Using a Family Discretionary Trust to own assets can provide many advantages, including reducing your income tax and capital gains tax, as well as providing asset protection.
Family trust structures have many advantages over other tax structures like partnerships and companies, although they have their own limitations.
Saving Income Tax when using a Family Discretionary Trust
One of the advantages of a Family Discretionary Trust is that net income in a financial year can be distributed amongst beneficiaries in a way which minimises total income tax payable by the family unit. This distribution has to be included in the beneficiaries’ income in the financial year when the trust has earned the income and not the year when the income is distributed.
As an example, where trust income of $10,000 is earned in the financial year ended 30th June 2019 and distributed to the beneficiary on 15th August 2020, this income has to be included in the beneficiaries income tax return for the financial year ended 30th June 2019 – not 2020.
- The classification of trust income, for example, dividend income, foreign income, or capital gain continues to be recognized under the same classification in the individual beneficiary’s income tax return. Any imputation credit or foreign tax credits flows through to the beneficiaries as per the Trustee’s discretion.
- If beneficiaries are under 18 years of age, by distributing income to them, trustees can avail their tax free threshold and low income rebates.
- If there are no individual beneficiaries in marginal tax rate lower than company tax rate (at the time of writing 30% – 27.5% for a small business entity), then trustees can distribute income of the trust to a (new and not trustee) company and pay tax on income at the company tax rate.
- The trustee can decide not to distribute any income of the trust and instead accumulate income of the trust. The trustee is liable to pay tax on the net income of the trust at the highest Individual tax rate. However, the commissioner of taxation has the discretion to charge tax rates applicable to an individual of an identical amount. When income is accumulated, it forms the part of the trust fund and not taxable to the beneficiaries when distributed on vesting date. Unpaid present entitlements can be an issue in some cases, and you will need specific advice.
- Only net income of the trust has to be distributed. A trust can also contribute superannuation for a beneficiary, which means that tax on income of the trust can be limited to the tax rate on contribution to superannuation – which at the time of writing is 15%.
- If a trust has a loss and has received imputation credits in the financial year, the trust can lodge its own income tax return and carry forward the loss to the next financial year and claim a refund of imputation credits.
Saving Capital Gain Tax when using a Family Discretionary Trust
Another advantage of a Family Discretionary Trust is that on the disposal of any asset of the trust, it is entitled to a 50% discount factor on capital gains, if assets are disposed after one year. This discount flows through to beneficiaries’ on distribution.
If the trustee distributes trust assets to a beneficiary, capital gain event triggers and the trustee will be deemed to have sold the asset to the beneficiary at its market value. This capital gain can be allocated / distributed to the same beneficiary or to another beneficiary with the discount factor if applicable.
Asset Protection Advantages when using a Family Discretionary Trust
- One of the main advantages of a Family Discretionary Trust is its asset protection capability. Assets which are held in a trust fund for the benefit of a particular person as distinct from assets directly owned by him/her are automatically protected from that person’s creditors. This can be very important for most professional advisers (eg -medical professionals, engineers and accountants) and business owner – operators, and those who are prone to litigation or in situations where business venture may become bankrupt.
- Assets which are being held in a trust fund prior to marriage, for the benefit of one party, may have an advantage in matrimonial disputes – however each circumstance must be separately considered.
- For estate planning purposes, if a person has already become bankrupt, assets passing on to him directly, say, from his parents, will be available to his trustee in bankruptcy. However if assets are passed on to a discretionary trust established for the benefit of him and his family, these assets can be protected from the bankruptcy proceedings. The trustee of that discretionary trust can ensure that any distributions to that person can be made after the expiry of any bankruptcy period.
However, family courts in certain situations are known to have ‘seen through’ the trust arrangements and allocated assets held in a trust amongst spouses. Likewise, few recent cases have raised the possibility of a trustee in bankruptcy accessing the assets in a discretionary trust over which the bankrupt beneficiary has ‘de facto’ control. You will need to obtain specific advice for your circumstances.
Other Advantages when using a Family Discretionary Trust
- Any distribution to a beneficiary need not be physically paid to them. If the beneficiary agrees, the Trustee can retain money which it has decided to distribute to beneficiary and establish a bare trust for that beneficiary within the family trust. The trustee can then invest that money on behalf of the beneficiary as per the powers given to them by the trust deed.
- Money’s belonging to beneficiaries who are under a legal disability, like minors, can be held by the trustee in trust, until they reach 18 years of age. The trustee may apply money held for a minor beneficiary in payment of education, clothing and other similar expenses. Alternatively, trustees can distribute minor’s money to their parent or guardian.
- Can safeguard certain social security payments for beneficiaries.