A Trust is an obligation imposed on a person or other entity to hold property for the benefit of the beneficiaries. A Trust is split between two parties. A “trustee” – the person who manages the Trust on behalf of the beneficiaries. The “beneficiary” – the people who own the property/assets.
Discretionary trusts are when the trustee chooses which beneficiaries receive the trust property, and how much of the trust property they get. The discretion is in the trustee having the option of splitting up the trust property however they like. There are no limits in a trustee’s discretion when allocating shares, as there is complete freedom in a discretionary trust.
In a discretionary trust, the trustee has the power to determine which beneficiaries receive the property or assets from the trust and how much each is to receive.
The trustee’s power only extends to nominated beneficiaries in the trust. Entitlement to assets is not predetermined and fixed, as is the case with a fixed trust. From a business standpoint, a fixed structure, such as a fixed unit trust, may be more appropriate where the beneficiaries are unrelated third parties sharing property and shares. But if the business is run within a family than discretionary trust model would be appropriate.
Characteristics of Discretionary Trusts: Trust Deed and Trust Property
Discretionary trusts are classified according to the following characteristics:
• The trustee (or trustees) can be an individual or a company (corporate trustee)
• The trustee is the legal owner of the assets held
• Depending on the deed, in most cases, trustees are given complete discretion when it
comes to distributing income and capital to the beneficiaries.
• While not recommended, minors can be named beneficiaries (although distributions to minors can be taxed up to 66%). In most deeds, they will be included under a class of beneficiaries, but income distribution is not recommended due to the steep tax rates for minors.
Advantages of a Discretionary Trust
A discretionary trust can be beneficial for asset protection and tax purposes. Some potential benefits of this structure include:
• Tax Efficient Trust Income Distribution
• Due to the nature of this type of discretionary trust structure, trustees can distribute income in a tax-efficient manner. For example, they can allocate funds according to each beneficiary’s income tax bracket.
• The trustee can distribute most of the trust income amongst beneficiaries who fall under a tax bracket with lower marginal rates. This way, the trustee can legally minimise the amount each beneficiary is bligated to pay. This is an attractive benefit for individuals looking to establish a family trust.
• Another benefit of this structure is the 50% discount on capital gains tax. Where the property is held for longer than 12 months and is sold at a capital gain, the trust may be eligible for a 50% capital gains tax discount, which can be streamed to the individual beneficiaries. For example, this may be advantageous where one of the beneficiaries has a capital loss.
• Estate Planning
• For many Australians, setting up a discretionary trust gives them the ability to have more control over how their estate devolves in any eventuality. By holding assets in a discretionary trust, instead of in their personal names, they can legally minimise the hassle and cost of transferring them according to a Will.
• For example, if your Will specifies that your property is to be devolved amongst your spouse and children, they will ultimately be burdened by capital gains tax and stamp duty. But, if the assets are retained in a trust, the beneficiaries can continue to benefit from them without triggering the costs associated with transferring the assets. Asset Protection
Because the assets are held within the discretionary trust for the benefit of the beneficiaries, they don’t legally own them. In other words, they belong to the trust, and the beneficiaries simply benefit from the trust income and gains generated. This means that, in most cases, creditors may not have access to trust assets unless the claim relates to debt within the trust. Disadvantages of a Discretionary Trust
The disadvantages are inclusive of:
• Complexity in establishing and maintaining a trust structure
• Only profits (not losses) are distributed
• Vesting date: in NSW, trusts generally end after no more than 80 years
• Trustees can be personally liable for the trust’s debts (subject to the trust’s deed providing that the trust’s assets are indemnify the trustee). However, if the trustee is a company its liability will be limited.
• A trust must distribute its profit/income to beneficiaries each financial year. Otherwise, the trustee must pay tax on any undistributed (i.e. accumulated) income at the highest marginal rate. Therefore, if the business requires any working capital, a company structure is more
appropriate as you only pay tax on undistributed company profits at the company rate.
Key Takeaways
A discretionary trust is a legal arrangement in which the trustee has the power to decide who will get income from the trust property and when. The trustee can also decide how much income should be given to each beneficiary of the trust.
As a result, this type of trust structure is particularly appealing for families in Australia or business owners looking to set up a more tax-effective structure.
There are pros and cons associated with choosing this type of trust, so you need to weigh up all options before making any decisions based on what might work best for your financial circumstances. It’s generally best to consult a financial advisor and qualified tax agent to help guide you in the right direction.
The team at Taxfin Business Services provides help in navigating with tax and financial outcomes. If you are unsure how to proceed with the appropriate structure, contact us today.
