected to Lawrence Lam of Lumenary Investment Management and we do not receive referral fees or commissions of any sort from them. This is purely general advice and market commentary from a trusted source and you should seek personalised financial advice before making any investment decision.

Looking for an adviser that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options. Do it! Make 2019 the year to get organised or it will be 2029 before you know it.

Please consider passing on this article to family or friends. Pay it forward!

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

 

Why you should make loans to your children not gift them money


I am always on the look out for interesting tips for clients and while this may not necessarily be SMSF related, many of my readers are also wish to help their children with money for house deposits, education funds or other ad-hoc expenses .  I read the blogs from Dr. Brett Davies at Legal Consolidated regularly and found them very informative and excellent guidance so, with his permission, I am “paying it forward” again!

In his blog Parents making loans to children he discusses why smart parents use loan agreements to protect the family wealth. Here is the detailed article and video he prepared.

Parents making loans to children

Sad parents

Mum and dad give their daughter, Joanne $400,000 to buy a house. She then marries Ken. Ten years later Joanne and Ken divorce. The house is still worth $400,000. It is the only asset of the marriage. The Family Court awards $200,000 to Ken. The Family Court is not interested that the money was a gift from Joanne’s mum and dad. Instead, loans to children are safer.

Smart parents

Mum and dad lend $400,000 to their daughter, Joanne. Joanne signs a legally prepared Loan Agreement built on Legal Consolidated’s website. Joanne purchases a house with the money. She marries Ken. Ten years later they divorce. The house is still worth $400,000. It is the only asset. The Family Court is shown the Loan Agreement. The Family Court orders that Ken gets nothing. This is because the assets of the marriage are nil.

To protect your loan build a legally prepared Loan Agreement – on a law firm’s website. Homemade loan agreements may not work. They carry less weight with the Family Court and Bankruptcy Court. Why take the risk?

But I love my children

There is nothing wrong with helping our children financially. It could be for their first car, grandchildren school fees, a holiday or a property. Today it is becoming more popular to help out our children with a home deposit, but simply giving away the money has real risks. It is important to protect the money in case:

  1. they divorce
  2. go bankrupt

  3. suffer from drugs
  4. suffer a mental condition
  5. stop loving you – ‘King Lear’ offers his daughters his Kingdom for the return of their love, but after they promptly abandon him
  6. you run out of money yourself, in your old age

loans to children

 

Documenting loans to children

Never ‘give’ your children money. Always ‘lend’ them money ‘payable on demand’. Get it back if something goes wrong. Treat yourself like you are a bank, and your children are taking out a loan.

Creating a loan agreement not only protects your own interests but also benefits the child as you can decide in the future to forgive the loan while you are alive or in your Will.

With loans to children, never rely on a verbal agreement. Press the Build button and build a Loan Agreement on our website. We are Australia’s only law firm website providing legal documents online. It puts everything in writing with rules about the loan.

Any tax issues?

There are no tax issues. The interest rate for the loan is ‘as advised by the Lender’. Therefore, while the interest rate is zero you have no income tax issues. If the child separates you can increase the interest rate to draw more money out of the failed relationship. There is less money for the Family Court to give to your ex-in-law.

A loan isn’t always for property and the grandchildren’s school fees. You can also fund the children’s Superannuation fund. Speak to your Financial Planner and Accountant.

At different times, it is common to benefit one child over another with money. If you benefit one child over another then it is adjusted automatically at the time of your death. Say you lend one child $500k and the other child $300k then that is adjusted at your death. So it is all fair again.

When making loans to children:

  1. talk with all your children together about the loans
  2. never gift children money – only loan them money (this protects both you and them).
  • don’t rely on home-made loans or IOUs – build a Loan Agreement

  •  

    loan agreement legal consolidated brett davies lawyers

    Can I just do a Loan Agreement on the back of an envelope?

    In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of a Loan Agreement, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT [2018] FCA 182 shows the additional care required to document even simple related-party transactions, such as loans. In this case, the taxpayer, a practising NSW lawyer, claimed he borrowed over $4m from his group of private companies. The Court said:

    ‘Mr Rowntree has not deliberately chosen to ignore the law. His evidence presented to the Tribunal suggests that he genuinely believed that there were arguments to support his view that a loan was in existence.’

    He failed. Only a legally prepared Loan Agreement satisfies the ATO, Bankruptcy Courts and Family Court.

