This is a question we get asked often by medical practitioners. Generally they have heard from a colleague that they need a discretionary trust but don’t quite understand how they work.
Discretionary family trusts are a more complicated structure than a partnership or a company, however the benefits of trusts quite often outweigh the complications and/or additional costs. They are an extremely useful tool when it comes to tax minimisation, especially for use as service entities or for holding investments such as ownership in medical practices or shares.
A trust is an entity that holds assets for the benefit of its beneficiaries via trust distributions.
A Discretionary Trust is a type of trust where the beneficiary entitlements to the trust fund are not fixed but are determined by the criteria set out in the trust deed. The settlor establishes the trust and is a third party (not a beneficiary), it needs to be a person (not a firm or company) and cannot perform any other role in the trust – the settlor is only the settlor. 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.
Some of the benefits and costs associated with operating a business or holding investments through a trust are as follows:
- Asset protection – If a person is not the appointor and is only a beneficiary of a trust, the person is only entitled to the share of undrawn income or capital they have been distributed in the current and prior years (e.g., 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 – can change the amount of income and capital distributions from year to year and between beneficiaries.
- Succession planning easier – 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.
- Can access 50% CGT discount on assets held for more than 12 months.
- Can access Small Business Concessions based on your aggregated turnover. The ATO have made updates in the 2020/21 Financial Year (check eligibility)
- Can access Small Business CGT Concessions – Four types of concessions available to significantly minimise any CGT paid.
- Yearly compliance – slightly more complicated than a partnership due to the complexity in establishing and maintaining a trust structure.
- Only profits are distributed – cannot use losses to offset other income (losses are quarantined in the trust for recoupment in later years)
- Discretionary trusts that receive personal services income such as patient fees must distribute that income to the principal individual generating the income. Trusts can receive business income, service fees and investment income.
The above is a brief summary of using a discretionary trust. Given the different business scenarios, there are other types of trusts that could be of tax advantage or of reduced complexity depending on your circumstances. For example, a fixed unit trust may be more suitable where the beneficiaries are unrelated third parties with a share in the trust’s properties and investments.
On the contrary, as a medical practitioner, if you fall under the category with Personal Service Income you would be better suited to operating as a sole trader rather than a trust.
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.