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Which structure is best for you? – Discretionary trusts

Which structure is best for you? – Discretionary trusts

Current as of July 2014

Family Trusts (aka discretionary trusts) are one of the two types of trusts available (the other being a unit trust which will be covered in a later issue).

A family trust is a trust where the beneficiaries do not have any fixed right to the income or capital of the trust. The income and capital are dealt with by the trustee at his/her discretion. The trustee of the trust can be a corporate entity in which case the directors and  shareholders of the company make the decisions on income and capital distribution. The trustee can also be an individual who would then have the same powers as above, but should not be a beneficiary of the trust.

In most trusts the deed, which governs the running of the trust in the same way a constitution does for a company, will mention the role of an Appointor (sometimes called a Parent). While this Appointor does not own any of the assets which are held within the trust he/she is able to exercise some control over the running of the trust by their ability to hire or fire the trustee. The Appointor in this case has the ultimate control over the trust and can be a beneficiary.

Advantages

  • FT can access the 50% CGT general discount where the asset has been held for more than 12 months. This can also be passed onto beneficiaries who receive this gain.
  • Most CGT small business concessions are available and can be flowed through to the beneficiary as long as the trust deed is drawn up correctly.
  • They are flexible in relation to who you can distribute the income and capital to. You are able to successfully split income amongst a number of beneficiaries using each of their marginal tax brackets.
  • Limited liability is available if a corporate trustee is used.
  • It is easy to return capital as there is no equity as such.
  • Streaming of different types of income to different beneficiaries is available if the deed is drafted properly.
  • You can admit new beneficiaries without losing control (although resettlement of the trust needs to be avoided for CGT purposes).
  • Have significant estate planning advantages as the death of a beneficiary does not affect the ownership of the business.
  • Allow distribution of income to beneficiaries that may have losses available to offset them.
  • Can be used equally as well for active or passive incomes.

Disadvantages

  • It is sometimes harder to borrow in a FT as a lot of banks have difficulty with the structure and will want legal advice as to whether the trust deed gives the power to borrow.
  • Losses are trapped in the trust.
  • The small business 15 year CGT exemption may be difficult to access as, to satisfy the controlling individual test, there will be a need for an individual to receive ≥ 20% of the income entitlement in every year of the 15 years to qualify.
  • Property held in a FT does not get the tax free threshold for land tax.
  • Does not allow you to easily admit new partners into the business (there are no fixed entitlements). You may be able to get around this problem with a partnership of FT’s.
  • There may be some restriction on who you can distribute to if you need to make a family trust election. This election is required if the trust is trying to claim losses from prior years or imputation credits on franked dividends received.

Recommendation

Family trusts are very popular structures which allow flexibility of distribution of income and capital, access to most CGT small business concessions, access to the general CGT discount, limited liability and estate planning advantages. The main disadvantage is the problem catering for succession planning, and who will control this trust after death of the original parent/appointor. This can be done by giving the problem proper legal attention, but is often overlooked.

DISCLAIMER
This newsletter has been produced by Stanley & Williamson as a service to its clients and associates. The information contained in the newsletter is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this newsletter, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under Professional Standards legislation. 

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