    Cheeky son refuses to pay Dad back

    In Berghan v Berghan [2017] QCA 236 the son borrows money from his Queensland aged father. The son refuses to pay it back.

    The son, in the first court case, successfully argues that the monies were given to him as a gift.  However, the Court of Appeal held that the amounts were loans.

    Portrait of an ungrateful childchild loan agreement

    The son’s company suffers financial stress.  The son gets $98k from this Dad. The boy continues to borrow more money from dad.

    Later, the son borrows his father’s credit card. The boy clocks up another $13k of debt.

    The First court case

    His Honour said that Dad failed to prove a legal binding agreement. There was no paperwork. There was no written loan agreement.  It was a gift.

    The Judge said:

    • The son promised to look after his Dad in old age. But that was just a moral obligation.
    • Dad is making the payments to the son, for the benefit of the company, was simply discharging his parental obligations. This is because their daughter was an employee at the son’s company.  The money was therefore of a charitable nature. Dad was protecting the son’s company so his daughter would keep her job.
    • Dad allowed his boy to use the credit card when the boy was injured and impecunious.  These circumstances are charitable.

    Good sense prevails in the Appeal

    The Court of Appeal had a better sense:

    • The lengthy period it took Dad to make a demand for the money does not count against his assertion that a breach of contract existed. The Court held post-contractual conduct is not taken into account when interpreting the terms of a contract.
    • The motive Dad had in transferring his son the money, be it “charitable” or otherwise, was not relevant.

    The Court set aside the decision of the District Court.  The Court said that the monies were paid with an understanding that they would be repaid. This was an “inescapable conclusion”. The transactions were a contract of loan. The Court gave judgement in favour of Dad of $286,000 including interest.

    This is another example of elder abuse. The decision shows the perils of not signing a loan agreement. Going to Court – twice in this instance – was expensive and exhausting for the aging father.

    What happens if your child has a partner and buys a home?

    What if your child has a partner? The loan agreement may change depending on whose name the home is purchased under. Best that your child signs the Loan Agreement and buys the home just in their name. This binds your child alone, and the partner has no say in the matter. What if the partner objects? It is important to stay firm and explain it is ‘to protect your interests, it is nothing personal’. This protects yourself and your child, if the relationship with the partner does not end up ‘happily ever after’.

    What happens if the home is purchased in both your child and their partner’s name? Then both your child and their partner sign the Loan Agreement. Our Loan Agreements allows the loan to be lodged as a caveat. Or our Loan Agreement can be registered as a second mortgage – but the bank is notified. So caveats are more common.

    Visit Parents making loans to children  to start the process or seek legal advice form your own Solicitor.

    We are in no way connected to Legal Consolidated, we do not receive referral fees or commissions of any sort from them. This is purely general advice from a trusted source and you should seek legal advice form them or your own solicitor before making any decision.

    Looking for an adviser that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options. Do it! Make 2019 the year to get organised or it will be 2029 before you know it.

    Please consider passing on this article to family or friends. Pay it forward!

    Liam Shorte B.Bus SSA™ AFP

    Financial Planner & SMSF Specialist Advisor™

    SMSF Specialist Adviser 

     Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

    Verante Financial Planning

    Tel: 02 98941844, Mobile: 0413 936 299

    PO Box 6002 BHBC, Baulkham Hills NSW 2153

    5/15 Terminus St. Castle Hill NSW 2154

    Corporate Authorised Representative of Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

    This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

     

    Trusts 101 – A Guide to What They are and How They Work in Australia


    With all the talk about Total Super Balance caps and where people will invest money going forward if they can’t get it in to superannuation, the spotlight is being shone on “trusts” at present. This has also brought with it the claims of tax avoidance or tax minimisation, so what exactly are trusts and are there differences between Family Trusts, Units Trusts, Discretionary Trusts and Testamentary Trusts to name a few.

    Trusts are a common strategy and this article aims to aid a better understanding of how a trust works, the role and obligations of a trustee, the accounting and income tax implications and some of the advantages and pitfalls. Of course, there is no substitute for specialist legal, tax and accounting advice when a specific trust issue arises and the general information in this article needs to be understood within that context.

