Family Trusts and Separation

What is a family trust?

A family trust — typically a discretionary trust established for the benefit of family members — is one of the most common structures used by Australian families and small businesses to hold assets, manage investments and distribute income. When a relationship breaks down, however, the trust can become one of the most complex and contentious issues in a property settlement.

The central question family lawyers and the courts must answer is whether the assets held inside a family trust form part of the matrimonial property pool available for division, or whether they sit outside it as a "financial resource" that only influences the overall division.

Property or financial resource: why the distinction matters

Under the Family Law Act 1975 (Cth), the court has broad power to alter property interests between separated spouses under section 79. But that power only extends to "property" as defined in section 4(1).

Property includes any vested or contingent legal or equitable interest in real or personal property. If an interest in a trust is found to be "property" of a party, the court can directly alter that interest — for example, by ordering the transfer of units, removing a beneficiary, or directing the trustee to act in a particular way.

Financial resources, on the other hand, are assets or income sources that a party can reasonably expect to receive in the future but which are not presently owned. The existence of a financial resource does not give the court power to directly transfer or alter it. Instead, it is taken into account as a factor that justifies a more favourable property division to the other party.

Whether a trust interest is classified as property or a financial resource can dramatically change the outcome of a settlement.

How courts determine whether trust assets are property

There is no single test. Courts look at the nature of the trust, the powers of the trustee, the rights of the parties, and the practical reality of control. The leading authority remains Kennon v Spry (2008) 238 CLR 366, in which the High Court examined whether assets held in a discretionary trust controlled by the husband could be treated as property of the marriage.

The High Court found that where one party has effective control over a trust — including the power to appoint trustees, add or remove beneficiaries, or direct distributions — the trust assets may be considered property or a sham. The court looks past the formal legal structure to the substance of the arrangement.

Key factors the court considers include:

• Control — who controls the trustee, and can they direct distributions or wind up the trust?
• Beneficiary status — is the party a named beneficiary, a potential beneficiary, or excluded?
• Trust history — have distributions been made to the party or the family unit in the past?
• Timing — was the trust established before or during the relationship? Was it altered after separation?
• Contributions — did either party contribute assets or income to the trust?
• Purpose — was the trust created for genuine asset protection and tax planning, or to defeat a family law claim?

Types of trusts and their treatment

Discretionary (family) trusts

Discretionary trusts are the most common structure for families and small businesses. The trustee has broad discretion to distribute income and capital among beneficiaries. Because no beneficiary has a fixed entitlement, an individual beneficiary's interest is usually considered a mere expectancy — not property.

However, if one party controls the trustee (for example, by being the appointor with power to remove and replace the trustee), the court may treat the trust assets as property of that party or as a sham trust. The court can also treat the trust as a financial resource if the controlling party can direct distributions to themselves.

Unit trusts

In a unit trust, unitholders have a proprietary interest in the trust assets proportionate to their unit holdings. This interest is generally recognised as property under the Family Law Act. The court can therefore make direct orders altering unit holdings between separated spouses, similar to shares in a company.

Fixed trusts

Fixed trusts give beneficiaries a specific, fixed entitlement to income or capital. These fixed interests are generally treated as property, making them directly subject to alteration under section 79.

Hybrid and testamentary trusts

Hybrid trusts combine elements of discretionary and fixed trusts, and their treatment depends on the specific rights each party holds. Testamentary trusts established under a will are assessed on their terms, the degree of control, and whether the party has received distributions or has a realistic expectation of receiving them.

Sham trusts and defeating claims

If a trust was created or altered for the dominant purpose of defeating a spouse's claim — for example, transferring assets into a trust controlled by a family member shortly before or after separation — the court may set aside the transaction under section 106B of the Family Law Act. The court can also pierce the trust veil if it is a sham, meaning the trust form is a facade and the controlling party effectively owns the assets personally.

Signs that a trust may be challenged as a sham or defeating transaction include:

• The trust was established shortly before or after separation
• Assets were transferred into the trust without genuine commercial purpose
• The trust is controlled by the party's relatives or associates
• No trust deed was properly executed or followed
• The trust has not operated in accordance with its terms (no distributions, no proper accounts)

Practical steps if you are separating and a family trust is involved

1. Gather documents early. Obtain the trust deed, any amendments, financial statements, tax returns and distribution minutes. These documents reveal the true nature of the trust and each party's rights.
2. Identify control. Determine who is the appointor, trustee, and whether any party has a power of direction or veto. Control is often more important than formal ownership.
3. Review contributions. Trace which assets were contributed to the trust, when, and from what source. Pre-relationship contributions, inheritances and post-separation acquisitions are treated differently.
4. Assess distributions. A history of regular distributions to the family unit strengthens the argument that the trust is a resource of the marriage, not an independent structure.
5. Consider tax consequences. Altering trust interests can trigger capital gains tax, stamp duty and other tax outcomes. Specialist tax and accounting advice should be obtained alongside legal advice.
6. Do not unilaterally alter the trust. Removing a spouse as beneficiary, changing the trustee or distributing assets without disclosure can seriously damage your credibility and expose you to costs orders or adverse findings.

What outcomes can the court order?

Depending on how the trust is characterised, the court has a range of powers:

• If the interest is property: direct transfer of units, alteration of beneficiary status, removal of the party as appointor, or an order that the trustee distribute assets in a specified manner.
• If the trust is a financial resource: adjust the overall property division in favour of the other party to reflect the resource's value and the controller's access to it.
• If the trust is a sham or defeating transaction: set aside the transaction and treat the assets as if they still belong to the party personally.
• In all cases: make orders for spousal maintenance, child support and costs as appropriate.

Protecting legitimate asset protection structures

Not every trust established during a relationship is vulnerable. Trusts created years before the relationship began, funded by third-party gifts or inheritances, and operated strictly in accordance with their terms may be protected — particularly if neither party has unilateral control and both spouses have historically benefited.

The court recognises that family trusts serve legitimate purposes: asset protection from business creditors, tax-effective income splitting, estate planning and wealth preservation across generations. The critical issue is whether the trust structure reflects genuine planning or whether it is being used to shield assets from a fair property settlement.

Frequently asked questions

Is my family trust automatically included in the property pool?

No. Whether a family trust is included depends on the type of trust, the rights of each party, the history of distributions, and who controls the trust. Discretionary trusts where one spouse is merely a potential beneficiary are not automatically property, but they may be treated as a financial resource.

Can my ex-spouse claim assets in a trust controlled by my parents?

If the trust is genuinely controlled by third parties (such as parents) and you have no power to direct distributions or remove the trustee, the trust assets may fall outside the property pool. However, if you have historically received substantial distributions, or if the trust was funded by matrimonial assets, the court may still treat it as a financial resource or investigate whether it is a sham.

What if I was removed as a beneficiary after we separated?

Unilateral removal of a spouse as beneficiary after separation is viewed seriously by the court. It may be characterised as a defeating transaction under section 106B, or as evidence that the trust is a sham. The court can set aside such actions and make orders as if the removal never occurred.

Does it matter when the trust was established?

Yes. Trusts established before the relationship began and funded by pre-relationship assets or inheritances are generally treated more favourably than trusts created during the relationship or shortly before separation. However, if matrimonial assets were subsequently contributed to the trust, those contributions may still be relevant.

Should I get legal advice before making any changes to the trust?

Absolutely. Any alteration to a trust deed, trustee or beneficiary roster after separation should only be made with specialist family law advice. Unilateral changes can backfire, expose you to adverse costs orders, and undermine your broader negotiating position.