A simple example:
Young Alice and Ben’s grandma has given them $500 each as Christmas gifts. Knowing the kids are under 18, grandma said to them: ‘You two are really beautiful kids, but you are still too young to take care of the money. How about I gave the money to your mum to ask her to take care of it for you? ‘Alice and Ben agreed and handed the money to their mother, Cindy.
If Cindy decided to open a bank account with the money, although the account’s name is under Cindy, but the interest income and principle actually belongs to the kids. If Cindy decided to buy some shares with the money, dividend earned and capital gains realized all belong to the kids. Of course, Cindy can also decide to buy some cloths or pay school fees with the money if she thinks it is appropriate.
This is actually a ‘trust’ – Cindy taking care of the money given by grandma for the benefits of her kids. Grandma is the settler of the trust, Cindy is the trustee, Alice and Ben are the beneficiaries, the $1,000 is the trust property, interest earned from the bank and dividend received are the trust income, profits realized from selling the shares are capital gains for the trust, money used to pay school fees are the corpus (capital) of the trust. Cindy should act in the best interest of her kids with the money. If she spends the money on her own gambling, then she will breach her fiduciary duty to her kids.
Imagine the money is a $1M dollar property which nets a $100K rental income per annum, or a wonderful business which can realize a capital gain of $1M when it is sold. Rather than holding the asset under your individual name, the asset belongs to your whole family (beneficiaries) and you are in charge of the asset as the trustee. In order to protect the trustee, a new empty company should be incorporated to be the trustee with the controller being the shareholder and director.
Benefits of holding the asset in trust:
• Profit can be shared between family members which could result lower amount of tax being paid
• Capital gains tax will be subject to 50% discount if the asset has been held more than one year and the capital gains are distributed to tax residents
• Asset protection because it is not under your individual name
• Part of estate planning because a trust can last for 80 years (apart from SA)
• Can protect vulnerable family members by taking over the control
Disadvantages of holding asset in trust:
• Profit must be distributed before the end of the financial year or trustee could be penalized with 47% tax
• Distribution to children under 18 could attract tax as high as 66%
• Trust loss cannot be distributed out which means no negative gearing effect
• Higher maintenance costs involved
• Land tax usually will be higher than in individual’s name
• If a discretionary trust deed has not excluded non-residents, extra stamp duty could apply when you use it to purchase a residential property
Of course, trust structure is a lot more complicated than the example. Depending on different situations, different kinds of trusts can be set up, such as discretionary trust which the trustee has the discretion to distribute profit & capital, unit trust which distributions are made to unit holders depending on how many units they have, hybrid trust which has the character of discretion and fixed entitlement, deceased estate trust which empower the dead to rule from the grave, and so on and so forth.
So, is trust a better structure for me? The short answer is it depends! There is no the best structure, only the most suitable structure at a certain time under a certain circumstance. That is why at ML Tax Solution, we understand our clients’ situation and will go through the pros and cons with you in details and work out the most suitable business structure for you.
Contact us on firstname.lastname@example.org or 03 95338980 if you would like us to work out the most suitable business or investment structure for you.