One of the most common queries we receive from medical practitioners is about the practical benefits of a discretionary/family trust. Often, they have been advised to set one up but are unsure of its practical applications. This article aims to demystify the concept and provide practical insights.
While discretionary or family trusts may seem complex, their benefits often outweigh the perceived complications and additional costs. They are a powerful tool for asset protection and tax minimisation, especially when used as service entities or for holding investments like ownership in medical practices or shares.
However, as a medical practitioner, if you fall under the category of earning Personal Service Income (PSI), you may be better suited to operating as a sole trader rather than a trust. There are tax rules that mean all PSI income needs to be declared in your personal name regardless of the structure. Read more about these rules in our article personal services income: the fact from the fiction.
A trust is an entity that holds assets for the benefit of its beneficiaries via trust distributions. A Discretionary Trust is where the beneficiary entitlements to the trust fund are not fixed but determined by the criteria set out in the trust deed. The settlor establishes the trust and is a third party but not a beneficiary. It needs to be a person, not a firm or company, and they cannot perform any other role in the trust. Quite often your accountant or lawyer will fulfill this role.
There are three important roles within any trust:
- Appointor – has ultimate control of the trust and can remove the trustee at any point in time.
- Trustee – controls the day-to-day activities and is to act in the best interest of the beneficiaries of the trust. Is the legal owner of any assets however holds them in trust for the beneficiaries
- Beneficiaries – receive distributions of income and capital at the discretion of the trustee.
Due to the discretionary power given to the trustees, distributions of income and capital can vary in both amounts and beneficiaries from year to year. This becomes a very useful tool in minimising the tax payable by a family group.
Below are some of the benefits and costs associated with operating a business or holding investments through a trust.
Benefits
- Asset protection – If a person is not the appointor and is only a beneficiary of a trust, they are only entitled to the share of undrawn income or capital they have been distributed in the current and prior years. For example, if the trustee has declared a $50,000 distribution and $20,000 has been taken in cash from the business, $30,000 is the only amount owing to that person
- Flexibility – The amount of income and capital distributions can be changed from year to year and between beneficiaries.
- Easier succession planning – A simple change of appointor can allow control of the assets to pass between generations. Neither Capital Gains Tax (CGT) nor stamp duty is payable if there is a mere change in appointorship, if the beneficial ownership does not change.
- Tax minimisation – 50% CGT discount can be accessed on assets held for over 12 months, meaning only 50% of the gain is taxable in the hands of the beneficiary.
- Small Business CGT Concessions can be accessed (subject to turnover and eligibility criteria) – Four types of concessions are available to significantly minimise any CGT paid.
Costs
- Yearly compliance is slightly more complicated than other entity types due to the complexity of establishing and maintaining a trust structure and having to determine the distributions each year
- Only profits are distributed, and losses cannot be used to offset other income. Losses are quarantined in the trust for recoupment in later years
- A trust must distribute all its profit at the end of the financial year. Any profits retained in the trust are taxed at the highest marginal rate, i.e. trustee tax rate.
- Discretionary trusts that receive personal services income, such as patient fees, must distribute that income to the principal individual generating the income. Trusts can also receive business income, service fees and investment income.
- Anti-avoidance provisions apply (s100A) where a beneficiary’s trust entitlement is paid to someone other than the beneficiary to reduce tax. For example, the distribution entitlement is with an adult child as they are on a lower tax rate; however, the funds are paid to the parents.
- Due to their nature, discretionary trusts are generally not appropriate for businesses with unrelated owners. In this instance, a unit trust or company might be more practical.
While these are the pros and cons of using a discretionary trust, different business scenarios might require the use of other types of trusts that could be advantageous from a tax perspective or have reduced complexity. For example, a fixed or hybrid unit trust may be more suitable where the beneficiaries are unrelated third parties with a share in the trust’s properties and investments.
If you wish to discuss the use of discretionary trusts and receive advice on the appropriate trust establishment per your business circumstances, please contact your local William Buck advisor.
Disclaimer: The contents of this article are in the nature of general comments only, and are not to be used, relied, or acted upon without seeking further professional advice. William Buck accepts no liability for errors or omissions, or for any loss or damage suffered as a result of any person acting without such advice. Liability limited by a scheme approved under Professional Standards Legislation.
