What Are the Tax Advantages of a Trust?

In Short

• Trusts allow flexible income distributions to adult beneficiaries, often reducing overall tax compared with a company’s fixed rate.

• Trusts can access the 50% CGT discount on assets held for 12+ months, then distribute gains to beneficiaries.

• Asset protection: assets are held by the trustee for beneficiaries, separating them from personal ownership.

Tips for Businesses

Confirm your trust deed permits income and capital gains streaming, and minute year-end distributions before 30 June to avoid top-rate trustee tax. Consider a corporate trustee, keep meticulous records, and get coordinated legal–accounting advice on CGT, beneficiary tax positions, and the cash-retention limits of trading through a trust.

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Table of Contents

• What is a Family Trust?
• Income Tax Advantages
• Capital Gains Tax Advantages
• Asset Protection
• Disadvantages of Operating a Business Through a Trust
• Key Takeaways

A discretionary/family trust is a structure where an entity holds assets on behalf of others. It is a popular structure for holding shares in a company or running a business due to its asset protection and advantageous tax aspects. This article will discuss what a discretionary trust is, and the personal asset protection and the tax advantages it provides.

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. This is in contrast to a company that has to pay the corporate tax rate on its net income every financial year. Generally, if the trust distributes the trust assets to beneficiaries, the cash, for example, is taxed in the hands of the beneficiary. 

Additionally, if a trust has net income for the year and does not distribute all the income to the beneficiaries, the trustee has to pay tax on behalf of the trust at the highest individual marginal rate. When you make a net income in the trust, such as through business profits or the sale of an asset (e.g. shares in a company), it is crucial to distribute all the income so you are not penalised at the top marginal rate.

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.

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.

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 counts as an intangible business asset, you would commonly record this in your accounting records. When you dispose of the business, you may trigger a CGT event related to the disposal of the goodwill.

For example, assume there are two businesses — one operating as a trust and one operating as a company, but otherwise having the same goodwill and circumstances during its disposal.

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 shares in a company, the shares that a trustee holds are trust property. Accordingly, the trustee does not hold the shares 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. Again, this is because the shares are property of the trust.

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This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.

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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. Therefore, it is important you understand the tax advantages associated with owning assets or running a business through a discretionary trust. 

To discuss whether a trust is appropriate in your circumstances, 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.