*Always seek the advice from a professional if you’re thinking about setting up a trust. The below is not legal advice, only my thoughts, and opinions.
I have decided to start a series of posts that will detail some of my methods of minimising the amount of tax you have to pay. Some of these techniques will apply to the way you invest but there will also be tips for people who are not at the investing stage just yet. And I’ll preface this post by stating very clearly
There is no legal way to pay no tax at all
Yes, you can negative gear your pants off but I’m not the biggest fan of that method. The idea is to minimise the amount of tax you pay by utilising legal methods. I love Australia and don’t have any problems paying my taxes to keep this awesome country running…BUT! That doesn’t mean I’m going to be donating extra money because lets be honest, sometimes the government doesn’t spend the tax payers money in the most efficient of ways…
Paying Taxes
Just like income tax you pay on your wages, you have to pay tax on the income produced by your assets and also the capital gain IF you sell the asset and realise the gain (more or that later). Income produced by an asset that’s in your name is added on to your regular salary income and is taxed accordingly. Below is the ATO tax rates for 2015-16
| Taxable income | Tax on this income |
|---|---|
| 0 – $18,200 | Nil |
| $18,201 – $37,000 | 19c for each $1 over $18,200 |
| $37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |
| $80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |
| $180,001 and over | $54,547 plus 45c for each $1 over $180,000 |
Let’s say you have had an investment property that is earning you $20K from rent after all expenses including depreciation (that some serious cash flow!) and your normal 9-5 job earns you a salary of $65K. In this situation, the ATO look at your income and conclude that you earn $85K and tax you accordingly.
Below is a break down on the taxes you pay on the extra $20K income produced by your investment property
15,000 * 32.5% = $4,875 PLUS 5,000 * 37% = $1,859
=$6,725
The last $5,000 dollars you earned were taxed at a higher rate of 37c for each dollar because you went over the $80K threshold.
Buying With Your Partner
Now let’s assume that you’re buying that asset with your partner and you are each allocated 50% ownership of the asset. Your partner only works 2 days a week and earn $12K yearly.
Now the ATO look at your taxes very differently.
Because you only have 50% ownership of the asset you only earn 50% of its income, which equals $10K. This $10K is added to your income which gives you a grand total of $75K. Your partner is given the other 50% which brings their income up to $22K. Now, this is where the tax savings come in. The $10K that was distributed to you was taxed at a rate of 32.5c for every dollar.This equals 10,000 * 32.5% = $3,250 in taxes paid to the ATO. Your partner, however, is very different. They only earn $12K which is too low to be taxed at all. Adding the $10K bring them up to $22K. They have to pay 19c for every dollar they earn over $18,200. $22,000 – $18,200 = $3,800 dollars.
$3,800 * 19% = $722. The total tax you paid on the $20K as a couple is now $3,250 + $722 = $3,972
Simply buying with your partner in this scenario will save $2,753 in taxes every year for this couple. If they have the property for 30 years the money they would save would equal =
$85,590!
If you think that’s impressive, wait until I show you how trusts work
Buying Assets In A Trust
There are actually a few different sorts of Trust that you can set up for different reasons. I’m only going to be talking about discretionary trusts (Family trusts) as that is the vehicle I’m currently using and what I have experience in.
What is a trust anyway?
A discretionary trust is a trust relationship whereby the trustee is obligated to hold assets for the benefit of the beneficiaries of the trust. This obligation is defined in the trust deed which the trustee must enter into. It’s basically a written agreement on how assets are held and distributed among the people that that should get them.
You need the following to set up a trust:
The Settlor
The person that creates the trust. Usually is someone who will have no more involvement after the trust is set up. I used my accountant as the Settlor for my trust.
The Trustee
The legal entity that owns all assets held in the trust. This can be a person OR a company. Yes, that’s right. A company can be the trustee of a trust. Now, why would you want a company being the legal owner of assets?
Because this is how you achieve asset protection!
If you buy in your own name and for whatever reason go bankrupt. The creditors have full access to anything that you own to get their money back. But what if you don’t actually own any assets but simply control them? What you can do is set up a company and be the only shareholder of it so you have complete control of its decisions. You then set up a trust and have the company be the trustee of the trust.
The company is now liable for the assets held within the trust and not you!
If something goes belly up the creditors will have access to all assets that the company owns including all assets within the trust but not outside of it. This makes sense when you think about too. If you invest in a company that goes bust, you’re going to lose your shares most likely but the creditors are not going to try to recoup their loss from the shareholder’s personal assets. That would be illegal.
And it works both ways too. If you were personally sued and lost the case. They could not go after any assets held within the trust because technically you don’t own them. The company does upon which you are simply a shareholder of 🙂 . I plan to have multiple trusts set-up eventually to limit the losses if something went drastically wrong in one of them.
The Appointor
The person who appoints the trustee of the trust. Has the power to remove a trustee and appoint another one. Needed in case the current trustee dies or doesn’t want to be trustee anymore.
The Beneficiaries
The beneficiaries are the entities that benefit from the trust in forms of distributions.
The real magic of the trust is its ability to distribute income to multiple beneficiaries at the most efficient rate that suits for that financial year. Let’s say that the trust earns $40K. This can be from rent income or capital gains. The Trust has the ability to choose where to distribute this income to. If you lost your job one year and didn’t earn anything. The trust could distribute you $18,200 dollars and you wouldn’t pay any tax on it. You can distribute income to your children but it won’t be tax-free money, there are special tax rates for individuals under 18 who receive money from a trust. Back in the day, there was a loophole whereby trusts could distribute money up to the tax-free threshold for minors and get away with it. You can’t do this anymore.
If you still have income left over in the trust after you have distributed most of it to the beneficiaries in a tax effective manner there is another beneficiary that you can distribute to whose tax rate never changes no matter how much they earn. That is another company. You can actually distribute income to another company whose tax rate is locked at 30%.
This is massive.
Lets say you buy a house for $60K in 1980 and over the next 40 years it produces $300K in cash flow after all deductions and losses ($7.5K positively gears per year)
For simplicity, I have left out a bunch of things here but we are trying to keep it as straightforward as possible so it’s easy to follow. $300K taxed at 45c (assuming that the surplus of money is tax at the highest rate) to the dollar equals $135,000 of tax to the ATO…OUCH.
If you had bought that asset in a trust, however, you would have the ability to distribute portions of that income stream to multiple people and to a company which is taxed at 30%. Let’s say both you and your partner are currently at the 32.5c threshold and you have no children. It would be more strategically advantageous to distribute the whole $300K to a company at 30c to the dollar which would turn out to be $90K instead of $135K.
That’s a $45K saving in tax by simply having the asset in a trust.
And the more you earn, the greater the savings are going to be. Income redirection along with asset protection is the reason I utilise this method. It gives me flexibility and security of my assets. I have used the above examples with properties but the trust works the same for shares.
Downsides Of A Trust
While I have painted a picture of milk and honey for trusts there are some disadvantages
- You cannot receive the main residency capital gains exemption tax which basically is when you sell your own home and don’t pay capital gains on it. This can be a strategy for an investor who lives in an investment for one year before selling to avoid CGT. You cannot do this with a trust.
- There are costs associated with setting up a trust and company and running them. It cost me $1500 to have a trust and company professionally set-up. You can do it yourself for around $600 bucks but I don’t think it’s worth it in case you stuff something up. It’s $200 a year to register the company and an extra $300 bucks a year my accountant charges for doing the accounting for the company and trust which are slightly more complicated than a normal tax return. Considering the advantages I have outlined above it was a no-brainer for me to pay a little extra now and set it up right to reap the benefits in the years to come.
- You cannot negatively gear in this structure. You cannot distribute a loss. You can carry it forward and offset any future gains but you can’t offset your personal income through a trust. This doesn’t really bother me because I don’t plan to negative gear when I buy assets. They might be slightly negative when I buy them but turn positive after 1 or 2 rental increases over time.
I hope you have gained a little more knowledge by reading this post. Investing through a trust is not for everyone or every strategy. But knowing it exists is beneficial in case you ever feel you could take advantage of it. I bought my first IP in my own name when I had no idea about trusts or how they worked. Unfortunately transferring an IP from your personal name to a trust will trigger CGT (if any has occurred) and you will be up for stamp duty again. For this reason, I will keep my first IP in my own name. I planned to buy all future IP’s in the trust I have set up. I will be paying slightly more upfront costs this way (running the trust) but will hope to reap huge benefits down the track.
If you have a better way to buy assets I’d love to hear about it in the comment section below as I’m always looking to do things better learning from people smarter than myself
Hey nice writeup – great food for thought. Could you please explain, if you have a second company as a trust beneficiary to absorb income taxed over 30%, what is required to put that money back into the trust for future investments? Can the company “give” the money to the trust without incurring expenses?
Great question Tony.
