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Establishing a Discretionary Trust in Australia

There’s likely over 1 million trusts in Australia by now. Yes, discretionary or family trusts are a common legal structure in Australia. Folks use them for their versatility in asset protection, tax efficiency, and estate planning and more. However, while they offer considerable benefits, discretionary trusts also present certain challenges. These must be very carefully weighed. Here we examine the benefits and drawbacks of discretionary trusts within the Australian context. We try to provide some insights for those considering their use – but remember! Contact your accountant or us before doing anything. This is just general information & has potentially nothing to do with your situation.

1. Benefits of Discretionary Trusts

1.1. Flexibility in Income Distribution

One of the most significant advantages of discretionary trusts is the flexibility they provide in distributing income. Trustees have the discretion to allocate income among beneficiaries according to their needs and circumstances.

• Tax Minimization: By distributing income to beneficiaries in lower tax brackets, families can effectively reduce their overall tax burden.
• Adaptability: The trustee can adjust distributions to reflect changes in the financial situations of beneficiaries, making the trust responsive to their needs.

As Stewart notes, “The discretionary nature of these trusts allows for income to be allocated in a tax-efficient manner, optimizing financial outcomes for the family unit” (Stewart 110).

1.2. Asset Protection

Discretionary trusts are often used for their robust asset protection features.

• Creditor Protection: Assets held within a discretionary trust are generally shielded from creditors, as beneficiaries do not have a fixed entitlement to the trust’s assets.
• Family Law Protection: In cases of divorce, assets in a discretionary trust are typically excluded from the property pool available for division, protecting family wealth.

According to Mortimer, “The protection of assets from creditors and in family law disputes is a key benefit of discretionary trusts, ensuring the preservation of wealth across generations” (Mortimer 67). Some add layers to this via corporate trustees and other layers within the structure too. Lawyers and accountants nerd out here.

1.3. Estate Planning Advantages

Discretionary trusts are an effective tool for estate planning, offering several advantages in the transfer of wealth.

• Seamless Wealth Transfer: Trusts enable the smooth transfer of assets to the next generation, reducing the complexities often associated with probate.
• Control Over Distribution: The trust allows the settlor to maintain control over how and when assets are distributed to beneficiaries, ensuring that the wealth is managed according to their wishes.

Ford and Lee emphasize, “Discretionary trusts provide a flexible and controlled mechanism for the transfer of wealth, which is particularly valuable in estate planning” (Ford and Lee 145).

1.4. Tax Benefits

Discretionary trusts in Australia can take advantage of several tax benefits, particularly in relation to capital gains.

• CGT Discount: Assets held for more than 12 months within a discretionary trust may qualify for a 50% discount on capital gains tax.
• Small Business Concessions: Trusts that qualify as small businesses can access further CGT concessions, reducing the tax impact when selling business assets.

Lyons states, “The ability to access CGT discounts and small business concessions significantly enhances the tax efficiency of discretionary trusts” (Lyons 94).

BUT IS IT ALL GOOD?

2. Drawbacks of Discretionary Trusts

2.1. Complexity and Administrative Burden

Despite their benefits, discretionary trusts can be complex to establish and maintain.

• Setup and Ongoing Costs: Establishing a discretionary trust involves legal and accounting fees, and ongoing administration requires diligent record-keeping and compliance with tax obligations.
• Complex Management: Trustees must manage the trust carefully, balancing the interests of various beneficiaries while adhering to the terms of the trust deed.

Eustice points out, “The complexity and ongoing administrative burden of discretionary trusts can be a significant deterrent, particularly for those without access to professional advice” (Eustice 83).

2.2. Risk of Family Disputes

The discretionary nature of the trust, while providing flexibility, can also lead to family disputes.

• Uncertain Beneficiary Entitlements: Beneficiaries do not have a guaranteed share of the trust’s assets, which can create uncertainty and lead to disputes.
• Potential for Conflict: Differences in opinions regarding how the trust should be managed or how distributions should be made can result in tensions among family members.

