Although trusts are common, they are often poorly understood. Setting up a trust is often driven by a new business opportunity, a growing business, or a need to better structure your investments. When set up correctly, there are clear tax benefits when it comes to operating as a family trust.
The importance of the correct structure in which to hold your investment, (be it property or any other) and its correct use could mean the difference between losing or retaining your assets and the paying or not paying of hundreds of thousands of dollars in excess tax over the longer term. 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.
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 can 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. 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.
You should always obtain advice from a specialist tax adviser and a solicitor when considering setting up 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.
All types of trusts (with the exception of Superannuation Trusts) established in either NSW, NT or Victoria need to be duty stamped upon execution.
How Family/Discretionary Trusts Operate
A discretionary trust or family trust is a common type of trust used to hold assets or run a family business. It is one of the most common trust structures. Essentially, it is a relationship where a trustee holds property or assets for the benefit of a beneficiary or beneficiaries.
The one who holds the assets is called a trustee. A trust is not a legal entity and it requires the establishment of a legal entity to enter into agreement for it on behalf of the trust. Trustees can either be an individual or a company.
The Trust is the relationship or structure between trustees and beneficiaries. You could think of a Trust as a container of sorts, that things are placed within. All assets placed into the container become property of the Trust, controlled by the trustee for the sake of the beneficiary. See the diagram below:
Who are parties to a Trust?
The Trustee
The trustee can be an individual, individuals or a company and they are the legal entity who owns the assets and makes decisions on the trust’s behalf. There can be more than one trustee and more than one beneficiary. In most cases, the trustees are usually parents or a company that they own, and the beneficiaries are their children or dependants.
The trustee owns and controls the business’ assets, distributes income, and must comply with the obligations of the trust deed and act with the best interests of the beneficiaries in mind. The trustee is also responsible for registering the tax purposes, lodging tax returns and meeting any other tax obligations on behalf of the trust.
Who will be Trustee?
Note as the decision maker, the trustee will be held responsible for actions by the trust, as is the case with any owner. We would normally recommend a company to be the trustee as the company would not own any assets and as such gives you an extra layer of protection, especially if you own assets in your name. If you as an individual are trustee, then your personal assets may be at risk in the event of legal action against the trust which insurance will or does not cover.
Beneficiaries
The beneficiaries are the people entitled to the income and assets of the trust. The beneficiaries of the trust are usually members of a family (family group), as well as companies and trusts that are controlled by that family. For example, the primary or default beneficiaries may be a parent or parents and the secondary beneficiaries maybe children, grandparents, companies etc.
The role of the default beneficiary is to receive and/or decide the direction of any funds that aren’t allocated by the trustee. It’s also important to note that you cannot change the default beneficiary without triggering capital gains tax and stamp duty. Beneficiaries will generally include their share of the trust’s net income as income in their own tax returns and if they receive income from other sources they will be taxed for these as well.
Primary Beneficiaries
You need to identify the primary beneficiaries by name. Depending on the deed the beneficiaries can be changed at any time and you can make distributions to anyone even if you do not identify them here. With certain deeds there may be tax consequences so get this checked before doing so.
Financial institutions, when looking at a loan application in the trust name or an individually named borrower, will also review this section of the trust and would normally require any named initial beneficiaries to be part of a loan application. Related parties to the initial beneficiaries are not normally party to the trust and as such are not normally part of the above review unless they have actually received distributions. The trust deed provides that the beneficiaries include such persons as are related to you as follows and as such there is no need to specifically identify them.
Note also that beneficiaries include companies and trusts associated with all the persons specifically identified
Appointor
The Appointor (sometimes called the Principal or Guardian) has, in fact, the most powerful role in a trust and should be carefully selected. While the trustee is the one who decides what happens to the assets, funds and profits of the trust, it is the Appointor who has the power to change the trustee and appoint a new one. It is important to consult with your solicitor and include in your will the transfer of this role upon your death and that this power is passed on to the person of your choosing.
Settlor
The Settlor should never be the beneficiary of the Trust to avoid income tax issues for the trustee. The Settlor is someone who puts down a sum of money to start the trust, commonly around $10. Once the trust is established, the Settlor has no other role, entitlements, rights or connection to the trust. This $10 is a gift to commence (settle) the trust. It takes on the literal meaning of a gift i.e. you cannot give it yourself and the giver must not get back anything in return. Therefore the settlor can never be a beneficiary of the trust. We would normally see a friend gift you the funds. The settlor will need to sign the trust deed when you get it, to confirm the gift, after which they have no involvement.
