Every so often I get asked about discretionary trusts – should I have one, does it mean I pay less tax, are they only for rich people?
As with all tax related questions, the answer will depend on your personal circumstances, but let’s go through a few of the basics.
A trust is a relationship where a person or entity (the trustee) is under an obligation to hold property for the benefit of other persons (the beneficiaries). A trust is not a separate legal entity although for tax purposes, it must lodge its own tax return. The legal status of a trust is comes about through the trust deed. It should be drawn up by a legal professional and will specify the settlor, beneficiaries and a trustee.
A discretionary trust is one where a beneficiary is not entitled to a fixed amount of the trust income or capital. A type of discretionary trust is a “family trust” because the beneficiaries are wide, include all family members and do not need to be individually specified in the original trust deed.
The main ‘players’ in a trust are:
Appointor: The appointor/s have the real power and control of the assets of the trust since the appointor has the power to appoint and remove trustees. It is generally good practise to have more than one appointor where possible. Clearly, a lot of thought must be given when choosing an appointor.
Trustee: the legal owner of the trust property (although not the beneficial owner). The trustee is responsible for managing the trust fund. All transactions are carried out in the name of the trustee. The trustee must obey the terms of the trust deed and to act in the best interests of the beneficiaries. It is often beneficial to have a company set up to act as trustee. This means changes are easier to make and a company continues indefinitely, saving the expense of transferring assets if the trustee is an individual and they die or retire. If a trustee incurs a liability from the proper exercise of their powers and duties, the trustee can be “indemnified” out of the trust assets.
The trust fund: the property of the trust.
Beneficiaries: the people (which can include individuals and companies) for whose benefit the trustee holds the property. The trustee can distribute both income or corpus (capital) to beneficiaries.
The advantages of a discretionary trust are:
- Asset protection – no one beneficiary has an entitlement to claim any assets of the trust. This is useful in situations of marriage breakdown, bankruptcy etc.
- Flexibility for the distribution of income and capital. This means that it is possible to distribute income in the most tax effective way.
- Wide range of beneficiaries and they do not need to be specified (will usually include a range of family members by blood or marriage and any companies in which they have an interest).
- Subject to less regulation than a company.
- A trust is easier to wind up than a company.
- Succession planning – a trust continues to operate regardless of what happens to individual trustees.
- Less transparency as to ownership of the business.
Disadvantages of a discretionary trust:
- More expensive to set up.
- Will often involve setting up other entities also. For example, a discretionary trust may need to have a corporate trustee (that is a separate company to act as the trustee) to ensure assets are protected.
- Additional costs of annual compliance. The trust must lodge a tax return and maintain appropriate records.
- A trust cannot last forever and has a fixed period of operation (not really a problem because this is usually 80 years!).
Some other issues which need to be considered:
- What is the purpose of running a discretionary trust structure and is a trust the best way to achieve that outcome.
- Will the trust hold and run the business Or, will the trust hold the shares in the company that owns the business.
- Who will be the trustee. The trustee is the legal owner of the assets of the trust. Therefore it may be necessary to have a corporate trustee (that is another company) which again adds to the expense and complexity of set up and ongoing arrangements.
- Who will be the appointer/s. This person can appoint and remove trustees.
- Timing is an issue if the company initially makes losses as it would not be advantageous to implement a new structure immediately as it may not be possible to utilise those losses.
This is a complex area of tax. But having said that, there are many reasons why setting up a trust is a good idea. BUT it must only be considered in the context of your overall financial situation. If you would like to discuss how a trust might work in your circumstances, I offer a FREE 30 minute initial consultation. You can easily book online here and I look forward to helping you sort your finances!