Overview of a Trust / Discretionary Trusts
The main advantage of a Discretionary Trust is that it allows an individual to distribute income from business activity to other individuals (“beneficiaries”), usually family members.
A Unit Trust is in many ways like a partnership because it is comprised of different “units” controlled by unrelated persons or entities who agree to carry on business together. It also has similarities in terms of governance and entitlements, to a company. Whereas shareholders own a specific number of shares out of the total shareholding, unit holders in a unit trust, own a specific number of units out of the total unit holding.
Tax advantages may be gained by utilising a discretionary trust or a unit trust structure. A trust structure allows for the distribution of income to beneficiaries or unit holders in a different to that by which dividends are distributed to company shareholders.
Discretionary trusts are also an excellent vehicle for protecting assets from future life events such as business failures, bankruptcy and relationship breakdowns.
The trustee is legally liable for the debts of the trust and may use its assets to meet those debts. However, if there is a shortfall the trustee is responsible for the difference. – Business.gov.au
The trustees of a discretionary trust will usually have absolute discretion concerning decisions on the distribution of trust income, subject to some opportunities for the beneficiary to enlist the assistance of the court. In the unit trust situation, the trustee is of less importance because it will ordinarily act according to the direction of the majority of unit holders.
Discretionary trusts and Unit trust are established by a trustee settling a Trust Deed. Particular care is required in drafting such needs to ensure that all potential circumstances are thought through and accommodated.
Key benefits of a Trust
Keep in mind the trust structures if you want to create a trust:
- Reduced liability, especially if the trustee of the company;
- Protection of assets;
- Flexibility in the allocation of assets and income.
Key liabilities and downfalls of a Trust
- Can be expensive and difficult to set up and manage;
- Difficult to remove, undo or alter once it has been decided, particularly when children are involved;
- Any income held to reinvest in the business will be subject to penalty tax rates;
- Can’t spread losses, just profits.
The trustee is legally responsible for its activities if you run your company as a trust. A trust trustee can be a company that provides some security to property.
Other factors to consider
A trustee must apply for a number of tax files (TFN) and request an annual return of accountability. The trust is not responsible for paying tax. Alternatively, tax is levied on the trustee or beneficiaries entitled to earn net income from the trust.
For more information regarding your tax obligations as a trust visit the ATO website.
Choosing the right business structure – Is Trust the right option?
Choose the one that best suits your business needs when you settle on a framework for your company. Research that choice carefully, as for each system there are key factors and rules to research. The structure of your business will determine:
- The licences that you need;
- How much tax you are paying;
- Whether you are an employee or a business owner;
- Your personal future responsibility;
- How much control you have over your business?;
- Continuous costs and paperwork frequencies for your business.
You can choose from a number of structures when you start or expand your business. Australia’s four most common types of business structures are:
- Sole trader – The simplest structure allows you to have full control;
- Company – More complex, your liability is limited because it is a separate legal entity;
- Partnerships – Consisting of 2 or more suppliers with profits or losses;
- Trust – Where a trustee is in charge of business transactions.
Seek advice from a professional business consultant, business structure lawyer or accountant before deciding which business structure to use.