Investing under a trust structure...

[rollers]

Hi guys,

I am currently carrying on an IT business as a sole trader, and now I'm considering moving to a discretionary trust structure with pty ltd as the trustee. I have been working my way through a few tax/trust books, but I am still lacking some fundamental knowledge that I would appreciate some insight into.

My trust will be carrying on a business, and paying me as an employee / contractor. So I imagine that my clients will be writing the cheques to the family trust, and this will be classed as family trust income. Is this correct so far? I understand that income paid into the trust by clients is untaxed, and is only taxed when distributed to beneficiaries, or alternatively, subject to the penal 'undistributed income' rate of 48.5% at the end of the financial year. Is this still correct?

Assuming that the above is correct, can the trust invest this income into shares / property etc, hold these investments for, say, 3 years, thus avoiding distributing the income or paying penal income tax rates during those 3 years? Or would the penal tax rate apply to 100% of the income even tho it has been re-invested in the interests of the beneficiaries?

I am young (19) and need minimal personal income at the moment, and would like to build some wealth (de-facto super I suppose) for use at a later date. Can this work? If not, is there another structure in which I can achieve the same result?

Kind regards,

Daniel.

 

[alexlee]

I am currently carrying on an IT business as a sole trader, and now I'm considering moving to a discretionary trust structure with pty ltd as the trustee. I have been working my way through a few tax/trust books, but I am still lacking some fundamental knowledge that I would appreciate some insight into.

My trust will be carrying on a business, and paying me as an employee / contractor. So I imagine that my clients will be writing the cheques to the family trust, and this will be classed as family trust income. Is this correct so far? I understand that income paid into the trust by clients is untaxed, and is only taxed when distributed to beneficiaries, or alternatively, subject to the penal 'undistributed income' rate of 48.5% at the end of the financial year. Is this still correct?

Correct so far.

Assuming that the above is correct, can the trust invest this income into shares / property etc, hold these investments for, say, 3 years, thus avoiding distributing the income or paying penal income tax rates during those 3 years? Or would the penal tax rate apply to 100% of the income even tho it has been re-invested in the interests of the beneficiaries?

NOT correct. Take a simple situation. The trust receives $10k in cash for services rendered. The trust MUST distribute $10k to beneficiaries for tax purposes or pay the trust tax rate, and the beneficiaries have to declare the $10k as income and taxed accordingly.

Now, accounting wise, the trust may choose to NOT pay the beneficiaries the distribution in cash, just carry a loan from the beneficiaries, and invest the cash into, say, shares. The benefit is that future income from the shares can be distributed to whichever beneficiary has the lowest marginal tax rate. The trust can keep owing the beneficiaries money.

You have to distinguish between trust INCOME and what it does with the actual cash.

I am young (19) and need minimal personal income at the moment, and would like to build some wealth (de-facto super I suppose) for use at a later date. Can this work? If not, is there another structure in which I can achieve the same result?

Yes, it can, but the income still has to be taxed somewhere first.

Also, a trust is usually used for asset protection and income streaming. I'm assuming you don't have a non-working spouse, etc that you can distribute income to. What would be the purpose of putting the business through a trust?
Alex

 

[The Y-man]

can the trust invest this income into shares / property etc.

Yes, but you'd defeat the very function of the trust by exposing your assets to your business risks - i.e. if something happens with your business, all the assets in the trust are up for grabs.

Cheers,

The Y-man

 

[rollers]

Hi guys, thanks for the replies... steep learning curve.

The trust receives $10k in cash for services rendered. The trust MUST distribute $10k to beneficiaries for tax purposes or pay the trust tax rate, and the beneficiaries have to declare the $10k as income and taxed accordingly.

Understood. I guess my main gap of knowledge here is related to the different ways of getting cash / assets into the trust, and how these are treated at tax time. In a scenario where parents are feeding a trust fund for their child with their post-tax dollars, is this classed as trust income or are these amounts gifted to the trust?

Now, accounting wise, the trust may choose to NOT pay the beneficiaries the [10k] distribution in cash, just carry a loan from the beneficiaries, and invest the cash into, say, shares.

So in this scenario, the 10k would still be taxed as personal income before being loaned back to the trust?

Also, a trust is usually used for asset protection and income streaming. I'm assuming you don't have a non-working spouse, etc that you can distribute income to. What would be the purpose of putting the business through a trust?

Point taken. My personal assets would be protected, but the trust assets would not. You are correct in assuming that I do not have a spouse. I have a sister and parents that I could stream to, however they are on a pension so the amount that I could stream would be minimal.

In summary, It sounds like I need to reconsider weather a trust structure is going to benefit me at all. A pty ltd tax rate of 30% sounds good for accruing wealth, but then of course, its taxed again when I draw on this as personal income, so again, the net gain is questionable.

Thanks again for replies, more reading required on my part I think!

Daniel.

 

[GZM]

Rollers

Something else to think about - there are restrictions on just setting up a trust to receive what is essentially your income from providing contracting services.

There is a threshold that you have to overcome before you can effectively alienate your personal services income into a trust. This all hinges on whether your services are classified as a "personal services business" and there are a series of hurdles you've got to get over to be classified as such.

I'd look into this with your accountant before thinking too much more about it.