Wilson argues, “The inherent flexibility of discretionary trusts can sometimes be a double-edged sword, leading to disputes and conflicts among beneficiaries” (Wilson 58).

2.3. Tax Compliance Challenges

Discretionary trusts must be managed carefully to avoid potential tax compliance issues.

• Trustee Obligations: Trustees are responsible for ensuring the trust complies with all relevant tax laws, including those related to income tax, capital gains tax, and GST. Failure to comply can result in significant penalties.
• ATO Scrutiny: The Australian Taxation Office closely monitors the use of discretionary trusts, particularly for tax avoidance schemes, requiring trustees to be diligent in their compliance. This can quite painful to maintain if you are not working with the right professionals.

Griggs highlights, “The risk of tax compliance issues and ATO scrutiny is a critical consideration for those managing discretionary trusts, emphasizing the need for careful administration” (Griggs 75).

2.4. Limitations on Distributing Losses

A key limitation of discretionary trusts in Australia is the inability to distribute losses to beneficiaries.

• Retention of Losses: Losses incurred by the trust must be retained within the trust, potentially limiting the tax benefits that can be passed on to beneficiaries.
• Impact on Tax Strategy: This restriction can complicate tax planning, particularly in years when the trust experiences losses.

Harris observes, “The restriction on distributing losses can undermine the tax efficiency of a discretionary trust, especially during periods of financial downturn” (Harris 103). This is a very good point. Because the economy will not always be “up”. Odds are you will face a couple of those in your lifetime. What then?

3. Strategic Considerations

When deciding whether to establish a discretionary trust, it is essential to consider both the benefits and the drawbacks in the context of individual circumstances.

3.1. Professional Guidance

Given the complexities involved, professional advice is crucial in setting up and managing a discretionary trust.

• Legal Expertise: A lawyer can help draft a comprehensive trust deed and ensure that the trust is structured in compliance with the law.
• Financial Advice: An accountant or financial advisor can assist in optimizing the tax benefits of the trust while managing its administrative requirements.

Mortimer advises, “Engaging with experienced professionals is essential for navigating the complexities of discretionary trusts and ensuring their effective management” (Mortimer 88).

3.2. Trustee Selection

Choosing the right trustee is vital to the success of the trust.

• Skills and Integrity: The trustee should have the necessary skills to manage the trust’s assets and the integrity to act in the best interests of the beneficiaries.
• Impartiality: Trustees must be able to act impartially, balancing the needs of all beneficiaries while adhering to the trust’s objectives.

Stewart remarks, “The selection of a competent and trustworthy trustee is fundamental to the effective operation of a discretionary trust” (Stewart 74).

Should you get yourself a family trust in Australian then?

Discretionary or family trusts offer significant advantages in the Australian context, including flexibility in income distribution, asset protection, and estate planning benefits. However, they also come with challenges, such as complexity, potential for disputes, and tax compliance issues. By carefully considering these factors and seeking professional advice, individuals can determine whether a discretionary trust is the right structure for their needs. With the proper management and guidance, discretionary trusts can be a powerful tool for achieving long-term financial and family goals. We definitely do not recommend you try any of this without the advice of an experienced accountant.

Bibliography

Eustice, Robert. Australian Trust Law and Practice. 4th ed., LexisNexis Butterworths, 2019.

Ford, H.A.J., and Lee, W.A. Principles of the Law of Trusts. 4th ed., Thomson Reuters, 2017.

Griggs, Lynden. Trusts Law in Australia: A Modern Perspective. 2nd ed., Federation Press, 2016.

Harris, Michael. Australian Taxation of Trusts. 3rd ed., CCH Australia Limited, 2018.

Lyons, Timothy. Taxation and Trusts in Australia. 5th ed., Oxford University Press, 2020.

Mortimer, Caroline. The Law of Trusts in Australia. 6th ed., Thomson Reuters, 2015.

Stewart, Miranda. Trusts and Taxation: A Practical Guide. 3rd ed., Federation Press, 2018.

Wilson, Andrew. Managing Family Trusts: A Guide for Trustees and Beneficiaries. LexisNexis Butterworths, 2017.