    Introduction

    Trusts are a fundamental element in the planning of business, investment and family financial affairs. There are many examples of how trusts figure in everyday transactions:

    • Cash management trusts and property trusts are used by many people for investment purposes
    • Joint ventures are frequently conducted via unit trusts
    • Money held in accounts for children may involve trust arrangements
    • Superannuation funds are trusts
    • Many businesses are operated through a trust structure
    • Executors of deceased estates act as trustees
    • There are charitable trusts, research trusts and trusts for animal welfare
    • Solicitors, real estate agents and accountants operate trust accounts
    • There are trustees in bankruptcy and trustees for debenture holders
    • Trusts are frequently used in family situations to protect assets and assist in tax planning.

    Although trusts are common, they are often poorly understood.

    What is a trust?

    A frequently held, but erroneous view, is that a trust is a legal entity or person, like a company or an individual. But this is not true and is possibly the most misunderstood aspect of trusts.

    A trust is not a separate legal entity. It is essentially a relationship that is recognised and enforced by the courts in the context of their “equitable” jurisdiction. Not all countries recognise the concept of a trust, which is an English invention. While the trust concept can trace its roots back centuries in England, many European countries have no natural concept of a trust, however, as a result of trade with countries which do recognise trusts their legal systems have had to devise ways of recognising them.

    The nature of the relationship is critical to an understanding of the trust concept. In English law the common law courts recognised only the legal owner and their property, however, the equity courts were willing to recognise the rights of persons for whose benefit the legal holder may be holding the property.

    Put simply, then, a trust is a relationship which exists where A holds property for the benefit of B. A is known as the trustee and is the legal owner of the property which is held on trust for the beneficiary B. The trustee can be an individual, group of individuals or a company. There can be more than one trustee and there can be more than one beneficiary. Where there is only one beneficiary the trustee and beneficiary must be different if the trust is to be valid.

    The courts will very strictly enforce the nature of the trustee’s obligations to the beneficiaries so that, while the trustee is the legal owner of the relevant property, the property must be used only for the benefit of the beneficiaries. Trustees have what is known as a fiduciary duty towards beneficiaries and the courts will always enforce this duty rigorously.

    The nature of the trustee’s duty is often misunderstood in the context of family trusts where the trustees and beneficiaries are not at arm’s length. For instance, one or more of the parents may be trustees and the children beneficiaries. The children have rights under the trust which can be enforced at law, although it is rare for this to occur.

     

    Types of trusts

    In general terms the following types of trusts are most frequently encountered in asset protection and investment contexts:

    • Fixed trusts
    • Unit trusts
    • Discretionary trusts – Family Trusts
    • Bare trusts
    • Hybrid trusts
    • Testamentary trusts
    • Superannuation trusts
    • Special Disability Trusts
    • Charitable Trusts
    • Trusts for Accommodation – Life Interests and Rights of Residence

    A common issue with all trusts is access to income and capital. Depending on the type of trust that is used, a beneficiary may have different rights to income and capital. In a discretionary trust the rights to income and capital are usually completely at the discretion of the trustee who may decide to give one beneficiary capital and another income. This means that the beneficiary of such a trust cannot simply demand payment of income or capital. In a fixed trust the beneficiary may have fixed rights to income, capital or both.

    Fixed trusts

    In essence these are trusts where the trustee holds the trust assets for the benefit of specific beneficiaries in certain fixed proportions. In such a case the trustee does not have to exercise a discretion since each beneficiary is automatically entitled to his or her fixed share of the capital and income of the trust.

    Unit trusts

    These are generally fixed trusts where the beneficiaries and their respective interests are identified by their holding “units” much in the same way as shares are issued to shareholders of a company.

    The beneficiaries are usually called unitholders. It is common for property, investment trusts (eg managed funds) and joint ventures to be structured as unit trusts. Beneficiaries can transfer their interests in the trust by transferring their units to a buyer.

    There are no limits in terms of trust law on the number of units/unitholders, however, for tax purposes the tax treatment can vary depending on the size and activities of the trust.

    Discretionary trusts – Family Trusts

    These are often called “family trusts” because they are usually associated with tax planning and asset protection for a family group. In a discretionary trust the beneficiaries do not have any fixed interests in the trust income or its property but the trustee has a discretion to decide whether anyone will receive income and/or capital and, if so, how much.

    For the purposes of trust law, a trustee of a discretionary trust could theoretically decide not to distribute any income or capital to a beneficiary, however, there are tax reasons why this course of action is usually not taken.

    The attraction of a discretionary trust is that the trustee has greater control and flexibility over the disposition of assets and income since the nature of a beneficiary’s interest is that they only have a right to be considered by the trustee in the exercise of his or her discretion.

