Family and Discretionary Trusts

In legal terms, a trust is a relationship (not a legal entity) in which one party (the settlor) gives property to another person (the trustee) to hold or conducts a business for the benefit of a third person (beneficiary). Trusts are treated as taxpayer entities for the purposes of tax administration. The trustee is responsible for managing the trust’s tax affairs, lodging tax returns and paying some tax liabilities. The beneficiaries (with some exceptions) include their share of the trust’s net income as income in their own tax returns.

Running your business through a trust offers many advantages. Trusts are a good way to manage your tax and protect your assets. A trust is a legal structure that allows one or more people (or companies) to manage property or run a business for somebody else’s benefit. Depending on what the trust is for, this person might receive:

• Capital
• Income, or
• A combination of the two.

There are different types of trusts. These include:

• Discretionary trusts
• Family trusts, and
• Many others

What are Discretionary Trusts?

Discretionary trusts are set up to allow the trustee who manages the trust to choose:

• Who benefits from the trust, and
• How much money each beneficiary is to receive

This means that the amount of money each beneficiary receives under a discretionary trust is variable. The trustee decides the amount distributed to beneficiaries each year.

What are Family Trusts?

Family trusts as largely discretionary trusts that hold the family’s assets or run a family business. Usually, one or more family members will manage the trust assets for the benefit of the whole family.

The Persons Involved in Trusts

• The settlor (typically a lawyer or accountant) is the person responsible for setting up the trust and naming the beneficiaries. The settlor cannot benefit from the trust, so once the trust is created, they normally have no further involvement.
• The trustee is the legal owner of the trust property, they manage the assets and run all the trust business affairs for the benefit of the beneficiaries. All transactions for the trust are carried out by and in the name of the trustee.
• The appointor (aka guardian or principal) has the power to appoint and remove the trustee. This usually happens when a trustee dies or otherwise cannot continue to manage the trust.
• The beneficiaries are the people or companies for whose benefit the trust is created and managed. The beneficiaries have the right to be considered when the trustee makes decisions about distributing money or property from the trust.

The Trust Deed

This is the legal document that formally creates the trust and outlines how it will work. It will usually set out:

• Conditions, terms and rules for creating and managing the trust
• The objectives of the trust fund
• Who the beneficiaries are
• Who the trustee is, and
• How payment will be distributed from the trust

The Advantages of Discretionary Trusts

People may choose to set up a trust for many different reasons. However, there are several business advantages of using discretionary trusts.

• Asset Protection – A discretionary trust allows a person to hold onto their assets without being the legal owner of the property. This can have significant advantages. For example, if creditors were to pursue the assets of a beneficiary, the trust property is generally protected because the trustee is the legal owner.
• Tax Management – A company structure has to pay income tax on its net income every financial year. Discretionary trusts, however, generally do not have to pay income tax. Instead, the beneficiaries pay tax on their share of the trust’s net income. In a family trust, this means that the trustee can distribute assets in a way that reduces the overall tax paid by the family.
• Discount on Capital Gains taxes – Trusts may be eligible for the general 50% capital gains tax (CGT) discount on the disposal of capital assets.
• Beneficiary Income – Discretionary trusts are a great way of providing income to beneficiaries who may be dependent or otherwise unable to manage their assets.

The Disadvantages of Discretionary Trusts

Even though trusts can offer many advantages, there are also some disadvantages of using trust as a business structuring option.

• Expense – Trusts can be quite costly to set up, administer and restructure.
• Liability of Trustees – Trusts offer excellent asset protection for the beneficiaries. However, because trustees are the legal owners of the trust property, they are personally liable for any trust debts incurred. Having a company trustee, rather than an individual, can reduce this liability.
• Growth and Investment – Investors tend to favour putting their money into company structures rather than trusts. Because of this, it can be harder to grow a business that runs through a trust.
• Retaining Profits – Unlike a company, trusts are not designed to keep any profits. If trust beneficiaries do not receive all profits, the trust assets will be heavily taxed.

Conclusion

A discretionary trust is a common business structure in Australia as it offers several important taxation advantages. It is also well-suited for family businesses as it maintains a high degree of flexibility and protection for beneficiaries.

However, discretionary trusts are not suitable for all types of businesses. In some cases, taxation is more burdensome with a discretionary trust than with another business structure. Business owners may also find that obligatory compliance is more than they want to manage. No two discretionary or family trusts are the same. After all, every business and every family is different.