Different Business Structures: Part 5: Discretionary Trust

A popular structure for small businesses and family groups

A discretionary trust, often referred to as a family trust, is one of the most common business structures in Australia. It’s especially popular among family businesses, professionals, and investors who want flexible income distribution and potential tax advantages.

Unlike unit trusts or companies, the beneficiaries of a discretionary trust do not have a fixed entitlement to income or capital. Instead, the trustee has full discretion – within limits set out in the trust deed – to decide which beneficiaries receive distributions and in what amounts.

What Is a Discretionary Trust?

A discretionary trust is a legal relationship set out in a trust deed, where a trustee holds assets for the benefit of a group of potential beneficiaries. These beneficiaries are often family members, but can also include companies or other trusts.

The trustee has the discretion to distribute income and capital to any one or more beneficiaries within the defined class. However, this discretion is limited to the terms and classes of beneficiaries listed in the deed.

Key Advantages of a Discretionary Trust

Flexibility and asset protection are key benefits.

• Tax-effective income streaming

  Distribute income to beneficiaries with lower marginal tax rates, reducing the overall tax burden.

• Access to CGT discounts and small business concessions

  The 50% CGT discount applies, and small business concessions can flow through to the ultimate individual owners.

• Tailored to your circumstances

  Trust deeds can be drafted to suit the unique needs of the principals and their families.

• Flexible distributions

  Both income and capital can be distributed in a way that suits the beneficiaries' personal or financial circumstances.

• Asset protection

  Assets in the trust may be protected from personal liabilities of the beneficiaries, especially when a corporate trustee is used.

• Simple to wind up

  Unlike more complex company structures, winding up a discretionary trust can be straightforward.

• Allows for remuneration

  Principals involved in the trust business can be employed and receive salary packaging.

Disadvantages of a Discretionary Trust

Not always ideal – and may carry hidden tax traps.

• Losses are quarantined

  Trust losses cannot be distributed to beneficiaries or offset against income in other entities.

• Tax on undistributed income

  If income is not distributed, it is taxed at the highest marginal tax rate.

• Trust loss provisions

  Complex ATO rules apply to carrying forward losses in discretionary trusts.

• Potential resettlement risks

  Adding beneficiaries or changing trust terms may trigger CGT or stamp duty due to resettlement rules.

• Understanding and compliance

  Trust deeds can be difficult for clients to understand. Calculating PAYG and distributions can be complex.

• More costly to establish and maintain

  Discretionary trusts involve legal and accounting costs, exceeding those of sole traders or basic company structures.

• Restricted dealings under family trust election

  Once a family trust election is made, dealings may be limited to within the family group or incur penalties.

• Personal liability risks for trustees

  Trustees (especially individuals) can be personally liable for trust debts if proper structures are not in place.

Is a Discretionary Trust Right for You?

Discretionary trusts can be powerful tools for asset protection, tax planning, and business structuring – but they’re not suitable for everyone. Speak to your accountant or advisor to determine if this structure suits your circumstances.

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Disclaimer:

The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.