My understanding of this is the business can loan the trust the money. If the business received $5K from the trust after all tax has been paid, the business could then ‘loan’ the trust $5K and that money would now sit in the trust for further investing. I will double check with my accountant about this though because my knowledge on this subject comes from the fantastic book called trust magic by Dale Gatherum-Goss but the copy I have was from 2009.
You can still defiantly do it as I have discussed this strategy with my accountant before we set up the trust but as to how it is done from an accountants point of view may have changed slightly.
I’m quite a while away from my trust generating positive income so I have never had to do this part yet but it’s always good to think ahead. If investing in trust interest you I highly recommend that book. HEAPS of cool stuff that I didn’t mention in my article in that book.
Cheers
Big watchout on distributing from a trust without actually shifting assets, especially to corporate beneficiaries! The related party rules may apply here, and you should definitely talk to your accountant about how Div7a applies in this case.
If your accountant is suggesting setting up an interest free loan from a company without covering off the Div7a impacts they are a bad accountant and you should go talk to someone else.
To directly quote the ATO: “Division 7A also contains provisions (Subdivision EA) which are designed to ensure that a trustee cannot shelter trust income at the prevailing company tax rate by creating a present entitlement to a private company without paying it”.
If you feel like doing your own research I strongly recommend googling the “Division 7A – Trust amounts treated as dividends – Loans” fact sheet on the ATO website. There is a lot of legal-ese there but worth a shot if you think you’re up to it.
Hi Brian,
Thanks for the link, you sound like you know what you’re talking about so I’ll defiantly be taking a look and get back to you.
I have not actually set up the second ‘bucket’ company to receive the lower taxed threshold and probably won’t need to for a number of years.
Who knows though, when the time comes the rules may have changed. But if I’m certain about one thing, it’s wealthy people bending the rules to become richer. And the vast majority of wealthy people own trusts.
So I’m quiet confident that when the time comes, there will be another clever strategy I can utilize to withdraw my income at a tax effective rate.
But then again…who knows right?
Although you have good intentions of presenting a simple way to investors to hold their investment property in a beneficial way, this trust structure is quite antiquated and doesn’t take into consideration structuring to address Division 7A loan risks – I think you should consider reissuing a revised trust structure. The notion of making loans back to the trust for working capital purposes is something the ATO has addressed at length. Dealing with it involved sub-trusts and Div 7A loan agreements. Here is a short article covering at a high-level the different considerations to take in when distributing trust income to a corporate beneficiary.
https://www.kmbba.com.au/2018/03/7-year-div-7a-reprieve-for-some-bucket-company-upes/
So am i correct in understanding that businesses are also eligible for the 50% CGT discount, so effectively if the business has held the asset for more than a year you only pay 15% tax?
Hi Michael,
Assets held in a trust are eligible for the 50% CGT discount
Just FYI, a business is different from a company but I’m assuming you mean company because that’s what i refer to in the article.
The 50% CGT discount is applied to the overall gain first. So if you had a $500K gain you would only be taxed for $250K if the beneficiary is also eligible for the 50% CGT. As Adam from the comments below has pointed out, the gains are grossed up in the beneficiaries hands. What this means is that discounted gains streamed to company beneficiaries lose their discounted status as companies are not eligible for the 50% CGT discount.
So to answer your question, companies/businesses are NOT entitled to the 50% CGT but Trusts are. The business/company is not holding the asset, the trust is.
You will only see tax savings when distributed income to the ‘bucket’ company. Not capital gains.
Hope this clears things up.
Great article, thanks. I have a modest stock portfolio at the moment and I don’t think it’s worthwhile to put money into setting up a trust for myself yet. I do plan to further down the track. Is there some kind of overall net worth you would recommend doing so? e.g. $100k onwards?
I actually bought my first IP outside my trust before I knew the benefits. For me to transfer it to the trust would trigger CGT and I would have to pay stamp duty, legal fees etc. all over again. You would have to do the same with your stocks (not the stamp duty but the CGT) so depending on how much you already have it may not be worth it.
The most effective way this can work is by setting it up correctly at the very start. You may want to create this structure and start a new portfolio in there from scratch and keep you current one out of there. If you could simply transfer ownership from you own name to the trust without triggering costs I would say go for it but unfortunately that’s not the case.
Speak to an accountant to work out the costs make you decision from there.
Great article mate, food for thought.
I invest in bitcoin. Am thinking of buying it in my trust too. But because my trust cannot open an account with an exchange. When I buy bitcoin in my personal exchange account and transfer it to my trust “cold” wallet. Do I also trigger CGT?
A trust is not an entity (its just a relationship) so it would be the trustee that opens accounts – with banks or crypto exchanges. A mere changing of trustee would not trigger CGT, and neither would the appointment of a trustee.
Seek specific legal advice
Good article, nice to find an Aussie FIRE blog.
2 things, firstly for asset protection in the trust yes the company trustee is the way to go, but you should not be the shareholder. If you went bankrupt, these shares would be taken by the bankruptcy trustee and he would then become director and have full control of the assets of the trust and then distribute the assets out to creditors. I’ve seen this exact situation happen recently. Solution – you are the director of the trustee company and run the trust, but the shareholder is a low risk individual, for example a stay at home spouse. If any threat comes from that end you can also change the trustee. It’s often also recommended that the at-risk individual not be the sole director or appointor either… This might be being overly cautious though.
Secondly, capital gains in the trust are eligible for CGT discount… But when streaming discounted capitals gains to beneficiaries, the gains are grossed up in their hands, any applicable losses applied, then the discount is reapplied if eligible. What this means is that discounted gains streamed to company beneficiaries lose their discounted status as companys are not eligible for the 50% CGT discount. Which is damn annoying as I have my investments set up in a trust much the same as you.
Still, can’t have your cake and eat it too, and trusts are a great idea for investment purposes, mainly for the asset protection. The tax planning side is just the icing on the cake.
Thanks 🙂
Very interesting.
Is it likely that the individual will go bankrupt in this situation though? Think about it, the whole trust structuring is designed so you as the individual own nothing including the debt associated with these properties but simply control them (by being the director of the trustee company). The trust may very well go bust but the individual is protected here because they are simply a shareholder in a company that controls assets. If the trust was to go bust then I would more than expect the lenders to have complete control over whatever is left in the trust, that’s fair enough too. One way you could get around this would be to have two trusts. If one goes bust then at least the other one is protected right? Just I thought anyway.
Bro! I just spent the last hour reading ato.gov.au and you sir are 100% correct!
BUMMER! It still works out better for income though since there is no capital gains discount. So basically when you start to generate some serious cash flow in the trust, unless you earn under $80K (or whatever the threshold is) you’re better distributing the income to a company right?
Thanks for the correction mate! This is why I put my stuff out there, so smart people like you can help me 🙂
Cheers
Well the whole point of an asset holding trust is to protect the assets held in it, so if the individual goes bankrupt, the idea is that the trust is protected. So it needs to be set up correctly.
You are definitely correct that if a trust goes bankrupt, you are safe from any claim if the trustee is a company. However this is more of an issue if it’s a trading trust which runs a business. Not so much if you are holding financial assets in the trust. If it’s properties with loans on them, you will likely have to sign a personal guarantee on the loan anyway as the banks aren’t that stupid! So the trust doesn’t protect you there, but that’s why you would only hold the directorship not the full control or ownership of the trusts or company trustees so problems in one trust can’t have a domino effect on other trusts.
In the situation I described before, the guy went bankrupt due to a business problem involving a personal guarantee. He then lost his other assets due to not structuring the asset holding trust correctly.
Even worse, he had a bunch of different assets in that trust, shares and properties. Like you said, it’s always a good idea to put each separate property asset in its own trust. Keep them separate, keep them safe. And shares in a different trust also.
For the CGT, yeah it does suck that you can’t send discount gains to company beneficiaries. However as you say, you can stream income and non-discount gains to a company for the lower tax rate, while streaming discount gains to individuals.
Everything you said made total sense! Are you an accountant by any chance?
Thanks for the tips mate, much appreciated! I’ll be looking over my structure with my accountant to make sure we have all this covered 🙂
I’m just old so I’ve seen a lot 🙂 All that stuff is worst case scenario, but plan for the worst hope for the best haha.
Wish I’d found out about FIRE when I was a lot younger.
Hi Adam, Firebug,
Great information! Keep it coming! I’m definitely going to check out the book recommendation!
I bought my first IP through a trust with corporate trustee, but now FIRE is a priority (Adam-ditto, wish I knew about it when I was younger!), would welcome advice on how to minimise the risk and/or downside going forward.
Do you think using the one trust vehicle for all investments is a short-sighted mistake? Would you recommend a trust for each property and another for shares/ETFs?
Do you know if you can have multiple trusts with the same corporate trustee? This would minimise set up costs.
