Running a business can be very rewarding. Ask any business owner. The Australian economy is built on the success of many small businesses. However, running a business carries many risks too. So, if you are a business owner, you must take proactive steps from the outset to limit your business creditors’ access to your personal assets, should your business run into trouble. Personal assets are any tangible or intangible assets of yours that are separate from your business assets. This can include, among others, your house, car and any publicly traded shares you own. One way to shield your personal assets from your business creditors is to set up a discretionary trust. Likewise, this trust will now own those assets. This article explores how discretionary trusts are beneficial for business owners from an asset protection and tax planning perspective.
What is a Trust?
A trust is a legal arrangement where the legal ownership of an asset is separate from its beneficial ownership. The legal owner, called a trustee, may deal with the asset at its discretion. Yet, any loss or profit made from those assets is for the benefit (or loss) of the beneficial owner. This person is the beneficiary. The trustee is obliged to act in the best interests of the beneficiaries.
What is a Discretionary Trust?
A discretionary trust is a type of trust structure. It gives the trustee the discretion to distribute income from the trust assets to the beneficiaries as it deems fit. The trustee’s discretion includes choosing whether to distribute income to a beneficiary and how much to give.
Likewise, discretionary trusts are particularly beneficial for business owners from an asset protection and tax planning perspective. The following section explains these benefits in greater detail.
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Setting up a discretionary trust to hold your personal assets is a great way to shield the assets from your business creditors should your business run into trouble.
Business Creditors’ Ability to Access Your Personal Assets
Irrespective of whether you have set up your business as a sole trader, partnership, or company, there are ways a business creditor can access your personal assets. To do so, the business creditor will need to establish that you are personally liable for your business’ debt. If they can establish this, the creditors can call upon you and potentially claim rights over your personal assets to satisfy that debt.
Establishing a business owner’s personal liability regarding the liabilities of their business is straightforward in the case of a sole trader and a partnership. A sole trader and each partner in a partnership are personally liable for any debts and obligations of the business. Alternatively, a business set up as a company is a separate legal entity from shareholders and company directors. This technically separates your personal liabilities from the liabilities of the business. However, third parties often find a way around the separate legal personality of a company. For example, they may require the company’s directors to personally guarantee the obligations of the business as a condition of entering into contracts with the business. Lenders, such as banks, commonly ask for this kind of requirement.
Asset Protection in a Discretionary Trust
By setting up a discretionary trust, that trust holds your personal assets. Likewise, your business creditors cannot generally access those assets. For example, you could hypothetically set up a discretionary trust where you and your immediate family are the beneficiaries, and you or a company controlled by you is the trustee. Then, any creditors who have a claim against you (either in your personal capacity or your business) cannot access those assets held in trust by you. This is the case, despite you being a beneficiary or the trustee of the trust.
The reason for this is that beneficiaries of a discretionary trust do not own the assets in a trust. Likewise, they also do not have any enforceable rights or interest in those assets. What they have is an expectation to be distributed an income at the discretion of the trustee. Additionally, the creditors cannot generally access the trust assets to meet the personal liabilities of a trustee, which that trustee did not incur in a trustee capacity.
Tax Advantage
An added advantage of holding your personal assets in a discretionary trust is tax benefits. This is especially so if your personal assets include profit-generating assets like:
- investment property;
- shares in companies; or
- cryptocurrencies.
As noted above, what distinguishes a discretionary trust from other trust structures is the power of the trustee to distribute the trust income to the beneficiaries as they wish. Hypothetically, you could set up a discretionary trust that holds your personal assets and the beneficiaries could be the members of your immediate family. If so, you may distribute any income from the trust assets among your immediate family members to minimise the tax you pay. For instance, you may choose to give the most significant proportion of the trust income for a given year to your child. Currently, children are taxed at a much lower tax bracket than adults. This is why discretionary trusts are often viewed as a tool for tax rate arbitrage.
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Key Takeaways
A discretionary trust is a type of trust arrangement. The trustee has the power to decide how much income from the trust is distributed to the beneficiaries, if at all. If you run a business, you may want to consider using a discretionary trust to hold your personal assets. Doing so may assist in shielding your personal assets from your business creditors should your business run into trouble. A discretionary trust can also provide tax benefits.
If you are interested in further discussing discretionary trusts and how they can help your business, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A discretionary trust is a type of trust arrangement. Here, the trustee has power (or discretion) to decide whether to distribute trust income to a beneficiary and how much to distribute. It is different from a unit trust where beneficiaries hold a certain number of units in the trust. Likewise, the trustee must distribute any income from the trust in proportion to the number of units a unitholder holds in the trust.
As a business owner, you are open to increased risk, should your business fail. Increased liability can come in the form of creditors seeking a debt repayment through your personal assets, like car or home. Hence, setting up a discretionary trust to hold your personal assets is a great way to shield the assets from your business creditors should your business run into trouble.
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