What are the Tax Benefits of a Trust?
Neither discretionary or unit trusts incur taxes. Rather, the beneficiaries are taxed on the income and profit that they obtain from the trust. However, in circumstances where the trust generates income that extends beyond what is required to be allocated to beneficiaries, the trustee will be taxed at a rate of 45%.
A trust is a fiduciary relationship between an individual or company (trustee) and a trustor, whereby the trustor bestows a right on the trustee to hold the title of particular assets for the benefit of a third party (beneficiary). There are two categories of trusts: discretionary trusts (or family trusts), and unit trusts. Discretionary trusts allow the trustee to operate and manage the distribution of profit and income to beneficiaries at their discretion. Conversely, a unit trust separates a particular asset into units and fixes the income and profit earned by unitholders.
It is important to note that this article is not tax advice, and it is always necessary to consult with an accountant or tax lawyer in order to obtain tax advice relevant to your business. Nevertheless, here are some tax benefits of discretionary, and unit trusts:
Tax Benefits of Discretionary Trusts
Income Tax Benefits
One advantage of a discretionary trust is that the income tax that has been accrued by the beneficiary is determined by their individual marginal rate. This can be extremely beneficial, as it means that the trustee can mitigate the overall tax obligations of the beneficiaries involved in a discretionary trust, as the trust income can be allocated to beneficiaries with lower marginal tax rates. This is also known as ‘income splitting’.
For example, Sally earns $500,000 per annum and as a result, she falls within the highest tax bracket. Sally also has a husband who earns $120,000 p.a and has 3 kids who all earn around $18,000. Now let’s say that Sally and her husband want to invest $150,000 into a discretionary trust. The trust begins to earn significant returns and, assuming Sally has declared herself as the trustee, she must decide how to distribute the trust money.
It would be wise if Sally distributes the bulk of the trust money to her husband and kids as they fall within lower tax brackets, as opposed to allocating it to herself. As such, the income from the trust will be taxed at substantially lower tax rates.
Capital Gains Tax (CGT) Benefits
There are also potential, and substantial benefits that a business can experience in relation to CGT. The following circumstances are examples of where CGT would apply:
- The sale of an asset will result in your company either incurring a capital gain or loss.
- If one were to dispose of their business, this would simultaneously dispose of the goodwill (intangible asset) attached to the business, and the CGT will likely apply.
Provided these assets were held for 12 months or more, the trust will be eligible for a 50% CGT discount. This means that only 50% of the sale of the asset is tax-deductible. While this, of itself, is a tax benefit, an additional benefit lies in the total net capital gain, which can be distributed the same as income tax, and yield the same tax benefit as a result.
Tax Benefits of Unit Trusts
Income Tax and CGT Benefits
Unitholders can also benefit from CGT. Like beneficiary trusts, unit trusts can be eligible for the 50% CGT provided that the asset is held for at least 12 months. However, this discount will only apply to individual beneficiaries, as opposed to companies that are beneficiaries.
A franking credit is essentially a tax credit that is attached to dividends, which are paid to shareholders by corporations. Provided that the benefits of franking credits are included in the trust deed, the tax payable by unitholders on their dividends are reduced by a significant amount based on how many franking credits they have. This is beneficial as it eliminates any potential for double taxation.
Trusts can be complex, and so can it’s tax processes. Though this article does underline the key tax benefits of trusts, it is arguable whether setting up trusts are appropriate in all circumstances. Nevertheless, if you are interested in setting up a trust, it is crucial to determine which type of trust is right for you.
If you need assistance in determining whether setting up a trust is right for you and your situation, please don’t hesitate to call us at 1300 337 997.