Also, can you distribute the surplus to the same corporate trustee, or would you need a new Pty Ltd to distribute to to take advantage of the 30% tax rate. Again, having just the one Pty Ltd would minimise set up costs?
Thanks,
Niv
Hi Niv,
Glad you’re enjoying the blog 🙂
I know some people who set up a trust for each IP but to me, that’s overkill and a little too cautious. It’s a personal decision.
You’re not going to get any more tax benefits. The only thing it protects you against is losing everything that that trust owns.
So if you split your wealth across two different trusts, you’re more protected. But I’m cool with one for now. Maybe if I got up to a few mil I’d considering starting another but it’s a personal decision.
I don’t believe you need to set up multiple companies but you may want to speak to an expert to make sure.
Great feedback…
I searched online, and found some very interesting information at the somersoft forum.
https://www.somersoft.com/threads/one-corp-trustee-with-multiple-trusts.13961/
The advice is from circa 2004, but is still relevant I guess. One of the most respected contributors appears to be either a lawyer or accountant and has seen cases where lawsuits are filed due to accidents at the rental properties owned by a trust, and that all the trust’s assets are liable to claim against, whether that is other properties or shares. This is definitely the worst case scenario. So the advice is, in order to partially mitigate risk, to limit each individual trust to a size of $1-2m each. Additionally, the opinion is to keep asset classes separate. Shares are seen as very safe, in the sense that there is hardly any grounds that a trust that just owns shares could end up in a lawsuit. Therefore keep one trust for properties, and a separate trust for shares.
Yeah a trust per 1-2 Mil sounds reasonable. By that stage, you’re definitely making enough $$$ to cover it.
Your comment was flagged as SPAM ps (must have been the link).
Sorry if you thought I didn’t approve it.
Cheers
Niv,
I believe multiple trusts can have the same trustee, although there may asset protection reasons not to. I have separate company trustees due to one of them being a trading company, i.e. actually running a business. The company is a minor cost compared to the trust deeds.
Multiple trusts can distribute to the same corporate trustee. It is no different to having multiple trusts distributing to the same charity.
Thank you for this article, Firebug! Really interesting to learn about trusts and ways of structuring them. I know this is definitely something that we will set up but I’m not sure I have a strong enough understanding of all the ins and outs to take the plunge just yet. A few questions I have are:
-When and how does a trust decide who the beneficiaries will be for that year?
– From a tax minimasation perspective, does the advsanatge of a trust solely rely on how many kids you have and whether your spouse is earning low/no income? Which I guess brings us to the question about using a company as a beneficiary.
– What is the benefit of having a company as a beneficiary of the trust? I understand that conmpanies get taxed at 30% but once the company distributes income to its directors, how will this income be taxed?
Thanks again, Firebug! Love reading your posts mate!
No worries mate. Glad you enjoyed it.
1. If the trust has income to distribute for that financial year. It can be distributed to any beneficiary that is named in the trust deed. Mine is written in a way that it can be all my family, extended family and friends. Basically anyone really.
2. No. Kids help slightly. But you can distribute to most people. The flexibility is great and if you’re in a position to take advantage of it then great. If not, then you’re not at a disadvantage, just distribute it to yourself.
3. You don’t distribute it back to yourself once it has been taxed at the 30% rate. Once you have claimed the 30% rate and the money is sitting in the company. You then reinvest that money back into the trust through a loan (from the company to the trust). This is exactly what would happen if you wanted to reinvest dividends (for example). They get distributed to you at your tax rate, and then you buy more shares with your dividend money. The difference is that the tax rate is capped at 30% for the company. This strategy works phenomenally in the later years of FIRE when your trust is generating a decent amount of cash flow.
This loan back method will usually invoke a Div7A loan (Google if you’re interested). It’s too complicated to go into in these comments but you need to know what you’re doing here and I would suggest going to an accountant that knows their shit.
Another alternative to this is to simply have the income sit in your company at the 30% rate and set up another trust as the shareholder for the ‘bucket’ company. The beauty of this is that you can then pass on the dividends and then distribute to beneficiaries at a low-income year for example. So the money sits in the company until it’s the most tax-efficient time to pass it on.
The trust structure works great in the later years. You will be worse off (because of fees) at the start. Read Trust Magic by Dale Gatherum. He explains this stuff heaps better than I can.
Hi Mr FireBug,
Great article and nice work on your journey this far- very inspiring!
Thanks for laying it all out. Hypothetically, if someone owned shares through their trust and opted for a automatic dividend reinvesting program, how would they realise the dividends (actually distribute them to a person)? Could you just track the earnings and ‘allocate’ them to one of the beneficiaries before FY end?
Or would you have to get dividends paid into your trust account, then transfer to your lower income spouses account (to show the actual allocation), then transfer back into the trust account as a ‘gift/loan?’ and then reinvest?
And is it the same story for franking credits? They can be distributed to a beneficiary of your choice? You just make that call when you do your tax return?
Thanks!
Hey,
That’s a good question because the money never actually hit the account. I know that you’re still going to have to distribute it even if you have DRP turned on. I have not had to do this yet but my guess is (and please be aware that I’m far from an accountant) you would either have to turn DRP off or have it turned on but record the distribution in the trust register/minutes.
Once the distribution has been made, that person or company can ‘loan’ that money back to the trust for reinvestment.
Franking credits is an interesting one. I believe that they come with the dividend itself so whoever is distributed the dividend would receive the franking credits.
But please check with your accountant to make sure.
Cool, thanks mate!
Thanks AFB! I never understood this bit. I have a trust and corporate trustee that I intend to make a beneficiary, but never understood how after the 30% tax is applied on the company I could then repurchase more shares.
What happens if you then want to distribute any excess income that you don’t want to use in DRP, from the company to the shareholders, after it’s already been taxed at 30%? Does it this income to the shareholders get taxed again? Or is this something where you would treat this as a dividend payment and have this franked?
A lot of good points here, and some ideas I had not fully considered. Adam’s comments re asset protection have got me reviewing my trusts. However there are 2 important points which are missing, especially with respect to property.
1. Land Tax.
The state based land tax is applied to trusts differently to individuals.
In the case of NSW a trust incurs land tax from the first $1 of value, whereas an individual does not incur land tax unless the total value of the land exceeds a threshold (%500k from memory, but don’t quote me on that).
In Vic a trust does have a land tax threshold, but it is far lower than for individuals.
The QLD threshold for trusts is not so bad, although it is still lower than for individuals.
I have not checked other states. I have a QLD property in trust, but would not put a NSW property in trust due to the extra costs.
2. (potential) new foreign investment / international laundering laws.
The federal government is planning to introduce new laws which will see trusts taxed at the top tax bracket if _any_ *possible* beneficiary is not an Australian tax resident, regardless of how the income is distributed. Considering how broadly most trust deeds are currently written, this will catch most existing trusts, e.g. do you specify that company beneficiaries must be Australian companies? What about if a relative changes country? Amending the deed must be done properly or it can cause the trust to effectively restart. The government has been too busy working out who is eligible to be in government to actually debate this change, but it is likely to happen some time next year. Will it affect all trust assets or just property? We do not know yet.
The point to note is that both levels of government like to tinker with the laws and trusts are an easy target since “they are only used by the wealthy”.
Great points Moragus.
I have properties in Vic and Queensland so I have not had to deal with the land tax issues that NSW trust investors have. But they are worth knowing about for sure.
To your point about the government tinkering with trusts… While they definitely could do this, I’m betting on them not going near it for the reasons that you mentioned. Trusts are used by the rich and powerful. Politicians are puppets for the rich and powerful. They will never pass law that makes themselves and/or there lobbyists worse off.
Hey I could be wrong, and part of me thinks it is unfair how the only the privileged people who can afford trusts can benefit from them while the every day tax payer is stuck. But I have to take advantage of what’s offered to me and history has shown that politicians look out for themselves first *cough*negative gearing*cough* even when it’s not the best policy to do so.
A lot of good entry level points, but to be fair with you I think you need to disclaim the above as a discussion as opposed to advice as there are some glaring errors and omissions (some of which you have fixed but shows your under-qualification to be talking about the subject without disclaiming your intent to provide a talking point as opposed to factually correct information).
For instance, you haven’t discussed the following: unpaid present entitlements to companies; division 7A implications; the fact that if you require the cash from the company you’ve distributed to you will be likely liable for top-up tax defeating the purpose of the corporate beneficiary; the cost of corporate beneficiaries and trustees on an annual basis; making family trust and interposed entity elections; test persons etc.
I appreciate you’re trying to educate Aussies, but not making it clearer that you are not an expert in this field diminishes the importance of the education fully qualified CA and CPA members have.
Hi Rebbazz,
You make a great point and I have added a disclaimer at the start of this article. The last thing I want people to do is to use the info on this site to make their financial decisions. I only blog about what I’m doing and give opinions on things. You should always seek a professional when making financial decisions.
