In tax tip #53, we discussed using a trust either as an operating entity or, as a business grows, evolving to a company structure combined with a trust structure as the shareholder.
In our view, a trust is the most useful entity and therefore the most essential entity for any business.
Why are trusts the most essential?
In one word – Flexibility.
This flexibility allows for greater tax planning.
For example, in the structure of a sole trader or a company owned by an individual, only the individual can receive income (sole trader) or dividends (company).
For a single person with a spouse, there is no flexibility to tax plan to distribute income to the spouse (if the spouse is on a lower marginal rate of tax) or distribute to a corporate beneficiary (known as a bucket company - useful if both the person and spouse are on a high marginal rate of tax) because neither the spouse nor bucket company are legally entitled to any income.
Gone are the days when a redeemable preference share (RPS) was issued to a family trust in order to provide flexibility due to the ATO’s view that such RPS results in dividend stripping under Part IVA (tax anti-avoidance provisions). It is possible to issue a RPS in respect of future profits to the family trust however the RPS must be redeemed after four (4) years otherwise the value shifting provisions (CGT Event K8) apply.
The simple answer – and in respect of a company, one which must be implemented at the start – would be an operating trust or a company structure where the shareholder is a trust.
ATO takes aim against trusts
There is no doubt the ATO continues to take aim at trusts as follows:
unpaid present entitlements and Division 7A
reimbursement agreements and section 100A
allocation of profits within professional firms
Nonetheless, even with these limits placed on a trust structure, the key feature of a trust remains – flexibility (albeit less than before but still remains).
Main disadvantage of trusts
The main disadvantage of a trust, but not for the lucky South Australians, is that a trust must vest after 80 years (the perpetuity period).
We’ve seen trusts established in the early 70’s and we’re sure there are older ones.
The impact of this is that those trusts will vest in the 2050’s. That seems a long way away however, to put it into context, the trust has been in existence for 50 years and there are only 30 years remaining.
In Queensland, it is proposed to extend the period to 125 years. A good result but not as ideal as the ground breaking rule in South Australia.
We are hopeful that the perpetuity period will be abolished across Australia.
Nonetheless, this disadvantage is worth accepting when compared to the flexibility afforded by the trust.
Further, and not to be facetious, the vesting of a trust will be the descendants’ issue as the current life expectancy in Australia is 84 years and, given a trust is generally established when a person is at least 18 years, the trust will still be in existence when the person passes away.
For more on our view of the pros and cons of trusts, refer to our discussion of the pros and cons of a trust in tax tip #44.
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