In this post we’ll be exploring discretionary trusts in part four of our series on business structures. We’ve also put up brief guides to running your business as a sole trader, via a partnership and through a company.
What is a trust*?
A trust is a fiduciary relationship in which a person or company is the holder of an interest in property but is subject to an equitable obligation to use or keep the property for the benefit of another person or for some commitment object or purpose. In plain English? A trust is an entity that can conduct a business and hold onto assets (example: copyright) on behalf of someone. The trust isn’t a legal entity as such so it needs someone/something to act on its behalf much the same as an underage child can’t enter into legal contracts on its own. This is known as the trustee and typically it’s an individual or a non–trading company.
To summarise, a simple way of looking at a trust is this – you’ve got an asset to stick in the trust (e.g. shares, cash, a business) and that is being legally held by someone (e.g. a trustee company) on behalf of someone else (the beneficiaries).
Set up Procedure
- A settlor (typically an accountant or lawyer) creates a trust deed
- Establish a trustee to control the trust
- Stamp the deed at the OSR (NSW)
- Registrations with the ATO (e.g. TFN, ABN, GST, PAYGW)
- Transfer of assets (if relevant)
- Setting up business systems such as bookkeeping, accounting, etc. (if relevant)
- With a corporate trustee – limited liability
- Asset protection – assets sheltered within the trust
- Flexible tax planning with ability to distribute income and profits to family and other entities
- Distributions from trust do not attract Workers Compensation and Superannuation Guarantee Charges
- Capital gains tax discounting flow through to beneficiaries
- Can distribute to a company utilising the company tax rate (restrictions apply)
- Cost of maintenance
- Constantly changing legislation
- Tax is paid at the beneficiary’s level hence possibly losing the 30% company rate
- Loses the land tax threshold if it owns property
- ABN registration – compulsory if using trust to carry on a business
- Tax File Number registration – compulsory
- GST registration – compulsory if turnover is over $75,000 (registration is voluntary if less)
- BAS – monthly or quarterly (if GST registered)
- Tax Return – yearly
- Financial records – financial accounts balance sheet and profit and loss statement
- Resolution – at the end of every financial year the trustee must pass a resolution to distribute the trust income
Most businesses which use a discretionary trust are after asset protection and require the flexibility of distributing to various different entities for the tax effective flow of income and related tax. Assets are often accumulated in a discretionary trust so as to keep these assets separate from the trading company that deals with the clients or customers. In the case of musicians, copyright is often assigned to a trust and a separate company is used for touring.
Given the generous tax advantages on offer when using a discretionary trust it only makes sense that the government is keen to make using a trust as difficult as possible and this is backed up by the constantly changing rules in this area. Some of these recent changes have actually made it so that using a trust to carry on a business can actually be less advantageous than simply using a company – this is especially true if your business is growing and you’re wanting to reinvest back into the business rather than distributing your profits each year.
*This summary is referring to a discretionary trust. For information on a unit trust or hybrid trust, or for information specific to your situation, please contact your accountant.
If you want to know more about the best structure for your business or investments, please get in touch. We’d love to help.