Now that that’s out of the way!
Division 7A certainly had me Googleing for a while. I’ll defiantly be having a chat with my accountant but it seems to imply that the money owed to the beneficiary (the bucket company) needs to be paid before the end of the financial year to avoid the ATO getting cranky? I’ll have to research this further.
the fact that if you require the cash from the company you’ve distributed to you will be likely liable for top-up tax defeating the purpose of the corporate beneficiary;
I use the corporate beneficiary for reinvestment purposes at the lower tax rate. Over the course of a lifetime, this tax-efficient method saves potentially hundreds of thousands of dollars in tax otherwise sent to the ATO. It all depends on how much income the assets in the trust are generating but I plan to have it pumping out a decent amount with the next few years and then it’s tax savings until I die! More than pays for itself imo (I have done the math too :P)
the cost of corporate beneficiaries and trustees on an annual basis;
I mention this in the article under ‘Downsides of a Trust’ which states:
making family trust and interposed entity elections; test persons etc.
As you have mentioned. This article has some good entry points which was the goal. I didn’t want to include all the technical mumbo-jumbo because it’s not enjoyable for most people to read and I’m not qualified to go into that level of expertise.
The main point was to show people how and why I’m structured the way I am.
as there are some glaring errors and omissions (some of which you have fixed…
I was pretty sure I cleaned up all my mistakes. Were there others that I missed?
Thanks for the comment mate. It’s comments like this from smart people like yourself that keeps me learning.
Cheers
Hi Firebug, the whole trust thing personally seems a bit too confusing for the vast majority of people. I think trusts are best in only two examples;
1.) You have your own business that earns significant money and you want to keep that separate from yourself.
2.) You earn a ton of money while young and pay the highest tax rate.
In my opinion, your explanation that the trust will become handy in later years after you have made a lot money is pointless. The whole premise of your blog is to retire early. By the time you are making a lot of money, you will be retired, meaning you won’t be “earning” an income and can personally qualify for the tax free exemption. It seems to me that money in a trust/company setting will lose out when compared to a retired couple with assets in their own name when not working.
Am I missing something here?
Hi Chris,
I can’t comment on the business side of things because I’ve never ran one.
But you’re right about point two. If you’re not interested in the asset protection side of things that a trust offers, and would only set one up to save on tax. Then your assets within the trust need to be producing a decent amount of income (>$50K p/y for example) for it to make sense.
You’re not going to be any worst off with a trust vs owning in your own name other than the fees you will be charged yearly if you can’t run a trust yourself.
The real magic comes from a trust’s ability to distribute income strategically each year at the most efficient tax rate.
If your wife is not working one year. Boom, all asset income is distributed to her.
If your sister goes overseas for a year, awesome, $18,200 can be distributed to her (assuming she’s over 18) tax-free and gifted back.
The opportunities are endless. But the key thing to remember is that the trust has to be generating a decent amount of income for you to see tax savings.
We plan to have our trust generating $50k within the next 3-5 years. And it’s only up from there.
Hi Firebug,
I have a family trust with a corporate trustee and I run a business through the trust. If I buy shares within the trust from its income would I then not have to distribute those earnings to the beneficiaries? Since the money was used to purchase assets owned by the trust.
Thanks
I think you would still have to distribute that income… I’m not sure mate. Best to speak to a professional when it comes to these finer questions. Sorry I couldn’t help
Hi Damo,
As I have mentioned below in reply to Satsii, the trust cannot retain profits. Since you are running a business through the trust, you really, really need to be talking to your accountant about this. I do consulting through a company & trust structure, so I have some knowledge, but this is an area where a little bit of knowledge can be a dangerous thing, and your business will be different to mine. Talk to your accountant, it may cost you money but is likely to save you from a lot of heartache, and potentially costs, later. Part of that discussion should be whether you should be investing via a trust that is also carrying out a business. My view is no, for the same reasons as stated in other comments on this page, and I have a separate trust for investments.
Hey Firebug,
Thanks for the write up. One question I had about the trust if you know the answer or can point me in the right direction.
How are earnings taxed if the profit isn’t distributed? Say the trust receives $10k in dividends and they are retained/reinvested without being dispersed. Is it at the company tax rate of 30%? Additionally at that point if that is how it works does the end recipient receive a franking/tax credit when they receive the funds as the trust already paid tax?
Does that make sense?
Cheers
Satsii,
While you should confirm with your accountant, my understanding is that a trust can_not_ retain any profit. _All_ profits must be distributed as part of the trust’s yearly tax return – the trust itself is not taxed, it is the beneficiaries that are taxed. A net loss can be carried forward to offset a future gain (in fact I don’t think the loss can be distributed), but not profits.
Note that the trust may not necessarily physically transfer the profits to the beneficiaries, but the profit distributions must be included on the beneficiary’s tax return, i.e. from the ATO’s point of view the distribution happens and the distribution is then gifted/loaned back to the trust.
With respect to the franking credits (from any share investments, not the trust), this is where accounts start to earn their fees, but essentially the franking credit is distributed with the profit.
Hope this helps, but you really should be talking to your accountant about how it would work for your specific situation.
Hi Satsii,
Greg makes some great points. My understanding was that if the trust doesn’t distribute an income, it’s taxed at the highest marginal rate avaliable.
So it never makes sense to not distribute income. But it’s also possible that you legally can’t keep the money in their. Best to speak to a professional about that one.
If you distribute income to a company at 30% marginal rate and then onwards to yourself… I would like to think that those dividends would come with franking credits but again, best to speak to an accountant. I have not yet had to distribute income in my trust (because of tax deductions from the properties) but most likely will next year. I’ll have a better answer once I actually start the process of distributing income.
Hope that helps a bit mate
Hey AFB,
You got me curious, cause I was pretty sure I was right, but it turns out we are both right! How is that possible? Well it all comes down to your trust deed and what its rules are regarding its beneficiaries. To put it simply, in most cases, if it can be distributed then it must be, but if not then the trustee is taxed at the highest marginal rate.
To quote the ATO website:
https://www.ato.gov.au/General/Trusts/Trust-income/
“If there is any part of the trust’s income for which no beneficiary is presently entitled, the trustee is taxed on the corresponding share of net income.” and
“The trustee is generally taxed on the trust income at the highest marginal rate that applies to individuals except for some types of trusts (including deceased estates), which are taxed at modified individual rates.”
When you stop and think that this is the ATO’s “simple explanation”, you start to realise just how complex these can be. You need to be dealing with an accountant who knows your trust deed and your situation.
When it comes to franking credits (of shares within the trust, which is different to the company distribution which you mention), try this link:
https://www.ato.gov.au/General/Trusts/In-detail/Distributions/Streaming-trust-capital-gains-and-franked-distributions/?page=13#Tax_treatment_of_trust_franked_distributions
Anyone that considers that easy reading is a closet accountant.
Even trust losses are not as simple as I thought. The first link I mentioned has the simple statement:
“A loss made by a trust in an income year can’t be distributed to beneficiaries. However, it can be carried forward and used to reduce the trust’s net income in a later year.”
Nice and simple, right… but hang on, what’s this “See Also” link after it… WTF, carrying losses is “subject to certain tests”!?! Maybe my accountant is worth his fees after all. Almost every page I read said “generally …” and had conditions or exceptions.
Thanks for sending me down that rabbit hole, now I have a nice headache …
Haha wow that was a big read. I’ll leave all these finer details to my account I think 🤓
If you are single with no children, then it sounds like a trust is not possible or at least would not have any advantages aside from asset protection?
I would tend to agree with this. It would be more hassle than it’s worth tbh. The real magic happens when you can distribute at a tax efficient rate.
Thanks for making a good effort explaining this situation. I agree that it is extremely difficult to navigate all the complexities of this structure. I found this article at cuffelinks to be the most informative for me.
https://cuffelinks.com.au/fuss-family-trusts/
I think you need to split this article into two after you introduced the issue of a corporate beneficiary. I admit I still don’t understand the issue of unpaid present entitlements and loss of the CGT 50% discount.
In this case, is property a good asset to hold in this structure? What is the ideal asset to hold when using a corporate beneficiary?
It’s very hard to tell what is the most optimal structure because everyone’s circumstances are different. It was a mistake on my behalf to have the properties in my Trust. They would have been better off in my personal name. But a strong dividend-focused share portfolio in the trust will enable me to distribute the income at the most tax efficient rate each year. So it will work itself out once I have sold all the properties and the shares are generating a decent income.
Cheers FireBug, appreciate you offering some insight into how things have worked for you.
I spoke to an accountant today who quoted $1000 to set up a discretionary trust, plus $500 to have a solicitor look over the deed prior to execution – so similar to what you paid.
