Discretionary Trust: Everything A Business Owner Needs To Know

Zeinab Farhat discretionary trustAuthor: Zeinab Farhat & Petro Kaloterakis, Progressive Legal

Discretionary Trust

In the world of Australian business, the discretionary trust stands out as a vital tool, offering tax advantages, asset protection, and distribution flexibility. As businesses adapt to changing landscapes, the discretionary trust becomes invaluable for entrepreneurs seeking a secure and adaptable framework.

On this page, we will uncover the essentials of discretionary trusts in Australia, including: defining what a discretionary trust is, its advantages, setup procedures, compliance, potential drawbacks, and the similarities/ differences compared to family trusts.

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What is a discretionary trust?

The term “discretionary trust” is gaining prominence, and for good reason. But let us start at the beginning – what is it? 

Simply put, a discretionary trust is a legal arrangement that allows a trustee to hold and manage assets on behalf of a group of beneficiaries. A beneficiary is a person who obtains the advantage of a trust through some designation.  

Unlike other trust structures, a discretionary trust offers unique flexibility, giving the trustee the discretion to distribute income and assets among beneficiaries in a way that can potentially maximise tax advantages. 

What are the advantages of a discretionary trust? 

There are a wide range of benefits of discretionary trusts, including but not limited to:

Tax Efficiency

One of the major advantages of a discretionary trust is its tax benefits. In Australia, businesses operating within this type of trust can strategically distribute income among beneficiaries, potentially leading to reduced overall tax liabilities. 

However, it is best to consult directly with an accountant who will be able to provide you with advice regarding any tax implications arising out of the formation of a discretionary trust and the operation of a business within that trust.  

Asset Protection

In an ever-changing business environment, protecting assets is paramount.  

A discretionary trust provides a protective shield, as assets are held separately from the personal assets of the beneficiaries. This separation can be instrumental in shielding the business from unforeseen financial challenges. 

For example, in a situation where a listed beneficiary of a discretionary trust is personally sued, the assets contained within that trust are protected as they do not constitute that beneficiaries’ personal assets. The opposite is true, such that where a trustee is sued personally, the assets contained within the trust remain untouched.  

Flexibility in Distribution

The beauty of a discretionary trust lies in its name – discretion. The trustee has the power to decide how income and assets are distributed among beneficiaries. This flexibility enables businesses to adapt to changing circumstances and ensure the financial well-being of the beneficiaries. 

How do I set up a discretionary trust?

Now that we have established the significance of a discretionary trust, let us walk through the steps involved in setting one up: 

Selecting a Trustee

The first step is appointing a trustee. This individual or entity holds the legal title to the trust property and is responsible for managing and distributing assets in accordance with the trust deed.   

A trustee has various responsibilities and liabilities, such as: a requirement to act in good faith, in the best interests of the trust, in accordance with any applicable documents such as a trust deed, to keep records, etc. In other words, it is important to appoint a trustee who you are confident will be able to adhere to its duties and responsibilities under the law. 

Defining Beneficiaries

Clearly outline who the beneficiaries of the trust will be. This could include family members, business partners, or even charitable organisations. The flexibility to add or remove beneficiaries adds an extra layer of adaptability. 

Drafting the Trust Deed

The trust deed is the legal document that outlines the rules and guidelines governing the trust. It’s crucial to ensure that the trust deed is carefully drafted to reflect the specific needs and goals of the business. 

Registering the Trust

While not mandatory, registering the trust with the Australian Taxation Office (ATO) can have practical benefits, especially when it comes to taxation.  

This step involves obtaining a tax file number (TFN) and an Australian Business Number (ABN) for the trust. Take a look at our guide for obtaining and finding your tax file number.

Legislation and Compliance

To ensure the legitimacy and effectiveness of a discretionary trust, it is imperative to adhere to relevant legislation. In Australia, the primary legislation governing trusts is the Trustee Act 1925 (NSW), with each State and Territory having its own variations.  

Additionally, the Income Tax Assessment Act 1936 (Cth) provides insights into the tax implications of operating within the trust. 

It’s advisable to seek professional advice to navigate the legal intricacies and ensure compliance with current legislation.

At Progressive Legal, our team of experts is dedicated to guiding you through the process, ensuring that your discretionary trust is not only legally sound but also tailored to your business objectives. However, if you require specific tax advice, you must consult with your accountant.

What are the disadvantages of a discretionary trust?

While a discretionary trust offers numerous advantages, it is crucial to be aware of potential drawbacks. These may include: 

Loss of Control

The trustee holds significant power in a discretionary trust, which can be a disadvantage for business owners who prefer a more hands-on approach to decision-making. 

Complexity in Administration

The flexibility of the trust comes with added administrative complexities. Proper record-keeping and adherence to legal requirements are essential to avoid complications. 

Limited Borrowing Capacity

Discretionary trusts may face challenges when seeking financing, as lenders may be hesitant due to the discretionary nature of income distribution. 

What are the differences between a discretionary trust and family trust?

The terms “discretionary trust” and “family trust” are often used interchangeably. However, it’s essential to understand the nuanced differences. 

A discretionary trust, as discussed, allows the trustee the discretion to distribute income and assets among beneficiaries as they see fit. This flexibility extends to a broad range of potential beneficiaries, including family members, business partners, and charitable organisations. 

While a family trust is a form of discretionary trust, it typically involves a more limited class of beneficiaries, often centred around family members. The main distinction lies in the focus on family relationships as a defining factor in determining beneficiaries. 

Legislation, such as the Income Tax Assessment Act 1997 (Cth), provides guidelines on the classification and taxation of trusts, shedding light on the specific characteristics of family trusts.

Key Takeaways

A discretionary trust is a powerful tool for businesses seeking flexibility, tax efficiency, and asset protection. By understanding the basics, navigating the setup process, and being aware of both advantages and disadvantages, business owners can make informed decisions aligned with their goals. 

At Progressive Legal, we specialise in simplifying complex legal concepts for business owners. If you are considering operating your business within a discretionary trust, our team is here to guide you every step of the way.  

Reach out to our experienced corporate lawyers at 1800 820 083 or request their expert advice below. 

Need help setting up a discretionary trust?

Contact us by giving us a call on 1800 820 083 or request our advice today.  

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