If you are setting up or running a business, you are likely familiar with the benefits of trusts. As a business structure, trusts can provide the ability to protect assets and give certain tax advantages.
Within Australian law there are various different types of trusts which can be set up depending upon the circumstance and requirements of the individuals or businesses establishing the trust. Each type of trust has certain advantages and limitations that go beyond just tax obligations.
At Stones Sharp, we help individuals and businesses with all their trust requirements from setting up the trust to tax obligations and management. We break down the different types of trusts and their benefits.
What is a trust?
A trust is a type of business structure, and is commonly used for investments and other business activities. The Australian Taxation Office (ATO) defines a trust as:
An obligation imposed on a person or other entity to hold property for the benefit of beneficiaries. While in legal terms a trust is a relationship not a legal entity, trusts are treated as taxpayer entities for the purposes of tax administration.
What is a trustee?
A trustee is appointed to manage all the trust’s tax related requirements, such as lodging tax returns and paying tax liabilities. A trustee can either be a company or an individual. The beneficiary of a trust can be a person, group of people or a company who receive a benefit from the trust, usually income. A beneficiary can also be a trustee depending on the structure of your trust.
If you have a trust as your business structure, then you are required to:
- Apply for a tax file number to lodge a trust tax return
- Apply for an Australian Business Number
- Be registered for GST if annual turnover exceeds $75,000
- Pay any required tax and Super benefits for employees.
Types of trusts and their benefits
There is a range of different trust structures which all have their own unique advantages and disadvantages for businesses. Here are the three most common types of business trust structures.
A discretionary trust enables a trustee managing the assets (money, land, and/or shares) to decide who can benefit from the trust and how much income the beneficiaries will receive. Discretionary trusts tend to be used for family assets, especially in the case of a family business and for estate planning purposes.
The best way to think about a discretionary trust is that it separates ownership from control. This is what makes a discretionary trust ideal for asset protection, as it enables a beneficiary to hold onto their assets without being the legal owner. For example, in the case of a beneficiary being pursued by a creditor, the assets within the trust are protected as they are not considered the legal owner, the trust is.
Differences in tax management for discretionary trusts are highly beneficial, as they do not need to pay income tax. Unlike traditional company structures who pay tax on their net income every year, discretionary trusts involve the beneficiaries paying tax on their share of the income. Trusts can also be eligible for the 50% capital gains tax discount which companies are unable to receive.
In a unit trust structure, beneficiaries have defined entitlement on specific assets and the overall income of the trust. This entitlement is referred to as ‘units’, which can be specified as clear percentages such as 30%. Unlike a discretionary trust where the trustee determines the distribution of income, a unit trust will distribute income via the units. For example, if one beneficiary has a unit of 45% they will receive the equivalent division of income.
Unit trusts are commonly used for people looking to pool resources to invest in property developments or in a business. A unit trust is not required to pay tax, but unit holders (beneficiaries) will pay tax on the income from the trust depending on their marginal tax rate.
Unit trusts, like all trusts, also have the benefit of facing less regulatory scrutiny from ASIC and the ATO than a traditional business structure. Much like a discretionary trust structure, unit trusts can provide necessary asset protection and can be eligible for the 50% capital gains discount.
If you are unsure whether a discretionary or unit trust is best suited to your business, then a hybrid trust structure is a great option. With a hybrid trust structure, you can receive the best of both worlds. By using a hybrid structure, you have the advantage of being able to divide the trust into fixed units while also having some flexibility to distribute by discretionary.
Choosing the right trust structure
The ATO is beginning to crack down on what they see as tax avoidance through the use of trusts, in particular, ‘reimbursement arrangements’, through the introduction of Section 100A. These avoidance measures tend to involve one person (an adult child in a low tax bracket or a person with a disability) being named the beneficiary when in reality another person (usually in a higher tax bracket) is benefiting from the trust.
To help prevent Section 100A from applying to your trust and facing issues of your beneficiary share being taxed at the top marginal rate, it is best to consult a professional tax agent to ensure that your trust is in line with the current draft guidance.
In order to determine the ideal trust structure for your business, we recommend discussing your needs with a registered tax agent. At Stones Sharp, we will be able to understand your unique situation and recommend a structure and tax planning strategy which works for you.
FCPA & CA
Shane is a Fellow of the Australian Society of Certified Practicing Accountants and a Chartered Accountant.
Shane’s passion is to consider the clients, the client’s business and taxation affairs with a holistic approach whilst providing business mentoring, business strategies, systems development, taxation advice and taxation planning in order to assist his clients and their business achieve their goals.