Trusts are relationships between the legal owner of the property of the trust (the trustee) and the beneficial owners (the beneficiaries). A family trust gives a trustee the power to distribute income to the beneficiaries each year at their discretion. This flexibility in distributing income has a variety of benefits and may be attractive when first deciding how to run your business. This article sets out the benefits of a family trust, being asset protection, tax planning and succession planning.
Trusts can be set up as a method of protecting personal assets. When you form a trust which includes your assets, you are no longer considered the legal owner of such assets—the trustee is the legal owner of the assets on trust for the beneficiaries.
Generally, those assets become out of reach of creditors if you get into financial difficulty (such as bankruptcy). In some situations, a trust is also a further layer of protection. The most common example of this is when the founders of a company hold their shares through a family trust rather than holding shares in their personal name.
However, it is essential to select the right trustee. The trustee may be an individual, a company or various individuals or entities. As trustees are personally liable for trust debts (although they have the right to reimbursement), using a corporate trustee provides additional asset protection advantages.
The advantage of using a corporate trustee is evident where a trustee borrows money to invest on behalf of the trust. If the investment were to lose value, the trust may no longer have sufficient assets to repay the lender. This would make the trustee personally liable and put personal assets, such as their family home, at risk. In contrast, a corporate trustee which has nominal capital and does not carry on any other activities will have an additional layer of protection.
Trusts may also be useful as you carry out your tax planning. Distributing income among beneficiaries who are on lower marginal tax rates can reduce the effective tax rate on a trust. This reduces the tax rate compared to taxing the entire amount in a single person’s hands. Overall, these tax planning benefits become clear when comparing how shareholders of company versus beneficiary’s of a trust may pay tax.
1. Where Shareholders Operate the Small Business
If a family business were to operate through a company with two individual shareholders instead of using a trust:
- the company’s profits will be taxed at either a flat 30% or 27.5% for certain small businesses (such as those turning over less than $25 million);
- if company profits are distributed as fully franked dividends to the two individual shareholders, they will be taxed at their personal marginal rates;
- even after applying the franking credits, the two shareholders are likely to be subject to top-up tax. This is the tax difference between the company’s tax and the shareholder’s personal tax rate of up to 45%; and
- as the maximum personal marginal tax rate is currently 45%, top-up tax can be up to 15% or 17.5%, depending on which corporate tax rate applies.
2. Where a Trust Operates the Family Business
Alternatively, where a family trust owns the shares in a company:
- the owners’ two adult children on the 32.5% marginal tax rate generally count as beneficiaries;
- the two adult children receive fully franked dividends; and
- the children would only be subject to a top-up tax of either 2.5% or 5%, depending on whether the 30% or 27.5% corporate tax rate applies.
This would require making a formal Family Trust Election so that franking credits could flow through the trust to the beneficiaries.
Further, this cannot merely be a paper distribution. An arrangement where the business owners receive the actual funds could fall foul of specific anti-avoidance rules known as reimbursement agreements.
The benefit of using a family trust is that you can control, but not own, trust assets. Trust assets do not form part of the controller’s estate on their death. Therefore, the controller’s will does not deal with trust assets.
Ordinarily, the trust deed includes succession provisions for the trustee and the appointor. Otherwise, the controller may pass day-to-day control of the trust following their death by bequeathing the shares in the corporate trustee.
Your estate planning and succession planning fit together to achieve your desired outcome with minimal tax and duty leakage.
There are numerous reasons to establish trusts, the most common ones being:
- asset protection;
- tax planning; and
- transferring assets.
A trust structure is often beneficial for holding assets. However, the method to best achieve that benefit is dependent on your particular circumstances. Therefore, it is important to seek legal and tax advice before making a decision to set up a trust. To discuss whether a family trust is appropriate in your circumstances, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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