I’ve also toyed with the idea of the $148 DIY option from Cleardocs. That $1352 saving is massing when pursuing FIRE. I wouldn’t easily drop that sort of cash unless I really had to. But I’m trying to think of horror stories of what a poorly drafted deed could expose you to: penalties for invalid distributions, estate planning issues if the trustee dies without proper arrangements, ineffective asset protection.
I guess the $1352 is peace of mind, but also an ‘insurance’ of sorts, or an investment in your investment structure. Because it could seriously come back to bite you if it goes wrong.
Have you heard any other stories about ‘DIY trusts gone wrong’? I just need a little bit more fear to talk myself out of trying the DIY route.
I have actually heard of success from the DIY routes but I can’t comment because I had it done professionally… But you need to be comfortable with whatever decision you make.
Hi Firebug,
Thanks for sharing your FIRE journey with us who do not know how or where to start. My husband and I are determined to take our first steps to financial independence. We are both 36yr olds, 2kids aged 6 and 8, mortgage in our PPOR, both working fulltime and tax bracket both at $3,572 plus 32.5c. Here is our simple plan, and we’d really like to keep it simple:
1. Open 4 trading accounts, one in my name, one in husband’s, one for each kid in our name as trustee for the child (i.e. husband’s name for child1, my name for child2). Invest $1k once a month into each account.
The purpose of this set-up is to ,in the future, minimise tax payable by distributing income among four of us without having to set up a trust. To minimise brokerage costs, we’ll probably invest only in VDHG for kids (thats 2x$9.5×12 = $228 annual costs) and VDGR for me and husband (another $228 annual cost).
Is this a sensible step? The way I understand it, compounding effect is not changed whether our investments are in one trading account or in 4 separate trading accounts. Brokerage costs, if kept to minimum, shouldnt make huge difference too.
2. Keep investing and holding for the next 15-20yrs
3. No salary sacrifice, no extra mortgage payment.
4. Retire when we can and if we want to.
Is this too simple to work? Is there anything I have missed or misunderstood? I dont understand enough about trust structure, and honestly the complexities is turning me off. Are we better off with the above plan considering the amount we are planning to invest, instead of paying trust structure fees?
I think what Im trying to ask is, any reason/s I should set up a trust structure? This decision is what holding me off from buying our first ETF. I fear that I might invest for several years and then realise that I haven’t done the correct first step.
I would really appreciate any opinion.
Hi Spark,
Nothing glaringly bad about what you’re proposing.
If I were in your shoes, I would research AFI and DSSP. It’s possible to invest on behalf of your children without getting slugged with the tax bill (minors can only earn a small amount before they start paying the top tax bracket) and once they hit 18, you can switch DSSP off and the inflow of dividends can roll on in.
Have a read of these comments which is specifically targetting for investing for children.
https://www.aussiefirebug.com/investment-bonds-genlife/
Hi Firebug,
Interesting read re trust structure – just like you, I bought an investment property under my name but looking at setting up a trust for purchasing ETFs for the future.
If I access equity from my investment property (held under my name) and use that money purchase ETFs under Trust’s name. Do you know, if I am able to claim a Tax deduction for the interest I pay on the loan against the investment property (ie equity access loan)?
Thanks,
Joe
Alway speak to a professional accountant with these sort of questions but my understanding is that if you withdrew money from the IP and that money is used for investing (through your trust), that portion of the loan is tax deductible.
Just want to throw in 2c here but I think there is an issue with land tax that trusts have – this might be totally wrong but:
Is it correct that trusts pay land tax from $1 and individuals pay from $1m?
I know of this because my father-in-law has put a large weekender property in a trust and has been stung for more land tax somehow.
Land tax rules differ in each state. I know that in NSW trusts pay land tax from the first dollar, as you describe, although the personal limit was not 1mil last time I checked.
I did mention land tax in one of my previous comments on this page.
I just checked – NSW 2019 $100 + 1.6% up to $692,000
Hi Firebug great post!
I am a little confused about something with trusts.
If I owned $1,000,000 worth of real estate, producing say $25,000k income. As an individual I would have to pay tax on that before I could reinvest the earnings.
Is it possible to use a trust as a vehicle to keep the earnings in the trust as a recurring reinvestment and take no profits out of the trust to avoid paying tax until you are ready to start taking profits out?
I was always under the impression that was the greatest benefit?
If you know of any other material on discretionary trusts worth reading please let me know!
Thanks,
Lachlan
Hi Lachlan,
Short answer is no.
Each tax year a trust’s profit must be allocated to the trust’s beneficiaries and is then included in the beneficiaries tax returns as “trust income”. The trust lodges a tax return but pays no tax because there is no profit to be taxed since the profit was allocated/distributed to the beneficiaries. (This is the normal scenario and exceptions are rare)
Note that this is the tax point of view, it does not mean you have to actually transfer the funds out of the trust. Often the funds are left in the trust, which is the same as you taking the distribution and then depositing the same amount into the trust.
From a tax point of view the benefit of a trust often tends to be the discretionary nature of the distributions, i.e. the ability to allocate the trust’s profits to the beneficiary(s) with the lowest tax rate, which can usually be different each year.
Hope this has helped and not confused you further.
Thanks Greg! That’s very helpful.
Clears things up nicely!
It’s likely something worth looking into a little later on when our incomes are a little higher or different.
Note that transferring assets, such as property or shares, is a capital gains tax event and equivalent to you selling the assets to the trust and the ATO will chase you if it considers the transaction was not at market value.
My point is that you need to plan ahead to get the benefits, especially in the case of property.
To my knowledge, it doesn’t work like that. You can distribute profit to a bucket company but it’s still taxed at 30%. It can stay there (and even be reinvested) until you’re in a lower taxable income year which it could then be passed on for spending…
I highly recommend the book called trust magic. It’s the best content avaliable for learning about trusts in Australia IMO
A lot of the discussion has centred around the ability of the trustee of a discretionary trust to allocate trust income to beneficiaries with the lowest tax rate. Be mindful that this practice may be turned on its head if the ALP wins the next election. One of the lesser known policies of the ALP is to tax all discretionary trust distributions to beneficiaries over the age of 18 years at a minimum rate of 30%. That would put these beneficiaries on the same tax scale as a corporate beneficiary. Of course, a lot of finer detail is yet to be released and would only surface from a post election consultation process if and when the ALP wins the election.
I’m watching that very carefully Stephen. I believe that law will never pass even if the ALP are elected. Too many people in power will be affected. Scraping franking credit refunds is a lot more likely to go through since it doesn’t affect the super wealthy.
He AFB,
I was thinking of setting up a trust but it occurred to me that if I decide to retire overseas, that may be a problem.
A non-resident trustee beneficiary is taxed at the highest marginal tax rate (45%) of a non-trustee individual beneficiary. https://www.ato.gov.au/individuals/international-tax-for-individuals/in-detail/australian-income-of-foreign-residents/taxation-of-trust-net-income—non-resident-beneficiaries–general-overview-of-the-changes/
Wonder whether if that has ever occurred to you?
Hi coinfection,
No it hasn’t actually. We planned to retire in Australia so it shouldn’t affect us.
If I could start over, I would not have bothered with the trust. It complicates things. We have already paid for the setup and I have educated myself with how it works so we will push forward with it…but you don’t need it to reach FIRE.
Hi AFB,
If you wouldn’t go with trusts if you could start over, how would you go about protecting your assets?
Cheers, Ben
Hi Ben,
Probably just use insurance. The odds of something happening are extremely low in terms of a percentage. Unless you work in a field where it’s more likely that you are sued like a doctor or something.
Cheers
> If I could start over, I would not have bothered with the trust. It complicates things.
Appreciate the honesty!
No worries 🙂
Hi AFB,
Great article (and podcasts). I’m currently considering using a Family Trust to hold my share portfolio. I mainly want the benefit of distributing the dividend income and CG profits to the beneficiaries, so they are taxed at the lowest marginal tax rate.
I’ve heard several times in your podcast that “If I could start over, I would not use a trust.” I think you mentioned “simplicity” as the main reason. It would be great if you could write an article or do a podcast episode, and explain your current position on trust in more detail.
I’d love to hear your thoughts about:
If not using a trust, what structure would you use for owning your share portfolio? You and your partner’s individual names or joint tenant? What insurance policies would you use for asset protection?
Thanks,
FB
Hi FB,
I’m planning to do another pod specifically on trusts. I have a really great guest in mind too. Just need to find the time.
Is it Terryw?
T’is indeedy 🙂
Just a serious thank you to taking the time to outline all of this. Hard to find good anecdotes specific to Australia
No worries Josh 🙂
Great article mate. I’ve particularly enjoyed reading the comments & appreciate that you’ve continued replying throughout the years. I noticed that recently (2019) you mentioned that if you could go back in time you wouldn’t have bothered setting up the trust. I wonder if you could/have outline the reasons why? I.e hidden disadvantages, inflexibility, legal changes, tax advantages not that great etc..
