What are the Benefits and Drawbacks of Using a Trust?

What is a Trust?

A trust is an obligation imposed on a person or other entity to hold property for the benefit of beneficiaries. From a strict legal perspective a trust is a relationship and not a separate legal entity, trusts are treated as taxpayer entities for the purposes of tax administration.

The trustee is responsible for managing the trust's tax affairs, including the lodgement of the annual income tax return as well as being personally liable for any income tax liabilities that may arise.

Beneficiaries (except some minors and non-residents) include their share of the trust's net income as income in their own tax returns. There are special rules for some types of trust including family trusts, deceased estates and super funds.

Trusts are widely used for investment and business purposes. Instead of an owner a trust distributes wealth to two or more people via a trustee. This person or company is tasked with managing all relevant operations regarding losses and income.

The three most common types of trusts are;

  • Discretionary Trust - Whereby the trustee has complete discretion on how to distribute the funds profits.

  • Unit Trust - Where profits are distributed to unit holders based on their relevant percentage of units held in the trust.

  • Hybrid Trust - Whereby unit holders have a fixed entitlement to profits based on their relevant percentage of units held with the trustee having the power to make exceptions in certain circumstances.

Either way the trust must comply with a trust deed - a document that outlines the fund's objectives, who can be a member, and whether benefits can be paid as a lump sum or an income stream.

How are Trusts Structured?

There are four key roles within the trust business structure. These are:

  • Settlor - This is the person responsible for establishing the trust and nominating the other roles within it. The settlor should not be a beneficiary under the trust.

  • Trustee - All trust transactions are administered by the trustee. They are duty-bound to distribute the trust’s property, assets, or money in a way that serves the beneficiaries’ best interests.

  • Beneficiary - Recipients of income distributed by the trustee, beneficiaries are the people (or companies) for whom the trust was set up. They’re classified as either primary (named in the trust deed) or general (not typically named in the trust deed).

  • Appointor - Not necessary in all trusts, the appointer holds the power to appoint or remove the trustee.

What are Some of the Benefits of Using a Trust?

The following benefits have seen the trust structure become favoured by many types of businesses, particularly family-run operations:

  • Income allocation - Trusts are an effective way to allocate income amongst beneficiaries in a tax effective manner. Any undistributed income at the end of the financial year is taxed under the trustee at the highest marginal tax rate thus encouraging the distribution of all profits prior to the end of the financial year, distributing profits to beneficiaries with the lowest marginal tax rate minimises the aggregate tax paid.

  • Estate planning and asset protection - Discretionary trusts can be a useful vehicle for estate planning as they allow wealth to be passed on with assurance it won’t be squandered by spendthrift beneficiaries.

    Beneficiaries don’t actually own the trust’s assets, so creditors or litigators are unable to seize them should the beneficiary incur debt or become bankrupt. It’s important to note. however, that the beneficiary’s share of funds in a unit trust can still be claimed.
  • Increased privacy - Trusts offer increased privacy compared to other business structures as they don’t need to be registered with the Australian Securities and Investments Commission.

  • Capital gains tax discounts - Trusts in which the beneficiaries are individuals, not companies, are entitled to a 50% capital discount on the disposal of capital assets held by the trust for longer than 12 months.

What are Some of the Downsides of Using a Trust?

Though trusts have their advantages, they’re not perfect for every business.

  • Complexity - Trusts are complex structures, and the vast majority of businesses don’t have the expertise to set up and maintain them. It’s therefore necessary for interested parties to engage with knowledgeable accountants and business advisors at all stages.

  • They’re temporary - Trusts are not a permanent solution - by law they can only exist for 80 years. A long time to be sure, but not long enough for family fortunes to pass through the same trust perpetually.

  • Undistributed profits - Unlike companies, trusts don’t enjoy favourable tax rates for undistributed profits and lack the ability to effectively retain profits. A company structure is more appropriate for businesses requiring working capital as it allows tax to be paid on undistributed profits at the reduced company rate.

  • Personal liability - There is still some degree of liability placed on the trustee. If they are unable to meet debts, creditors may be able to make a claim against the trustee, this risk can be mitigated by appointed a company to act as a trustee for the trust.

  • Difficulty getting finance - Financial institutions may be reluctant to approve loan applications to trust beneficiaries. Without a fixed interest in the business, an individual’s entitlement to profits may be seen as uncertain which raises concerns about whether they can reliably service any debt.

    Again, it’s recommended that you consult business advisory and tax experts when encountering difficulty obtaining finance.

Should you use a Trust?

Without a thorough analysis of your current business and financial situation it’s impossible to determine whether a trust is the ideal structure for you.

While this article provides a handy overview of trusts as a whole, there are countless factors you need to consider before committing to any one business structure. The only way to ensure you find the right fit is by consulting with dedicated accounting and business advisory professionals, like those at Sentrika.

We specialise in providing business advice and accounting services that deliver optimal outcomes for clients. Discover how you can achieve your financial goals with Sentrika - the leading Gold Coast accountants and business advisors.

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