    Bare trusts

    A bare trust exists when there is only one trustee, one legally competent beneficiary, no specified obligations and the beneficiary has complete control of the trustee (or “nominee”). A common example of a bare trust is used within a self-managed fund to hold assets under a limited recourse borrowing arrangement.

    Hybrid trusts

    These are trusts which have both discretionary and fixed characteristics. The fixed entitlements to capital or income are dealt with via “special units” which the trustee has power to issue.

    Testamentary trusts

    As the name implies, these are trusts which only take effect upon the death of the testator. Normally, the terms of the trust are set out in the testator’s will and are often used when the testator wishes to provide for their children who have yet to reach adulthood or are handicapped.

    Superannuation trusts

    All superannuation funds in Australia operate as trusts. This includes self-managed superannuation funds.

    The deed (or in some cases, specific acts of Parliament) establishes the basis of calculating each member’s entitlement, while the trustee will usually retain discretion concerning such matters as the fund’s investments and the selection of a death benefit beneficiary.

    The Federal Government has legislated to establish certain standards that all complying superannuation funds must meet. For instance, the “preservation” conditions, under which a member’s benefit cannot be paid until a certain qualification has been reached (such as reaching age 65), are a notable example.

    Special Disability Trusts

    Special Disability Trusts allow a person to plan for the future care and accommodation needs of a loved one with a severe disability. Find out more in this Q & A about Special Disability Trusts.

    Charitable Trusts

    You may wish to provide long term income benefit to a charity by providing tax free income from your estate, rather than giving an immediate gift. This type of trust is effective if large amounts of money are involved and the purpose of the gift suits a long term benefit e.g. scholarships or medical research.

    Trusts for Accommodation – Life Interests and Right of Residence

    A Life Interest or Right of Residence can be set up to provide for accommodation for your beneficiary. They are often used so that a family member can have the right to live in the family home for as long as they wish. These trusts can be restrictive so it is particularly important to get professional advice in deciding whether such a trust is right for your situation.

    Establishing a trust

    Although a trust can be established without a written document, it is preferable to have a formal deed known as a declaration of trust or a deed of settlement. The declaration of trust involves an owner of property declaring themselves as trustee of that property for the benefit of the beneficiaries. The deed of settlement involves an owner of property transferring that property to a third person on condition that they hold the property on trust for the beneficiaries.

    The person who transfers the property in a settlement is said to “settle” the property on the trustee and is called the “settlor”.

    In practical terms, the original amount used to establish the trust is relatively small, often only $10 or so. More substantial assets or amounts of money are transferred or loaned to the trust after it has been established. The reason for this is to minimise stamp duty which is usually payable on the value of the property initially affected by the establishing deed.

    The identity of the settlor is critical from a tax point of view and it should not generally be a person who is able to benefit under the trust, nor be a parent of a young beneficiary. Special rules in the tax law can affect such situations.

    Also critical to the efficient operation of a trust is the role of the “appointor”. This role allows the named person or entity to appoint (and usually remove) the trustee, and for that reason, they are seen as the real controller of the trust. This role is generally unnecessary for small superannuation funds (those with fewer than five members) since legislation generally ensures that all members have to be trustees.

    The trust fund

    In principle, the trust fund can include any property at all – from cash to a huge factory, from shares to one contract, from operating a business to a single debt. Trust deeds usually have wide powers of investment, however, some deeds may prohibit certain forms of investment.

    The critical point is that whatever the nature of the underlying assets, the trustee must deal with the assets having regard to the best interests of the beneficiaries. Failure to act in the best interests of the beneficiaries would result in a breach of trust which can give rise to an award of damages against the trustee.

    A trustee must keep trust assets separate from the trustee’s own assets.

    The trustee’s liabilities

    A trustee is personally liable for the debts of the trust as the trust assets and liabilities are legally those of the trustee. For this reason if there are significant liabilities that could arise a limited liability (private) company is often used as trustee.

    However, the trustee is entitled to use the trust assets to satisfy those liabilities as the trustee has a right of indemnity and a lien over them for this purpose.

    This explains why the balance sheet of a corporate trustee will show the trust liabilities on the credit side and the right of indemnity as a company asset on the debit side. In the case of a discretionary trust it is usually thought that the trust liabilities cannot generally be pursued against the beneficiaries’ personal assets, but this may not be the case with a fixed or unit trust.

