Summary
- Trusts can provide significant tax advantages for businesses, including income splitting among beneficiaries to reduce overall tax liability.
- Capital gains tax (CGT) discounts may be accessible through a trust structure, potentially reducing the tax burden on asset sales.
- Trusts do not pay tax directly; instead, tax is distributed to beneficiaries, who are each taxed at their individual rates.
- This article is a plain-English guide to the tax advantages of trust structures for Australian business owners, covering key considerations under Australian tax law.
- The content has been produced by LegalVision, a commercial law firm that specialises in advising clients on trust structures and business taxation.
Tips for Businesses
Consider whether a discretionary or unit trust suits your business goals, as each offers different tax outcomes. Review how income will be distributed among beneficiaries each financial year. Keep accurate records of distributions and ensure your trust deed permits the arrangements you intend to use. Engage a qualified tax adviser when establishing or varying a trust.
A discretionary/family trust is a structure where an entity holds assets on behalf of others. It is a popular structure for holding company shares or for running a business due to its asset protection and tax advantages. This article will discuss what a discretionary trust is, the personal asset protection it provides, and the tax advantages it offers.
What is a Family Trust?
There are two main roles in a discretionary trust.
The trustee is an entity (an individual or a company) that holds the trust assets on behalf of the trust and makes the decisions regarding the trust assets. Decisions a trustee may make include whether to:
- purchase an asset and hold it on trust;
- sell an asset; or
- distribute trust assets to beneficiaries, amongst others.
The beneficiaries of the trust are the individuals entitled to the trust assets. The trustee may choose to distribute the trust assets to the beneficiaries in any proportion it chooses.
Trust Taxation
Broadly speaking, a trust itself does not have to pay income tax (unless the income is retained in the trust and not distributed) as income is typically taxed either in the hands of the beneficiaries or the trustee in certain circumstances (and this is taxed at the highest marginal tax rate). This is in contrast to a company that has to pay the corporate tax rate on its net income every financial year.
Additionally, if a trust has net income for the year and does not distribute all of it to the beneficiaries, the trustee must pay tax on the trust’s income at the highest individual marginal rate. When a trust generates net income, whether from business operations or capital gains (such as the sale of company shares), it’s recommended to distribute the entire amount to beneficiaries. This distribution strategy is critical to avoid the possible tax consequences of undistributed trust income, which is typically taxed at the highest marginal rate. By allocating all income to beneficiaries, the trust can potentially access more favourable tax treatments, as the income is then taxed in the hands of the individual beneficiaries at their respective tax rates. This approach not only optimises the overall tax position but also aligns with the intended flexibility and tax efficiency that trusts can offer when properly managed.
Income Tax Advantages
The trustee of the discretionary trust, whether a company or individual, has discretion and flexibility to determine how they will distribute the trust assets to each beneficiary. As the trust’s net income is taxed in the beneficiary’s hands, the beneficiary is taxed at their individual marginal rate.
Continue reading this article below the formCall 1300 544 755 for urgent assistance.
Otherwise, complete this form, and we will contact you within one business day.
Capital Gains Tax Advantages
One of the tax advantages of a family trust is related to capital gains tax (CGT). Namely, the 50% CGT discount if the assets are held for longer than 12 months. This discount effectively halves the taxable capital gain, potentially resulting in significant tax savings.
As part of the trust’s net income or net loss, the trust has to consider any capital gain or loss. To calculate a capital gain or loss, you have to determine if a CGT event has happened. For example, the most common CGT event is the disposal of an asset. Therefore, you will make a gain or loss on that asset upon selling it.
When you run your business as a trust, your business may acquire goodwill in the form of:
- branding identity;
- reputation amongst customers; or
- expected growth.
Since goodwill is an intangible business asset, you would typically record it in your accounting records. When you dispose of the business, you may trigger a CGT event on the goodwill.
For example, assume there are two businesses — one operating as a trust and one operating as a company — that have the same goodwill and circumstances at the time of disposal.
| Trust | Company | |
| Cost base of Goodwill | $10,000 | $10,000 |
| Goodwill value on sale | $100,000 | $100,000 |
| Gross capital gain | $90,000 | $90,000 |
| Less 50% CGT discount | $45,000 | N/A |
| Net capital gain | $45,000 | $90,000 |
As described above, the trustee can distribute to the beneficiaries who will pay on their individual marginal rate.
Asset Protection
If you utilise a trust to hold property, such as an investment property, or even shares in a company, the property and shares held by the trustee are trust property. Accordingly, the trustee does not hold the shares or property personally. To the extent that a trustee is sued in their personal capacity, it is difficult for creditors to access trust assets to satisfy a debt.
Corporate Trustee and Individual Trustee in Asset Protection
There are two types of trustees, individual trustees and corporate trustees. Both can help protect assets, but in different ways.
Individual Trustee:
- This is when a person is the trustee.
- It’s simpler and cheaper to set up.
- The trustee has direct control over the trust.
- But, the trustee might be personally responsible for trust debts.
Corporate Trustee:
- This is when a company is the trustee.
- It costs more to set up and run.
- It provides better protection because the company’s responsibility is limited, adding an additional layer of protection.
- The company doesn’t die so that the trust can continue easily.
Ultimately, by setting up a trust, you can achieve asset protection that would not ordinarily be available when holding certain assets.
Running a small business? Download this free guide to understand your corporate governance responsibilities, including the decision-making processes.
Disadvantages of Operating a Business Through a Trust
When running a business through a trust, it makes it difficult to grow your business through external investment. If you are operating through a company, investors can easily invest by injecting cash in return for an equity stake in the company. There are also many ways to invest in a company, such as through convertible notes and simple agreements for future equity. You can also set up an employee equity plan in a company with far greater ease.
However, in a discretionary trust scenario, the trustee must distribute certain trust assets at the end of the financial year. Otherwise, the trust will be taxed at the highest marginal rate. This means the trading trust cannot retain profits to use to grow the business from year to year.
In comparison, a company:
- can hold cash for an indefinite amount of time;
- can use the cash; and
- does not have to distribute profits to shareholders.
Key Takeaways
When starting a business, it is crucial to consider whether using a discretionary trust is appropriate in your circumstances. Compared to other structures, the discretionary trust can offer CGT and income tax advantages as well as asset protection.
However, it’s essential to thoroughly understand the tax implications and responsibilities associated with owning assets or running a business through a discretionary trust. Before making a decision, consider seeking professional advice to fully understand the potential benefits and drawbacks as they apply to your specific situation.
LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced business lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
A family trust can provide tax flexibility and asset protection. Trustees can distribute income to beneficiaries in a way that minimises overall tax liability, and assets held in the trust are generally protected from personal creditors.
Trusts make it harder to attract investors because profits must usually be distributed each year. This limits the ability to retain earnings for business growth, unlike companies that can hold and reinvest profits.
A trust typically does not pay income tax if it distributes all income to beneficiaries, who then pay tax at their individual marginal rates.
Trusts can access a 50% CGT discount on assets held longer than 12 months, effectively halving the taxable capital gain upon disposal.
We appreciate your feedback – your submission has been successfully received.
