A discretionary trust, or more commonly known as a family trust, is where a person or company agrees to hold an asset for the benefit of others, usually their family members. A family trust is a popular vehicle for running a business because its offers asset protection and income tax advantages. Below, you can find a summary of the tax advantages associated with setting up a trust.
Broadly speaking, a trust itself does not have to pay income tax. This contrasts a company which has to pay the corporate tax rate on its net income every financial year. Generally, if the trust distributes net income to beneficiaries, the money is taxed in the hands of the beneficiary. If one of the beneficiaries is under 18, they will be taxed at the top marginal rate upon receiving income.
Additionally, if a trust has net income for the year and does not distribute all the income to the entitled beneficiaries, then the trustee has to pay tax on behalf of the trust at the top individual marginal rate. When you make a net income in the trust, such as through business profits, 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 family trust, whether a company or parent, can decide each year on how much to distribute to each entitled beneficiary. This means that trusts have the flexibility of deciding how much to distribute to each beneficiary on a year by year basis.
Because the trust’s net income is taxed in the beneficiary’s hands, the beneficiary is taxed at their individual marginal rate.
For example, the Smith Family Trust runs a small business. They have three beneficiaries, being, Parent 1, Parent 2 and a child (18 years). In the financial year, the trust makes a net income of $80,000. Parent 1 is a professional earning $80,000. Parent 2 works in the business but has no other income. The trustee has the discretion to distribute to all or one of the beneficiaries. The Smith Family Trust trustee decides to distribute:
- $6,000 to Parent 1;
- $37,000 to Parent 2; and
- $37,000 to Child.
This means that each person pays tax on their individual marginal rates.
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 take into account any capital gain or loss. To calculate a capital gain or loss, you have to determine if a CGT event has happened. As an 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. This may take the form of branding identity, reputation amongst customers or expected growth. Because goodwill counts as an intangible business’ asset, it is commonly recorded in your accounting records. When you dispose of the business, you may trigger a CGT event related to the disposal of the goodwill.
As an example, let’s assume there are two businesses — one operating as a trust and one operating as a company, but otherwise have the same goodwill and circumstances during its disposal.
|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.
When starting a business, it is crucial to consider whether using a family trust is appropriate in your circumstances. Compared to other structures, the family trust can offer CGT and income tax advantages as well as asset protection.
Therefore, it is important you understand the process of setting up and taxing a family trust. To discuss whether a family trust is appropriate in your circumstances, contact LegalVision’s tax lawyers on 1300 544 755 or fill out the form on this page.
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