Entering into a trust can be difficult to navigate with the various legal and tax requirements. However, it can be a very beneficial way to manage and protect your assets. This Legal Kitz blog will discuss the difference between discretionary trusts and unit trusts. If you would like to know more about trusts or are entering into a trust, it is recommended that you seek legal advice for the protection of your assets.
What is a trust?
A trust is an obligation imposed on a party(s) or entity that requires them to hold the documented property for the beneficiary’s benefit. A trust is regarded as a taxpaying entity for the purpose of tax administration. The trustee is responsible for managing these trust tax affairs including registering the trust into the tax system, lodging tax returns for the trust, and paying tax liabilities.
What is a beneficiary?
A beneficiary can be a person, a company, and a trustee of another trust. In some circumstances, a trustee can also be a beneficiary, but cannot be the sole beneficiary. Beneficiaries can have an entitlement to the income/ capital of a trust when set out in a trust deed or can acquire an entitlement because the trustee exercises discretion to pay them income or capital.
What is a discretionary trust?
A discretionary trust is formed to allow the trustee(s) managing the trust to choose who can benefit from the trust and how much money the beneficiaries will receive. The beneficiaries that may receive money from the trust are not fixed, and the amount of money the beneficiaries would receive from a non exhaustive discretionary trust is also not fixed. This allows the trustee to have discretion over who can benefit from the trust and the amount of money each beneficiary would receive every year.
What are the advantages and disadvantages of a discretionary trust?
Advantages:
Having a discretionary trust enables a person to be able to hold onto their assets without the responsibility of being the legal owner. Companies are required to pay income tax for their net income each financial year. However, a discretionary trust usually does not pay income tax, and instead, the beneficiaries pay taxes on their own share to the net income of the trust. In family trusts, the trustee is able to distribute assets to reduce the overall tax paid by the family.
Disadvantages:
Although a discretionary trust offers strong asset protection for the beneficiaries, since trustees are the legal owners of their trust property, they will be liable for their personal debts. To reduce this liability, a company trustee is often used.
What is a unit trust?
Unit trusts are fixed and express trusts. Compared to discretionary trusts where the shares are allocated at the discretion of the beneficiaries, unit trusts allocate shares of the property on behalf of the beneficiaries in the trust. Unit trusts allocate and identify a “unit” in the trust property beforehand, in accordance with the beneficiaries’ proportion of “units”. A “unit” is a property that the trustee can buy and sell. Therefore, the beneficiaries’ benefits will be proportionate to their “units”, compared to the shares in a company.
What are the advantages and disadvantages of a unit trust?
Advantages:
Unit trusts give the unit holders more certainty as to the benefits the beneficiaries will receive. Unit trusts can have significant tax advantages for unit holders as unit trusts are not considered separate tax entities. Therefore, the trust’s entire income or capital will be distributed to unit holders before any tax is deducted.
Disadvantages:
Because unit trustees do not hold legal rights over the trust, it is relied upon by the functions of the trustee. Since the trustee in unit trusts makes all the decisions on behalf of the beneficiaries, the trustee may make decisions that the beneficiaries don’t agree with. In other circumstances, the trustee will make decisions that lead to a loss and this will mean the trust cannot be distributed between the beneficiaries.
Legal advice
If you would like to know more about the different types of trusts available or would like to speak with one of our business specialists about what trust is best for you, click here to book a FREE 30-minute consultation with one of our experienced business specialists. You can also get in contact at [email protected] or at 1300 988 954.