There are many ways to use family trusts and they are likely to remain an important feature of the Australian economy, including as part of a small to medium enterprise (SME) business structure.
While they can be more complex and harder to understand than a simple company structure, the added flexibility offered by a family trust can make it worthwhile. And recent communications from the Australian Taxation Office (ATO) concerning distributions from family trusts further highlight the use and advantages of family trusts within a business structure.
Two of the more common methods for utilising a family trust in carrying on a business include:
Family trust carrying on a business
The simplest approach is for a family trust to carry on a business, which provides similar asset protection to trading through a private company as any debts and business risks are separated from the family members, and assets owned by the family, such as their home and other passive investments, can be protected from claims by creditors of the business.
The main advantage offered by a family trust is a high degree of flexibility compared to a company that has its shares owned by one or more individuals, as the trustee can make decisions each year on a discretionary basis as to how the net profit of the business should be allocated among different family members or related entities falling within the class of eligible beneficiaries.
Companies can be used as beneficiaries and may be entitled to a 25% tax rate. However there are strict rules on how this situation is managed which require the funds to be either paid to the company or “loaned back” on standard seven-year principal and interest terms (the interest on the loan should be tax-deductible to the trust).
It is also important to note the nature of a discretionary trust means this structure works best for a business controlled by a single family and is unlikely to suit two or more unrelated families carrying on business together, although this is sometimes addressed by the less common structure of trading through a partnership of different discretionary trusts.
Family trust owning shares in a company carrying on a business
A more sophisticated approach to business structuring which can work well in the right circumstances is to have a company carrying on a business where all the shares are owned by a family discretionary trust.
This structure has all the simplicity of a regular operating company, which is readily understood by all involved including the business owners, family members, customers, suppliers, lenders, and potential future purchasers.
It also allows profits to be retained by the company to fund working capital and/or to help grow the business and only paid out as dividends – usually fully franked – to the trust, when funds are required by the family for their own purposes. When dividends are paid, this will represent income for the trust in the year of the dividend, which will then be allocated to various trust beneficiaries on a discretionary basis.
Family trusts remain a popular vehicle with an enormous level of flexibility that can be used in a wide variety of ways and for a whole range of purposes.
As always, please consult with your HLB Mann Judd adviser who can provide the appropriate guidance for you and your personal circumstances.
This article was first published in the Spring 2022 issue of Financial Times.