- Discretionary/Family Trusts: Advantages
Asset Protection
Many business owners face a degree of risk in owning a business, for example if the business fails, they may be sued personally or put at risk of bankruptcy. Similarly, those in partnerships, particularly those with bank debts, can face similar risks. Assets that are within a family trust are protected from creditors, so even if a claim is made against you, the assets are not in your name and therefore cannot be accessed in these circumstances.
Tax Advantages
Operating your business from a family trust and having the company act as trustee means you can retain the limited liability benefits of a company structure while taking advantage of the tax flexibility benefits of a family trust.
When set up correctly, there are clear family trust tax benefits for individuals and businesses. Because the trust itself does not pay tax, beneficiaries are taxed based on the amount of income placed in their name (as well as any other income they may have from other sources). A family trust allows you to distribute profit amongst family members to utilise their income tax “tax-free thresholds”. If the business’ profits grow too large to distribute effectively, a family trust can also distribute to a separate company to cap the tax rate at 30 percent.
Keeping it in the Family
Whether you’re looking to keep your family home in the family or want to stagger inheritance distribution to ensure it’s not all spent at once, a family trust prevents, will contests and secures assets. Assets held within the trust do not form part of a deceased estate preventing contests to a Will or your child’s spouse claiming their share of an inheritance.
A family trust can provide long-term financial support for your children or grandchildren, allowing you to invest in their long-term education and distribute family assets to future generations. A family trust can also be a great way to protect vulnerable beneficiaries who may make poor spending decisions if they were to control their own assets.
- Family/ Discretionary Trusts: Disadvantages
Any income earned by the trust that is not distributed is taxed at the highest marginal tax rate. If you do find you are making a lot of profit as a family trust, those profits must be pushed out to beneficiaries. You could run out of beneficiaries and those beneficiaries will be paying highest tax rate. With a family trust, you can add additional beneficiaries if the trust deed allows for it, but care must be taken as capital gains tax and stamp duty may be triggered if done incorrectly. The trust cannot allocate tax losses to beneficiaries either.
Family Matters
There can be challenges in running the trust when other family issues occur. There can also be some complexities regarding succession planning and asset allocation upon the death of the trustee. With a Will, you can dictate what goes to who, however, a family trust is separate to an individual’s will and you may be able to choose who controls the trust, you don’t dictate how they control it.
Negative Gearing
One of the disadvantages of a discretionary trust is the loss of some benefits associated with negative gearing investments through the trust. Namely, if a discretionary trust acquires a property and borrows to invest in that property, then any losses generated are accumulated in the trust and cannot be distributed to the beneficiaries.
This is not such a problem if the discretionary trust itself other sources of income has but can give rise to significant problems for, say, PAYG-type taxpayers who wish to acquire a property and negatively gear at the same time.
Obviously, the advantages of having the property owned by a discretionary trust may be outweighed in this case by the disadvantage of any negative gearing being generated in the trust itself. The development of a unit trust (one where the discretionary nature is preserved in the trust deed but allows the issue of units) is an attempt to overcome this negative gearing problem.
Family Trust vs Company
One of the key differences between a trustee company and a trading company, is that the trustee company doesn’t trade, it doesn’t have its own tax file number and it doesn’t lodge a tax return of its own. It simply makes decisions for and on behalf of the family trust.
Some other important distinctions are:
- Companies cannot access the 50% capital gains discount, whereas a family trust can. Small business capital gains tax discounts can be accessed by both
- A company is paying tax at 30% or 25% and pays tax from the first dollar. However, a family trust doesn’t pay tax and profits are pushed out each year
- A company can accumulate profits and reinvest those profits into the business as working capital
- Companies are great for doing business with unrelated parties and you will be protected by the Corporations Act. As for a trust, if a party is not within family group, you cannot bring them into the trust with you
How can we help?
If you have any questions or would like further information or you are seeking property tax advice, please feel free to contact our office via email –info@investplusaccounting.com.au or phone 02 9299 7000 to either speak with someone or arrange a time for a meeting so we can discuss your requirements in more detail. You can arrange a free 15 minute no obligation chat to discuss your options. Please arrange an appointment with our office by clicking here
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