Would be great to hear from personal experience!
Hi Al,
My opinions on certain things change over time. I’ve come to realise that while setting up a trust does offer asset protection and tax efficiencies… it comes at a big cost of complexities.
You don’t need a trust to reach FIRE. It’s overkill for the majority of people (myself included). I don’t think it’s worth the headaches of the added complexities now as I once did when I was younger.
I’ve already done the hard work of setting one up and educating myself on how they work so I’m going to stick with it. But for the vast majority of Aussies trying to reach FIRE, I wouldn’t bother.
Hey Aussie Firebug,
Thank you for this very informative article.
I have one question, if i setup a trust, can i transfer my existing assets to the trust and get the tax benefit?
You can transfer ownership but it will trigger any CGT and/or stamp duty if it’s property.
The question then really becomes, is it worth it? And my opinion on this matter has changed throughout the years. I don’t think you need it to reach FIRE and it complicates things IMO
Hi AFB, I re-read this article again in November 2019 after Labour didn’t win the election, so no major change to the trust and investment landscape (e.g. franking credit).
I wonder if I have investment properties in my name, but I plan to build wealth going forward by LICs or ETFs, for asset protection purpose, I would want the portfolio of LICs and ETFs inside the Trust. Just in case someone is injured from my investment property and the landlord insurance can’t protect me, I may end up being sued and lost everything under my name. The only thing that is still safe would be the portfolio under the Trust (as I don’t own it but just control it).
I come to the question of whether is it ok to setup the trust and use myself as an individual trustee, instead of setting up a Corporate Trustee?
From the risk point of view, there should not be any legal liabilities arising from LICs and ETFS inside the trust that will sue the trustee (myself as an individual trustee). So, this will save cost of at least $270/year for ASIC renewal of the Corporate Trustee and also save a bit of accounting & admin fee of $200/year for the Corporate Trustee (E.g. need my accountant to prepare the solvency statment and paperwork for the Corporate Trustee).
In essence, by using the individual trustee will save me around $500/year. Over 10-20 years it is a considerable amount of money. It will be massive if thinking about opportunity cost if I can put $500/year to invest at 8-10%/yr growth over 10-20 years.
I know that it can create headaches down the tract if eventually I pass away or decide to use Corporate Trustee later, I need to submit many paperworks to the bank and share broker to change the trustee’s name. But given I tend to have 1 bank account to hold cash and 1 share broker (may be selfwealth) that hold upto 4 LICs + 1 ETF, it should not be too hassle.
Have you done any research or hear any idea about this strategy (use Individual trustee to look after the trust that only holds passive investment like LICs, ETFs, Shares, Managed Fund)? Wanna hear your thought.
By the way, I am single and if I get married down the track, I don’t plan to have a child. So, the trust is just mainly for asset protection purpose. I have researched and found too many horror stories about litigation from investment properties. Moreover, even I don’t invest in property, the litigation can comes from random angle such as driving a car and accidentally hit someone on a street then that person becomes permanent disable and the car insurance doesn’t cover this incident due to whatever fine prints. Or, if I play golf and the golf ball hit someone’s head accidentally.
Appreciated your comment. Thank you.
Hi Victor,
I’m not an expert in this area but I’m under the impression that you need a corporate trustee for the trust for asset protection. Without one, I don’t think it works the same… Sorry I couldn’t provide much help with this one. Have a google mate and speak to an accountant maybe before going ahead.
Cheers
Great write up AFB,
I know you’ve said on this blog that you wouldn’t bother setting up a trust if you had your time over due to complexity and/or cost so I was interested in what your approach would be in terms of how you would split your investments to be the most tax effective.
ie: Would you and Ms FB invest in joint name or the lowest income earner?
I’m currently the higher income earner (in 37% tax bracket) so our current portfolio (pre learning about FIRE) is all setup in my wife’s name.
This makes total sense given our currently employment situations however I’ve been wondering what happens once we reach FIRE?
I will likely wind down my work to a few days a week (possibly going into a lower tax bracket 32.5% ?) while my wife will be paying tax on the dividend income (about 40K which will also be in the 32.5% bracket).
Ideally we’d want to split the dividend income between us once we reach FIRE for max tax efficiency but unsure the best way to do so.
Are we better off just investing in joint names now as it will benefit us more in the long term even though it will hit us during our accumulation phase?
Is one other possibility that I could start investing in my name when my active income reduces toward a more beneficial taxable amount?
Obviously not wanting legal, financial advice here just keen to get your thoughts.
Thanks for reading,
Tom
Hi Tom,
There are so many variables for this sort of question and everyone’s circumstances are different.
If we didn’t use a trust, I’d go straight down the middle, 50-50.
Yes, you’re going to be hurt in the accumulation phase, but in retirement, it’s going to be a lot more efficient (with out numbers anyway).
Cheers
Good general article Aussefirebug, but I would be worried people take it as advice and go and set up a trust without getting legal advice or considering some of the many issues that haven’t been covered.
Some Random Points – based on the comments mainly
Getting money into the trust
A new trust will have assets of about $10. To buy shares or property it will need more money and this can come from
a) Gifts, and/or
b) Loans
Loans can be private loans or loans from banks etc. they can be at market rates or at nil interest.
Watch out for no interest loans as if there are no repayments for about 6 years the loan can become unenforceable.
Unpaid Distributions
When the trustee makes someone presently entitled to income of the trust that person is taxed on that income whether they receive it or not. If the income is not paid out it is called an Unpaid Present Entitlement or UPE. There are lots of legal issues to consider with UPEs – especially in relation to estate planning.
Dividend reinvesting will mean UPEs are being generated unless the trust has other cash to pay out to the beneficiary.
UPEs are not loans, they are debts in equity with some legal differences, but are similar to loans.
Retaining Income
A trust can retain income, if the deed permits, but the trustee will be taxed at the top marginal tax rate on this.
Gifting
A person should consider whether gifting to the trust is better than lending. If it is the gift should be clearly documented as a deed.
Death
The assets of a trust do not pass via a person’s estate if they die. If they are trustee, the trust will continue with someone else having to become trustee.
If they are the appointor the deed will specify who the next appointor will be or how it is decided. If the deed says it will be the legal personal representative of the last appointor then seek legal advice immediately or a stranger could take over the trust.
If a beneficiary dies nothing happens with the trust generally. Their estate might be a potential beneficiary, but once this is wound up that’s it. The deceased beneficiary cannot will their position as beneficiary. Sometimes death can change the beneficiary make up of the trust too. A deceased person is no longer a beneficiary so their spouse might no longer meet the definition etc.
Control after death
If you control the trust now being the appointor and director of the trustee, carefully consider how this control will be passed on. What if you have 3 kids. Could 2 take control of the trust and exclude the 3rd one? What if you have 2 and they disagree, could there be a Mexican stand off?
Bucket Companies
Carefully consider who should own the shares in the bucket company.
If a dividend is paid to a bucket company with franking credits the bucket company can pay this to its shareholders with the same franking credits attached. But a bucket company can only pay dividends to shareholders.
The shareholder of a bucket company should not be the trust from which it receives a distribution – s100A
Trust income v Taxable income
There are some very complex issues with determining trust income and it may not be the same as taxable income.
Family Trust Elections
A trustee might need to make a FTE pretty soon. This should be carefully considered as lots of implications, especially after the death of the test individual.
Single Beneficiary?
A trust can have just 1 beneficiary, btu the trustee cannot be the same person as the sole beneficiary as there would be no trust by definition.
Usually however the deed will be worded so the single person would be the primary beneficiary with secondary beneficiaries being their current and future relatives.
A trust can still work well for a single person with no family as if they were on the to tax rate they could still use the bucket company strategy and cap the tax at 30% or 27.5% even. Think of all the extra compounding this could achieve.
Never use an Accountant to Set up a Trust
Trusts are deeds which can only be prepared by lawyers. Setting them up is pure legal advice. An accountant, who is a tax agent, can only advise on taxation (Commonwealth only) so they can help with potential tax consequences but not with who should be the trustee, what happens if the appointor dies, who does clause xx mean.
If an accountant is merely acting as facilitator and getting the deed from a law firm you can bypass them and cut out the middleman.
Online deeds might be preferable, but risky too as they cannot be amended before paying and the terms of the trust are not known either. They also come without advice. I recently seen one set up where there was no appointor and no possibility of adding one.
A Trust is not a legal entity
A trust is a relationship and not a legal entity like a company is. It cannot enter contracts or be sued. It is the trustee that is the legal entity.
To confuse things though under tax law a trust is treated as if it was an entity – it is a tax entity, a separate taxpayer.