    Powers and duties of a trustee

    A trustee must act in the best interests of beneficiaries and must avoid conflicts of interest. The trustee deed will set out in detail what the trustee can invest in, the businesses the trustee can carry on and so on. The trustee must exercise powers in accordance with the deed and this is why deeds tend to be lengthy and complex so that the trustee has maximum flexibility.

    Who can be a trustee?

    Any legally competent person, including a company, can act as a trustee. Two or more entities can be trustees of the same trust.

    A company can act as trustee (provided that its constitution allows it) and can therefore assist with limited liability, perpetual succession (the company does not “die”) and other advantages. The company’s directors control the activities of the trust. Trustees’ decisions should be the subject of formal minutes, especially in the case of important matters such as beneficiaries’ entitlements under a discretionary trust.

    Trust legislation

    All states and territories of Australia have their own legislation which provides for the basic powers and responsibilities of trustees. This legislation does not apply to complying superannuation funds (since the Federal legislation overrides state legislation in that area), nor will it apply to any other trust to the extent the trust deed is intended to exclude the operation of that legislation. It will usually apply to bare trusts, for example, since there is no trust deed, and it will apply where a trust deed is silent on specific matters which are relevant to the trust – for example, the legislation will prescribe certain investment powers and limits for the trustee if the deed does not exclude them.

    Income tax and capital gains tax issues

    Because a trust is not a person, its income is not taxed like that of an individual or company unless it is a corporate, public or trading trusts as defined in the Income Tax Assessment Act 1936. In essence the tax treatment of the trust income depends on who is and is not entitled to the income as at midnight on 30 June each year.

    If all or part of the trust’s net income for tax purposes is paid or belongs to an ordinary beneficiary, it will be taxed in their hands like any other income. If a beneficiary who is entitled to the net income is under a “legal disability” (such as an infant), the income will be taxed to the trustee at the relevant individual rates.

    Income to which no beneficiary is “presently entitled” will generally be taxed at highest marginal tax rate and for this reason it is important to ensure that the relevant decisions are made as soon as possible after 30 June each year and certainly within 2 months of the end of the year. The two month “period of grace” is particularly relevant for trusts which operate businesses as they will not have finalised their accounts by 30 June. In the case of discretionary trusts, if this is done the overall amount of tax can be minimised by allocating income to beneficiaries who pay a relatively low rate of tax.

    The concept of “present entitlement” involves the idea that the beneficiary could demand immediate payment of their entitlement.

    It is important to note that a company which is a trustee of a trust is not subject to company tax on the trust income it has responsibility for administering.

    In relation to capital gains tax (CGT), a trust which holds an asset for at least 12 months is generally eligible for the 50% capital gains tax concession on capital gains that are made. This discount effectively “flows” through to beneficiaries who are individuals. A corporate beneficiary does not get the benefit of the 50% discount. Trusts that are used in a business rather than an investment context may also be entitled to additional tax concessions under the small business CGT concessions.

    Since the late 1990s discretionary trusts and small unit trusts have been affected by a number of highly technical measures which affect the treatment of franking credits and tax losses. This is an area where specialist tax advice is essential.

    Why a trust and which kind?

    Apart from any tax benefits that might be associated with a trust, there are also benefits that can arise from the flexibility that a trust affords in responding to changed circumstances.

    A trust can give some protection from creditors and is able to accommodate an employer/employee relationship. In family matters, the flexibility, control and limited liability aspects combined with potential tax savings, make discretionary trusts very popular.

    In arm’s length commercial ventures, however, the parties prefer fixed proportions to flexibility and generally opt for a unit trust structure, but the possible loss of limited liability through this structure commonly warrants the use of a corporate entity as unitholder ie a company or a corporate trustee of a discretionary trust.

    There are strengths and weaknesses associated with trusts and it is important for clients to understand what they are and how the trust will evolve with changed circumstances.

    Trusts which incur losses

    One of the most fundamental things to understand about trusts is that losses are “trapped” in the trust. This means that the trust cannot distribute the loss to a beneficiary to use at a personal level. This is an important issue for businesses operated through discretionary or unit trusts.

