A declaration of trust happens when the legal owner of an asset declares that they now hold that asset on trust for another person or persons.
A more technical definition is found in legislation, for example in section 8(3) of the Duties Act 1997 NSW which has:
“declaration of trust” means any declaration (other than by a will or testamentary instrument) that any identified property vested or to be vested in the person making the declaration is or is to be held in trust for the person or persons, or the purpose or purposes, mentioned in the declaration although the beneficial owner of the property, or the person entitled to appoint the property, may not have joined in or assented to the declaration.
Homer owns 123 Smith Street. He is the legal and beneficial owner. One day he decides he wants to begin holding that property but for the benefit of his son Bart. Homer makes a declaration of trust that from this day forward he holds the property as trustee for Bart.
Homer is still the legal owner, but now Bart is the beneficial owner of the property. If Homer goes bankrupt the property is, at face value, not his property and not available to creditors (but…). If Homer dies this property is not one that can pass via his will. If the property is rented out the income will be taxed in the hands of Bart etc.
There are also various tax and duty consequences to making a declaration of trust and I will cover these in a future post.
Where a trust has income and no one is presently entitled to it, the trustee of the trust will be taxed on this income at the top marginal tax rate because of s99A(4) ITAA36
Note that the income doesn’t necessarily need to be distributed, it could be retained by the trust yet still be taxed in the hands of the beneficiary if they have been made presently entitled to it.
On present entitlements and trusts see this post I wrote a few years ago:
Legal Tip 87: Trusts and Unpaid Present Entitlements
Simpson family trust has $10,000 in income in year 1. The trustee makes Bart presently entitled to the income so Bart is the one that is taxed on this income. The trustee may not physical transfer the money, but if the is the case Bart will still be taxed (and he will have an unpaid present entitlement with the trust, which is similar to a loan). Bart has no other income and pays no tax.
In year 2 the trust has $10,000 in income, but the trustee doesn’t make anyone presently entitled – perhaps they forgot, or perhaps their resolutions were defective.
The trustee will pay the tax at the top tax 47%