Trusts have been an accepted part of English law since the Crusades, and although companies are more common in business, trusts have substantial benefits over companies in a business environment.
There are many types of trusts; however, the discretionary trust is probably the most common. Discretionary trusts will have discretionary beneficiaries – those individuals (and possibly companies) who will take income and capital out of the trust subject to the exercise by the trustee of a discretion in their favour.
Here’s what to consider before choosing to run your business using a trust.
The benefit of discretionary trusts is that income and capital can be distributed to individual beneficiaries in accordance with their own needs from time to time. This minimises tax for all involved.
For the past few years, you have been able to stream capital gains and franked dividends to nominated beneficiaries. This further enhances the tax benefits of discretionary trusts.
Another significant benefit of discretionary trusts is that the 50 per cent CGT discount will apply to individuals who are beneficiaries where the trustee has held the asset for at least 12 months. However, this benefit does not apply to companies that are beneficiaries.
Undistributed income is generally taxed in the hands of the trustee at the rate of 45 per cent. Accordingly, the trustee has a good reason to distribute income in each financial year unless there is a more compelling reason to accumulate it.
Protect capital against divorce claims
The benefits of a discretionary trust extend to protecting the income and capital of the trust against the divorce claims of the ex-spouse of a beneficiary.
The entitlement to income and capital of such a beneficiary can be discontinued for the duration of the family law proceedings, and whilst the Family Court may consider the potential entitlement to a distribution as a financial resource, the capital of the trust is generally preserved.
Protect capital against bankruptcy of beneficiary
The capital of the discretionary trust is protected against the bankruptcy of a discretionary beneficiary. The trustee simply refrains from distributing to that beneficiary until the end of the bankruptcy.
Having a trusted appointor whose consent is needed for key management decisions can prevent directors of the trustee company from turning feral against other stakeholders.
Change with the times
Trusts are enormously flexible. Since about 2011, amendments to trust deeds can now generally be made without stamp duty consequences. Such changes can include the adding of beneficiaries and the removal of beneficiaries so long as the amendments are made pursuant to a valid exercise of the power of amendment found in the trust deed.
Having a wide capacity to amend the trust deed is important because it gives the trustee power to upgrade the trust deed from time to time to reflect changes to the law, including tax law.
CGT Roll-Over Relief
If your turnover is less than $10m, and you want to change your business structure from a company to a trust (or vice versa) then you may be eligible for CGT roll-over relief. One key prerequisite is that there be no change in the ultimate economic ownership of the new structure.
Protection against trust creditors
In some states, trust deeds can prevent a trustee from being indemnified against trade creditor claims out of the trust assets. This can be an important asset protection mechanism. However, the cases in New South Wales generally indicate that such a try-on does not work in that state.
Trusts can be created with a stamp duty implication of as little as $500.
But if down the track, amendments to a trust deed are made which are too far-reaching and cause a change to the ‘charter of rights’ then stamp duty on the full value of the trust assets can be imposed.
A hot topic for trusts at the moment is trust splitting whereby within the power given to the trustee by the trust deed, the trustee establishes a sub-trust within the original existing trust such that there is still only (arguably), one trust but different trustees are appointed for different assets.
The splitting of the trust does not generally involve a change to the beneficiaries or to the power conferred on the trustee.
Whether a trust can be split will largely depend on the powers provided in the trust deed to appoint a separate trustee in respect of particular trust assets.
Trust-splitting can be of great assistance from the point of view of asset protection and estate planning. However, the Commissioner has recently published TD 2019/14 which although strongly criticised by accountants and lawyers alike, indicates the Commissioner’s current disdain for such arrangements.
No one-size-fits-all but a close review of the options available is highly recommended when you are starting up a business or considering whether you should change it.