Example uses of discretionary trusts in Australia
Real world examples of discretionary or family trusts are often not clearly understood in Australia. We will explain what a common commercial set up which involves a discretionary trust so you understand whether it can be helpful to you.
Discretionary trusts in operating business
Running a business through a discretionary trust has benefits as the business can have a lot of assets such as equipment and intellectual property. In this respect, the trading company earns income and has a written agreement between the trading entity and the trustee company that owns the assets such as plant and equipment, real estate and intellectual property. This means that if someone sues the trading entity, the assets are protected because they are owned by a separate entity and used under a licence agreement. The business owner can then wind up the trading company and establish a new one and enter into a new license agreement. In this respect, the business continues trading despite litigation as the trading entity can be wound up and the trustee enters into a new licensing agreement for a new trading entity to make a written agreement with.
The above example illustrates the importance of a trustee company owning assets and not carrying on trading activities so that it has separate potential liabilities.
Discretionary Trust for asset protection
Another benefit of a discretionary trust is its ability to protect assets from being litigated over. For example, if you were a lawyer or doctor and run your own practice, the business is held by a family trust where you are the Trustee. The family trust can own investment properties and blue chip share portfolios. Contrast this with a practice owned by the sole practitioner and they are sued for negligence. They can lose their practice as the damages awarded against the business can exceed the insurance coverage. By having the business separate from the trust which owns the properties and shares, its assets can be quarantined from commercial risk of the business.
Similarly, if a beneficiary is declared bankrupt. The assets of the trust would not be considered assets of a bankrupt beneficiary. This means the assets would not be available to creditors. However, the units of a trust which the beneficiary is entitled to may be made available to creditors. In this respect, trust property can still benefit the bankrupt’s family.
Discretionary Trusts in family law matters
Where a beneficiary may be subject to family law divorce proceedings, assets held in a trust are not considered an asset of the marriage. However, the trust assets may be taken into account when apportioning assets under a property settlement. Depending on how the trust is structured, the Family Court may not be able to force trust assets to be transferred to the spouse. However, for fixed trust units these may be transferred to a spouse.
Discretionary Trusts for succession planning
If you have a business and have adult children, you may want to pass on your business to one or more of your children. You can do so by appointing one of your adult children as a trustee of a cloned trust which holds the business so that they control that business. You can also appoint a trustee of the original trust which holds the investment properties and shares.
Distribution of business income
Another benefit of having a discretionary trust operating a business is when instead of having a sole trader being taxed at the highest income tax marginal rate the profits can be spread between family members such as a spouse and daughter. This can involve income tax savings in the tens of thousands. There may also be tax-deductible super contributions that can be made. In this respect, income is taxed in the beneficiaries’ distributed amounts. Where income is not distributed it is taxed on the Trustee. Trust distributions are made by resolutions by a trustee or directors of corporate trustees whereby the trustee’s powers are contained in the Trust Deed and there is an absolute entitlement to a share of trust distributable income. It is important to note that distributions to non-beneficiaries will be void and a residue or balance clause in the income distribution resolution will not be effective.
Operating a discretionary trust
A discretionary trust has less regulations compared to a company and can be used to avoid restrictive regulations. The Trust’s financial performance can be confidential and there is no requirement that trust accounts be audited. They are also less expensive to establish and maintain as well as are easier to wind up than a company such as through the power of revocation contained in the trust deed, consent of all beneficiaries or distribution of the trust property.
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