Advantages and Disadvantages of a Discretionary Trust

If you are considering starting your business through a discretionary trust, it is important to understand how the discretionary trust will impact your business running and understand this structure is appropriate for meeting your purposes. In this article, we’ll explain the advantages and disadvantages of a discretionary trust.

What Is a Discretionary Trust?

Discretionary trusts are often called “family trusts” because they are usually connected with tax planning and asset protection of family members. In a discretionary trust (or family trust) the beneficiaries do not have a fixed entitlement or interest in the trust funds. The appeal of a discretionary trust is that the trustee has better control and flexibility on the disposition of assets and income because the nature of a beneficiary’s interest is that they only have a right to be considered by the trustee in the exercise of his or her discretion. This offers a great deal of flexibility, but might seem too nebulous for some stakeholders.

So, this business structure may work well for one business, but may not be the best option for another business. That’s why it is essential to balance the advantages and disadvantages of a discretionary trust.

Advantages of Discretionary Trusts

There are several benefits of discretionary trusts when you determine to operate your business through a discretionary trust. It may be more suitable to achieve some business objectives.

1. Flexible and Easy Distribution of Trust Income and Capital

Discretionary trusts provide ways for the trustee who has better control and flexibility on the disposition of assets and income. The trustee could use their discretion to change the allocation of funds to beneficiaries without having to make any major changes.

2. Asset Protection

A Trustee of a discretionary trust holds the property beneficially for the beneficiaries. Property held by a person as trustee cannot be taken by a creditor in bankruptcy, unless the debt relating to the creditor was a trust debt. Similarly, property held by a company, as trustee for a trust, cannot be taken by creditors in a liquidation of that company unless the debt is a debt of the trust.  Any properties held in trust can only be attacked by creditors of that trust.

3. Tax Efficiency

Discretionary trusts allow for the accumulation of assets for beneficiaries.

Then, the trustee can distribute income which is regard to tax-specific individual circumstances. Such ‘income splitting’ can minimise overall family tax obligations if the trustee chooses to distribute the trust income to the beneficiaries that have an unused tax-free threshold or a lower marginal tax rate. For example, trust income may be paid to a wife who is on a lower tax rate or to a private company associated with the spouse. The way a trustee distributes income can be changed from year to year to reflect marginal rates for that year.

4. Discount on Capital Gains

If you select your company as a discretionary trust, the trust entitled to a discount on capital gains made on the disposal of assets held by the trust for longer than 12 months. Other tax benefits include availability of the 50% CGT concession where capital gains are distributed to natural person beneficiaries; potential for application of the CGT small business concessions; and capacity for loans to be made to beneficiaries tax-effectively and with flexibility.

Disadvantages of Discretionary Trusts

Unfortunately, there are also some disadvantages when you choose the discretionary trust.

1. Family Trust Distribution Tax

This Family trust distribution tax applies when a distribution is made outside of the “family group.”And a family trust does pay tax is if the income isn’t distributed to its beneficiaries. In this case, the trust gets taxed at the highest marginal tax rate. So, it’s highly important for trustees to make the election and choose the appropriate “test individual” for the family group, and the “family group” is designated by making the election.

2. Losses cannot be distributed

The trust structure cannot distribute capital or revenue losses to its beneficiaries. Hence, when a trust incurs a loss, beneficiaries are not able to offset that loss against any other assessable income such as salary, interest, dividends etc.

3. Beneficiaries Lack Legal Interest in Trust Property

Since the trustee or trustees can use their discretion to change allocations, beneficiaries don’t have certain legal interests in the trust property. Beneficiaries can’t rely on receiving their “share” of the assets because allocations could be changed on a whim.

Although there are some disadvantages of discretionary trusts, this type of trust is still a common business structure in Australia because it maintains a high degree of flexibility and protection for beneficiaries.

Although there are some disadvantages of discretionary trusts, this type of trust is still a common business structure in Australia because it maintains a high degree of flexibility and protection for beneficiaries.

If you want more suggestions and seek for assistance about discretionary trusts, call BOA & Co. accountants in Chatswoodon 02 9904 7886 and our Trust Specialist will be pleased to assist you.

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