It is common for a founder to hold the shares they own in their company through a discretionary family trust. Accountants and lawyers alike recommend this type of structure due to the tax benefits and asset protection it brings.
A discretionary trust can also be a useful vehicle for estate planning purposes. This article will discuss some of the tax benefits of a discretionary trust. This article is not tax advice. It is best to obtain your own accounting and tax advice that applies to your business and personal circumstances.
What is a Discretionary Trust?
A discretionary trust gives a trustee the discretion to distribute income or property to beneficiaries of the trust. This discretion includes whether to distribute monies in a certain income year and how much each chosen beneficiary receives.
It is important to remember that a trust in and of itself is not a legal entity. As such, the trustee will own all of the trust’s property on behalf of the trust.
What are the Tax Benefits of a Discretionary Trust?
The tax benefits are not actually realised by the trust itself but rather for the trust’s beneficiaries. A discretionary trust allows the trustee to distribute income to the beneficiaries in its absolute discretion. This can be useful for beneficiaries on different income tax brackets. Consequently, a trustee can “spread out” the income to the various beneficiaries, meaning beneficiaries pay less tax in total on any income the trust receives.
However, a trustee of a discretionary trust should be wary of entering into any arrangement that could trigger the anti-avoidance provision in the Income Tax Assessment Act 1936 (Cth) (the Act). Broadly, the Act seeks to prevent a tax benefit from arising under a pre-existing agreement between multiple people where:
- a beneficiary is presently entitled to a share of the trust’s income (for example, because the trustee resolves to distribute that income to the beneficiary);
- a party, other than the beneficiary, receives a benefit in some way (for example, the beneficiary then transfers the income to someone else);
- at least one party to the agreement has a purpose of reducing the amount of tax that might have otherwise been paid; and
- the agreement was not entered into during ordinary or family dealings.
If the ATO audits an arrangement and decides the Act applies, the high-level implication is that the beneficiary is deemed to have never been presently entitled to that share of trust income. Likewise, the trustee is assessed at the highest marginal rate (47%).
Continue reading this article below the formOther Considerations When Utilising a Discretionary Trust
Trusts are not always appropriate in all circumstances. Ultimately, it is essential you get your own tax and legal advice before establishing a discretionary trust. These are additional administrative costs in maintaining a trust. So, you should weigh these against the benefits of setting one up (tax benefits, asset protection and estate planning benefits).
If you choose to set up a discretionary trust, there are some essential things to remember:
- if the trustee does not distribute 100% of the trust income in a financial year, they will be taxed at the highest marginal rate on that income;
- if the trustee distributes any income to minors, those minors will be subject to the highest marginal tax rate; and
- if you act as the trustee of your trust, you owe certain duties to the trust and its beneficiaries. There can be serious consequences if you fail to uphold these duties.
This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.
Key Takeaways
A discretionary trust is a common way to hold your shares and investments. They can offer both tax and asset protection advantages. The tax benefits arise because a trustee can distribute trust income to different beneficiaries with different income tax brackets. This spreads out the tax liability potentially payable on the income, which can be reduced to nil if distributed to beneficiaries who do not earn enough to pay any income tax. However, a trustee must be careful not to enter anything that could trigger the anti-avoidance provision in the Income Tax Assessment Act 1936 (Cth). Otherwise, the tax liability will shift back to the trustee.
It is essential you get your own tax and legal advice before setting up a trust to ensure it is right for your circumstances. For more information, our experienced taxation 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 where the trustee has discretion over the distribution of monies to the beneficiaries. This discretion includes whether or not to distribute monies and, if so, how much each beneficiary receives.
The main tax benefit of a discretionary trust is the trustee’s ability to distribute income to different beneficiaries, who will then be taxed at their own marginal tax rate. Depending on the beneficiaries ‘ circumstances, this spreads out the tax liability and can even reduce it to nil.
A trustee can only distribute trust income to a beneficiary under the trust deed. For the most part, the trustee has the ultimate discretion to choose which beneficiaries (if any) receive trust income. However, any distributions to minors will be subject to the highest marginal tax rate.
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