    Establishment procedures

    The following procedures apply to a trust established by settlement (the most common form of trust):

    • Decide on Appointors and back-up Appointors as they are the ultimate controllers of the trust. They appoint and change Trustees.
    • Settlor determined to establish a trust (should never be anyone who could become a beneficiary)
    • Select the trustee. If the trustee is a company, form the company.
    • Settlor makes a gift of money or other property to the trustee and executes the trust deed. (Pin $10 to the front of the register is the most common way of doing this)
    • Apply for ABN and TFN to allow you open a trust bank account

    Establish books of account and statutory records and comply with relevant stamp duty requirements (Hint: Get your Accountant to do this)

    Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

    Liam Shorte B.Bus SSA™ AFP

    Financial Planner & SMSF Specialist Advisor™

    SMSF Specialist Adviser 

     Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

    Verante Financial Planning

    Tel: 02 98941844, Mobile: 0413 936 299

    PO Box 6002 BHBC, Baulkham Hills NSW 2153

    5/15 Terminus St. Castle Hill NSW 2154

    Corporate Authorised Representative of Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

    This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

    SMSF Jargon busting – Who are the related parties of an SMSF?


    "Related Parties"

    So you have a great idea to move some assets to your SMSF but you want to stay within the rules and keep your fund compliant. Then you hit the jargon associated with Superannuation rules and regulations.

    You need to understand who are “related parties” of your SMSF for two reasons, to ensure compliance with the acquisition from a related party rules and to determine the in-house assets.

    A related party is defined in the Superannuation Industry Supervision) Act 1993 known as the SIS Act. This is the bible when it comes to Superannuation so you should save that link above. Anyway in the SIS Act sec 10(1) a related party is defined as:

    • Fund member
    • Standard employer-sponsor of the fund or
    • Part 8 associate of a fund member or a part 8 associate of a standard employer-sponsor of the fund.

    Ok the first one is easy. Any member including you yourself is a related party.

    Standard Employer

    A standard employer sponsor of a fund is an employer who contributes to the fund due to an agreement between the employer and the trustee of the fund. These were common in the early days of SMSFs but largely non-existent now.

    Where an employer only contributes to a fund due to an agreement between the member and the employer such as under a salary sacrifice arrangement, they will not be considered a standard employer sponsor.

    If an SMSF has a standard employer sponsor, which would be uncommon, the relationship will be noted either in the trust deed or in an attached schedule to the deed.

    Part 8 associate

    Now prepare for a headache to hit you hard after reading this one.

    Part 8 associates are broken down in the legislation to Part 8 associates of individuals, companies and partnerships. However, if there is no standard employer sponsor, we only need to examine the part 8 associates of the members who will always be individuals.

    The part 8 associates of a member are:

    1. a relative of the member (parent, grandparent, brother, sister, uncle, aunt, nephew, niece, linear descendant or adopted child of the member or their spouse or a spouse of the aforementioned)
    2. other members of the SMSF (a person who is not a member but acting as individual trustee or director under an Enduring Power of Attorney is not necessarily a Part 8 associate)
    3. a partner of the member (legal partnership, not ‘business partners’ i.e. company directors) and their spouses and children
    4. the trustee of a trust the member controls and
    5. a company sufficiently influenced by, or in which majority voting interest is held by the member and their Part 8 associates either individually or together.

    A member of the fund will be deemed to control a trust where the member and/or their part 8 associates are:

    • entitled to a fixed entitlement of more than 50 per cent of the capital of the trust,
    • entitled to a fixed entitlement of more than 50 per cent of the income of the trust,
    • able or accustomed (formally or informally) to direct the trustees to act in accordance with their directions or
    • able to appoint or remove trustees.

    A company will be deemed to be controlled by a member where the directors are accustomed or under an obligation to act under the instructions of the member and/ or their Part 8 associates or the member and/ or their part 8 associates have more than 50 per cent of the voting rights.

    OK, so I warned you to beware of the headache inducing nature of dealing with “Part 8 Associates”. Was I right or was I RIGHT!

    The best advice I can give you is to get advice before transferring assets and ask for the advice and get that advice in writing so all parties are sure of the scenario and no mistakes are made.

    Are you looking for an adviser that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

    Liam Shorte B.Bus SSA™ AFP

    Financial Planner & SMSF Specialist Advisor™

    SMSF Specialist Adviser 

     Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

    Verante Financial Planning

    Tel: 02 98941844, Mobile: 0413 936 299

    PO Box 6002 BHBC, Baulkham Hills NSW 2153

    5/15 Terminus St. Castle Hill NSW 2154

    Corporate Authorised Representative of Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

    This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

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