Overseas related issues
Trusts are very complex and so are the taxation laws in relation to international issues. Being a non-resident beneficiary can have some serious tax consequences, but these can be overcome potentially – to a degree anyway, with careful planning.
Asset Protection
If the trust will only hold shares the trustee cannot be sued in relation to this – except perhaps in private company situations. So there is no need to have a company act as trustee. The reason a company is used is for business and property when contracts are entered into and there is a potential for litigation. The trust is a relationship so it will be the trustee that is sued, hence the $2 company.
Asset protection on bankruptcy exists because under the bankruptcy act if a trustee goes bankrupt the assets they hold as trustee are no able to be taken, s116 from memory. If an appointor goes bankrupt the position of appointor is not property which can fall into the hands of creditors – the case of Burton, If a beneficiary goes bankrupt the creditors of that person cannot get access to the trust assets as the beneficiary only has an entitlement to be considered for income distributions, not a right
Epic points Terry.
One questions… you wouldn’t happen to be the same TerryW from propertychat.com.au would you?
Because if you are, I’m truly honoured to have you comment on the blog. I must have read over 1000 of your comments throughout the years. You were always one of the most knowledgeable people online for Australians.
Maybe you should come on the podcast one day 🙂
Yep – the same or similar one!
That’s crazy!
Well… the offer still stands. Would you like to come on the podcast to talk about investing through trusts? Flick me an email if you’re interested ([email protected])
Thanks Matt, will send you an email.
Hi Terry,
Amazing insight! Thanks for sharing!
1) Re: Single and Trusts: Can the same person be the appointor, director of the corporate trustee and the sole beneficiary?
2) How does the trust deed need to be worded to so the single person would be the primary beneficiary with secondary beneficiaries being their current and future relatives?
2) For non-resident beneficiary, what kind of serious consequences are you referring to and what kind of planning need to be done to to overcome it?
Looking forward to your reply!
Hi J
1. Yes this is possible. But did you mean to imply a trust with one beneficiary or one primary beneficiary? A trust can have just one beneficiary, as long as the trustee is not that beneficiary – otherwise a trust would not exist. A discretionary trust can have one beneficiary if the trustee has the power to accumulate income – but would be extremely rare to find one.
2. The deed could have different classes of beneficiaries with one or more Primary Beneficiaries that are named and Secondary beneficiaries would be relatives etc of the named Primary Beneficiaries
3. CGT and franking credits are 2 issues that come to mind. These can’t be over come, other than the trustee distributing to other resident beneficiaries. Non-residents can’t claim franking credits on shares. And non-residents do not get the 50% CGT discount.
Hi Terry,
Thanks for your reply!
Let me rephrase:
I understand that a trust is not valid with the same appointor, trustee who’s also the sole primary beneficiary, but what the below?
Is a trust valid if I were the sole appointor, sole director of the corporate trustee and sole primary beneficiary?
Hi J
I trust will be valid if a person is the sole trustee, sole appointor and sole primary beneficiary – but not the only beneficiary.
same if the one person is the director and shareholder of the trustee company, sole appointor and sole primary beneficiary and sole person to ever benefit from the trust.
See NSW Supreme Court case of Smith v Public trustee. A Doctor had set up a trust to hold her main residence. she left the residence to a charity via her will – which isn’t possible as she didn’t own the property. The charity argued that the trust didn’t exist because the one person held every role and treated the property as if it was her own. They lost.
But just because you can do something doesn’t mean you should. It adds to the ‘asset protection’ strength by having a second appointor for example.
Hi Terry,
Amazing insight! Thanks for sharing!
1) Re: Single and Trusts: Can the same person be the appointor, director of the corporate trustee and the sole beneficiary?
2) How does the trust deed need to be worded to so the single person would be the primary beneficiary with secondary beneficiaries being their current and future relatives?
2) For non-resident beneficiary, what kind of serious consequences are you referring to and what kind of planning need to be done to to overcome it?
Looking forward to your reply!
Hi AFB,
I wonder if you could share your experience with being a non-resident beneficiary (NRB)?
1) How did the trust continued to be a resident trust? Was there a 2nd resident trustee? Or a newly appointed resident director.
2) If distributing to the NRB, did the trustee have to withhold tax at the highest marginal tax rate at 45% for the NRB first which is a not a final tax, then what need to happen? Or did you simply distribute it to another resident beneficiary instead of a NRB?
Hi Coinfection
1. A trust could remain a resident trust fairly easily if the trustee is a resident. This could happen by appointing an Australian company as trustee with the company having at least one resident director.
2. If the trustee is required to withhold tax this is not the final tax. The trustee would remit this to the ATO and the beneficiary would lodge their own tax return.
The trustee should use an accountant who is a tax agent that is experienced with trusts as many things to consider.
Hi Terry,
Thanks for your reply. Does the following trigger CGT?
1) Change from a human trustee to a corporate trustee
2) Change from human trustee to another human trustee
No.
A mere change in legal ownership such as a change of trustee doesn’t trigger CGT. But it could trigger stamp duty in some states such as NSW if the new trustee can become a beneficiary of the trust.
Always get legal advice before do any changes to trusts that hold assets.
Hi Terry,
Thanks so much for sharing your expertise!
What if it was a non-resident trustee beneficiary? After the trustee paid tax at the highest marginal tax rate to the ATO, would the non-resident trustee beneficiary be able to get a refund if they lodge their own tax return.
It appears that non-resident beneficiary is assessed differently from non-resident trustee beneficiary according to https://www.ato.gov.au/Individuals/International-tax-for-individuals/In-detail/Australian-income-of-foreign-residents/Taxation-of-trust-net-income—non-resident-beneficiaries–General-overview-of-the-changes/
Hi Coinfection
I should state that I am no expert on international taxation and in fact refuse to advise on this because it is not my area so seek proper advice – which will probably be very expensive!
Do you mean ‘non-resident beneficiary’ or are you talking about being trustee of another trust which is a beneficiary of the Australian Trust?
If you are just a beneficiary and are a non-resident you will need to lodge you own tax return to get to the final tax payable by yourself. if the trustee has withheld too much tax you will get some back.
Hi Terry,
Wow! Someone with your skills and experience must be in high demand. I have done so much reading on this topic and you are the first person who writes about this stuff in a way that makes a lot of sense. This blog is amazing so thankyou FIREBUG and Terry.
I am wondering how everything works between a Family Trust and single beneficiary that is a Company (Corporate Beneficiary with the Company set up as a bucket Company). The purpose of the bucket Company would be to receive profit from the family trust, pay 30% tax rate and then retain some of the profits, and paying out the remainder as a dividend to another Family Trust for further distribution to family beneficiaries. The thing I am struggling with is that if you go back to original Family trust which owns the assets and receives dividends if the nature of the dividends are Dividend reinvestment then while the trust will show there has been income to be declared and assume a profit to distributed in actual fact there is no “cash” to distribute.
How does the original Family Trust and Corporate beneficiary account for this? The Family Trust has distributed “profits” to the Corporate Beneficiary but no actual cash has been paid so how does the Bucket Company (Corporate Beneficiary) pay its 30% tax, retain some in retained earnings and then pay out a dividend to its shareholder (another family trust) to then distribute to family beneficiaries.
Over time as the assets get larger in the Family Trust it may be decided to switch off DRP thus receiving cash which can be passed through the entities/process above but that could many years into the future (30+ years).
Thanks
Terry’s got the good below mate but yeah basically my parents became the directors of the corporate trustee that controls the trust. When I return to Australia, I’ll take control again.
Jamie, there are a whole host of tax and other legal issues with this. If a trust makes a beneficiary presently entitled to income but doens’t pay that income over it is called an Unpaid Present Entitlement or a UPE. With companies there are Division 7A issues if the company gives a benefit to shareholders or related parties which could happen if the income is not paid over.
There are 3 ways this could go
a) The trust pays the income over to the company in full – no division 7A issues
b) the trust makes the company presently entitled to the income – division 7A loan agreement needs to be entered with repayments made
c) the trust makes the company presently entitled to the income, but holds it on subtrust for the company. The trustee would essentially be acting as bare trustee for the company for this amount and any income further generated will belong to the company as well. This will have to be converted into a Division 7A loan later on to avoid further tax issues.
With all of this you need to consider the estate planning aspects and asset protection aspects as well.
Division 7A loans are not easy to manage with companies because they have to be repaid as PI loans over 7 years generally. The trust will need funds to do this which might need to come from dividends or other cash reservces – which could come from loans or gifts.
Advice in this area will generally be expensive because it is so complex.
Thanks so much Terry. Yes I am going to have to more thinking about this and get some advice :).
Sorry what do you mean with Option C in terms of acting a bare trustee- The trustee would essentially be acting as bare trustee for the company for this amount and any income further generated will belong to the company as well.
