Business Structuring 101- Part 5: Using a Family Trust
 

A trust is a business structure unlike any other. Everyone has heard of them, in particular ‘Family Trusts’ but very few business owners understand how they work. As a result, they tend to avoid them and stick to sole trader or company options. It’s such a shame because a trust can provide your tax advisor with some great tax planning opportunities, most of which are unavailable to any other structure.

The Trustee carries on the operations of the Trust on behalf of the Beneficiaries. The rights and obligations of all parties involved are contained in the Trust Deed, which is why your accountant will always ask for a copy of it!

If a corporate trustee is used the trust offers all the same asset protection benefits as using a company structure along with the additional benefits of using a trust. A trust that has individuals acting as trustees exposes the trustees to same levels of business risk as a sole trader.

Broadly speaking there are two common trust forms that you will encounter when making your business structuring decision, Fixed Trusts and Discretionary Trusts.

 

Discretionary Trusts

A discretionary trust is the most flexible form of business structure for a family trust. No single beneficiary has a fixed interest in the trust property or the trust income. The trustee has complete discretion in the distribution of funds to each beneficiary. This makes the discretionary trust (with a corporate trustee) a strong and flexible option for a family business. The family members are protected from business risk and the trustee has the discretion to distribute the income in the most effective way possible.

It is important to remember that all of the benefits offered by a discretionary trust for a family business make it a poor choice for a business where more than one family or group is involved as neither group of beneficiaries retains a fixed right to property or income.

Advantages of a Discretionary Trust:

  • Flexibility with income and capital distribution;
  • Tax planning possibilities;
  • Access to Small business CGT concessions;
  • 50% 12 month CGT discount;
  • Asset protection (if a corpoate trustee is used)
  • Can pay salaries and wages as well as superannuation;
  • Less regulations than a company

Disadvantages of a Discretionary Trust:

  • Distributions must be in accordance with the Trust Deed;
  • Risk of resettlement if changes are made to trust members or trust property without giving consideration to the rules outlined in the trust deed;
  • Losses cannot be distributed
  • Costly to establish and maintain when compared to Sole traders or partnerships;
  • Trustees can be personally liable for some debts of the trust (if individual trustees are used);

 

Fixed (Unit) Trusts

Fixed (Unit) trusts are recommended when more than one family or group is involved in the business operation. The interest in the trust is divided into units, similar to shares in a company. The Trustee distributes income to the beneficiaries in accordance with their respective unitholding in the trust. This is the key point of difference between the fixed and discretionary trusts. The units removed the Trustees discretion around the distribute income.

Advantages of a Fixed Trust:

  • Fixed Interests provide protection where more than one family or group in involved in the business;
  • Asset protection (where a corporate trustee is used);
  • Access to small business CGT concessions;
  • Access to 50% 12 month CGT discount;
  • Can pay salaries and wages as well as superannuation;
  • Less regulations than a company.

Disadvantages of a Fixed Trust:

  • Sale of units can be a CGT event and attract stamp duty;
  • Not as flexibility as a discretionary trusts;
  • Trustees can be personally liable for some debts of the trust (if an individual trustee is used;

 

Where to from here?

Business owners looking to establish their business operation inside a trust structure can experience a number of benefits. However, there are also a number of potential issues that must be carefully managed. I would never recommend any small business owner work through this process without seeking some sort of professional advice. Panic Atax works closely with every client we have that operate through a trust to ensure all the risks are managed and any potential issues are identified early enough to correct them.

I would encourage you to read the rest of the articles in this series. Each article explores a different structuring option and its important to understand all of them to make an informed decision. In particular, you may want to read our article on private companies.