So, should you consider a trust for your business structure?
What is a Trust?
A Trust is in essence a relationship between the legal owner of an asset/s (the trustee) and the parties that will benefit from the asset/s (the beneficiaries). A trust is governed by a Trust Deed which is created upon its establishment. The trust deed set outs the terms and conditions that the parties of the trust must follow.
In this article we will discuss two common types of trust structures that we see in practice and the benefits and potential disadvantages of each. The two trusts being covered are a discretionary trust and a unit trust.
What is a Discretionary Trust?
A discretionary trust, commonly referred to as a Family Trust, is a trust arrangement where the beneficiaries of the trust do not have a fixed entitlement or interest in the trust and the trustee has ‘discretion’ to determine which of the beneficiaries will receive a benefit from the trust. The benefit received can be in the form of capital or profits generated by the trust.
For a discretionary trust to be established a person, referred to as the settlor, provides a settled sum as a gift to the trustee of the trust for the purposes of establishing a trust for the benefit of the beneficiaries. The trustee can then add to the trust by way of acquiring assets or starting up a business to be held or conducted for the benefit of the beneficiaries.
The trustee of the trust can be an individual, group of individuals or a company. The beneficiaries of the trust are generally determined by selecting a primary beneficiary or beneficiaries and the general beneficiaries of the trust are then determined by way of relationship to those primary beneficiaries.
In practice, it is common for a discretionary trust to be established to conduct a business where the business principle is the trustee (either individually or as the director of a company) and the business principle and their spouse/partner are the primary beneficiaries. The group of beneficiaries of this trust will then include any individuals related to the primary beneficiaries through birth or marriage as well as certain entities that the beneficiaries are involved in/have an interest in. Accordingly, the beneficiary group of a discretionary trust can be quite wide.
The trustee of a discretionary trust becomes the party that looks after the day-to-day operations of the trust. The trustee makes the decisions, enters into contracts and determines which beneficiaries will be distributed the trust’s income or capital on an annual basis.
The obligations of a discretionary trust include lodging an income tax return each year disclosing its activity along with the details of beneficiaries that have received distributions of income and capital. The beneficiaries are then required to record this income or capital in their personal tax returns for assessment. In addition to an annual tax return, a trust may also need to prepare and lodge Activity Statements if it is registered for GST and is required prior to the end of each financial year to prepare written documentation as to its distribution plans.
Advantages of a Discretionary Trust
Whilst a trust is a more complex structure than that of a sole trader or partnership, it has many advantages to being used as a structure to operate a business activity. These advantages include:
- Income and capital of the trust can be distributed across beneficiaries in a tax effective manner.
- No one beneficiary can claim an interest in the assets of the trust, improving asset protection of the assets held by the trust.
- Trusts, like individuals, can access the general 50% CGT discount as well as the various small business concessions where the relevant conditions are met.
- A trust can have the ability to distinguish between income and capital beneficiaries as well as distinguish between different classes of income subject to the trust deed.
- Beneficiaries can inject funds by way of loans or gifts fairly easily.
- Control over the assets can be passed by way of changing the trustee and controllers of the trust without triggering capital gains tax and indirect taxes in most situations.
Disadvantages of a Discretionary Trust
When deciding whether a trust structure may be a suitable option, it is important that you weigh up any disadvantages associated with this type of structure. These include:
- A trust must follow various regulations, including those imposed by trust law as well as those imposed by tax legislation pertaining to trust structures.
- A trust must distribute the income and capital it derives each year, unlike a company that can retain profits. This can be a challenge for businesses where the profits generated do not match the cash available to distribute given lock up in working capital such as trading stock or accounts receivable. In this scenario, the beneficiaries of the trust may end up paying tax on income that they have not physically received which can cause cashflow issues at the individual level.
- Losses incurred by a trust cannot be distributed to beneficiaries to be offset against their income. Further, there are rules around the ability for a trust to carry forward losses for future recoupment.
- A trust does not have perpetual existence and will therefore cease to exist after the term as set by the trust deed (usually 80 years)
What is a Unit Trust?
Like a discretionary trust, a unit trust is a relationship between the trustee and the beneficiaries, however, in the case of a unit trust, the beneficiaries, referred to as unit holders, have a fixed entitlement to the income and capital of the trust.
A Unit Trust is often established where unrelated parties want to join together to run a business or buy an asset together. Under this type of structure, each unit holder has a fixed entitlement based on the units they hold in the structure, noting that different classes of units may contain different rights.
Ownership changes in a unit trust structure will be performed by way of buying/selling units or issuing new units in the trust. All transactions undertaken by the unit holders for this purpose must follow the terms of the trust deed and care must be taken in quantifying any tax implications of doing so.
A unit trust structure can have multiple unit holders, however there are limits before it hits a certain status which brings with it further regulations. A unit trust with 20 or more unit holders is classed as a Managed Investment Scheme and a unit trust with 50 or more units holders will be classed as a Public Unit Trust. A unit trust being used to conduct a business will generally stay well below the 20 number limit.
Advantages and Disadvantages of a Unit Trust
The advantages and disadvantages associated with a unit trust structure include many of those pertaining to a discretionary trust as well as the following:
- A unit trust offers a similar structure to that of a company given the fixed entitlement position, however, a unit trust is not as heavily regulated as that of a company under ASIC.
- The use of a discretionary trust to hold the units in a unit trust structure can provide for income and capital to be distributed in the most tax effective manner.
- From a public perspective, ownership details of a unit trust structure can be limited to the trustee company details and not the actual unit holders of the trust, which may be an important factor if you are seeking privacy.
The above provides a brief summary of how a trust structure works and the advantages of considering this type of structure for your business.
As we have mentioned in previous articles, the secret to making the right decision about your structure is getting the right advice at the start of your business journey. We are here to help you identify which structure may best suit your business needs. Contact us on (03) 5221 6399 or at firstname.lastname@example.org for further information and to schedule a no obligation, no cost meeting to discuss your options with one of our Tax and Business Services specialists.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.
This article was written by Senior Accountant Tamara Wright.