If a subtrust is created my thinking is that the amount in that subtrust will increase each year as given the profits will be “distributed on paper” by the Trust but cash not physically transferred (hence increase of UPE) given its DRP set up.
Also what events/factors triggers the UPE in the trust to turn into a loan and how will that loan effectively be paid out/reduced to zero by the trust and amounts transferred to the Company? I assume the Trust would need to sell its Trust assets (part or full), pay out the loan to zero and transfer the funds into the Company or as you say get money into the trust by capital contribution or gift?
Can the Loan amount be forgiven by the Company and can the loan exist forever or does it need to be paid off by a certain year (is that the 7 years from when it turns into a Loan not when UPE was created which means thus you need to make sure the Trust has enough assets to pay this loan or at least get it hands on money to pay it as a gift into the fund externally)?
Thanks again mate.
Yes amounts will be increasing each year if held on a subtrust – plus income will belong to the company rather than the trust.
A UPE can be converted to a loan by the parties entering into a written loan agreement.
Forgiving a debt can result in a deemed dividend and tax consequences – taxed on the whole loan basically, without franking credits.
The trust doesn’t necessarily need to sell assets to repay its loan. It could have other capital such as gifts, or even loans from individuals which could be used to pay the company.
I should point out that I am not an expert in this area, I only know enough to know problems when i see them and I often see people doing things like parking company funds in their personal offset accounts etc.
Thanks so much Terry. You’re a legend!
Sorry for asking a slightly off-topic question. You mentioned “a strategy for an investor who lives in an investment for one year before selling to avoid CGT”. I thought that as long as you have used a property to produce income, you will have to pay CGT on it. In another words, if an investor owns a rental property for 9 years and moves into it for one year before selling, then he would still have to pay CGT on 9/10th of the gain, or am I mistaken? Many thanks in advance!
yes, if you move into a rental property that you had never lived in before the CGT would be worked out like that. in your example 10% of the capital gain would potentially qualify for the main residence exemption.
Hi AFB! Just had a couple of questions.
I’m looking for someone to do my tax returns for my trust and you mentioned your accountant can do it for $300? I haven’t found anyone who can do mine at this price. Any chance I could get referred to them? 🙂
And my other question was, if I received income into my trust (from say dividends), do I need to distribute that income to my beneficiaries first before I use it to purchase shares? Or can I just purchase shares directly? WIll that dividend income be taxed as well? Or does tax only apply when I distribute from the trust?
Thanks and great articel btw!
Hi Tony,
I was doing a lot of the work for the trust back when I wrote this article. I have since paid my accountant a lot more to take on most of the administration. I’m not an expert but my interpretation of the rules is yes, you have to distribute the income first. Any profits need to be distributed from the trust or else it’s taxed at the highest rate. I hope that helps mate
It does thank you!
Hey AFB,
I was speaking to a financial planner recently and I mentioned that I was interested in setting up a discretionary trust for my investments so that I would be able to distribute income to multiple beneficiaries at the most efficient rate. I gave him the following hypothetical scenario:
My partner and I use a discretionary trust for our ETF investments. The dividend income is distributed 50/50 as both of us are in the same tax bracket. My partner loses her job, the trustee pays 100% of the income to her while she is unemployed so that we’re able to reap the benefits of her being in a lower tax bracket. A similar scenario could be applied to one of us retiring before the other.
He said that the ATO would probably consider this to be tax avoidance.
The ATO have an article ‘What attracts our attention’ (https://www.ato.gov.au/general/trusts/in-detail/compliance/tax-avoidance-taskforce—trusts/?anchor=Whatattractsourattention#Distributionstotaxpreferredbeneficiaries)
The article says:
‘We focus on distributions to tax-preferred beneficiaries that may have been used by trustees to attempt to reduce the amount of tax paid on the trust’s net income
Tax-preferred beneficiaries include: entities that pay lower or nil rates of tax
Situations that attract our attention include where: steps were taken to change the character of the trust income so that the income of the tax-preferred beneficiary is favourably taxed’
Do you know much about this scenario? Has your accountant provided any advice on this topic? Does it depend on the nature of the adjustment?
Love the pod mate! Thanks 🙂
Hmmm not 100% sure mate. But Terry does know he’s stuff… I’ll have to talk to my accountant
It is best to take tax advice from a lawyer or a registered tax agent, not a financial planner.
Nowhere does it say on the ATO website on the link provided that this would be considered tax avoidance. The ATO can only apply the law and there is nothing wrong with the trustee making 2 spouses presently entitled to the income of the trust if the deed allows it.
The situation could be different though if you cause the trustee to distribute to uncle Fester who has a capital loss and he gifts it back to the trustee or a related entity to the trustee. This could be caught by section 100A ITAA36 as a reimbursement agreement.
There also used to be some strategies in the old days where the trustee made a charity presently entitled to the income but never told them about it and kept it. This is no longer possible.
Sounds like I’d better speak to a lawyer or a registered tax agent then.
Thanks for the info Terry, much appreciated 🙂
G’day AFB. Great write up on trusts and something I’m seriously thinking about given I’ll be withdrawing $500k+ in equity to invest very soon so investigating various structures.
I’ve heard you frequently lament on setting the trust up in the first place so wondering if you have ever calculated how much you’ve saved in tax by using the trust vs investing in personal names? Given how much you have invested now, would be interested to know if the $’s saved was worth the extra time.
And big thanks to Terry too, very generous of you to be sharing your wisdom across so many forums!
I’ve never done the calculations mate (they would be very hard to do).
The trust is saving me money now that we have a decent amount of income being produced by the portfolio but I just think it’s unnecessary. If you actually like learning about structuring (I once did) then it’s not the worst thing you can do. For people who don’t want to learn about it though, it just complicates things IMO and it’s not needed to reach FIRE.
I can’t comment on what AFB would have saved in tax between using a trust or not to hold the investment assets and it may have not saved him anything in tax.
But the trust will give flexibility in distributing income and capital gains – you may never need this flexibility, but it might come in handy at some point in the future.
Imagine someone sets up a trust to hold shares and each year the entire income of the trust is distributed to the husband and wife in equal shares. They would have bought the shares jointly anyway so the income may have went 50/50.
But down the track the income might be large enough to be diverted to a bucket company, or there may be kids who turn 18, or the husband may have made a capital loss from some shares he bough years ago etc.
Hi AFB,
I have a couple of questions about owning shares in a trust and tax… This is my first go at setting up a trust and owning shares with Franking Credits. Your blogs and podcast have been so helpful but I’ve still got a lot to learn.
I own Vanguard VAS ETFs in a family trust. I noticed there is Tax withheld on my dividends, it’s around 47%. It is shown on Computer Shares when you open the dividends info. The Vanguard payment summary also shows it.
The reason for setting up the Trust was for dividends to be taxed at the individual’s personal income tax rate.
How do you claim back the Tax witheld on your shares? I provided my TFN to my accountant.
Secondly, my Accountant says the Trust has ran a loss the last 2 years due to set-up fees ($1600) and low value invested ($20k). I asked about Franking credit refunds but he said there are none and a loss will be carried forward. But then there was a $200 distributions paid to me last year.
How do you know if you are getting a Franking credit refund when you do your returns? Something seems odd that I would get a distribution but he said the trust is running a loss.
Any help is appreciated, thanks,
Jasmine
The trustee probably hasn’t given its TFN to the share registry and would have to claim this back in its tax return.
The set up costs of a trust are not deductible so it is not an expense that can reduce the taxable income of the trust. Franking credits attach to income there must be income of the trust to distribute for the trust to distribute the franking credits. If there is a taxable loss the franking credits are lost.
you might need a new tax advisor.
Terry thanks for your response. The Trustee is a Company that I have set up to be a Corporate Trustee. It doesn’t trade or do any business. I don’t believe it has a TFN. I will look into that.
Yes I thought it was conflicting that there was a distribution but he said it’s running at a loss. I changed my accountant to him because he said he deals with Trusts. If you know of any accounting businesses in Brisbane or Australia that you can recommend please let me know. I will be looking also.
The trust is not a separate legal entity but it is an entity for tax and should have its own TFN. The trustee company probably shouldn’t have one as it would then need to lodge a nil tax return. A trust needs to do a tax return if it has income, even if that income is negative or it distributes all the income out to beneficiaries.
Ok that makes sense. Yes the Trust has a TFN. I will look into giving it to the share registry.
Jasmine, to prevent Tax withheld, you need to provide your trust’s TFN to Computershare. You accountant is unlikely to be authorised to provide your TFN and you need to do it. If/When you buy more shares/ETFs they may use a different share registry, in which case they will also need your TFN if you want to avoid tax withheld.
A trust is a complex tax entity with associated costs which will erode your investment returns. Get professional advice to determine if a trust is of benefit to you.
Greg, thanks for your comment I appreciate it and I will look into that