The tax and succession benefits of a family trust are widely known – but the starting question should always be – is a family trust right for me? There are many instances when a family trust is a poor business and investment structure and we go through the 9 instances when this is the case.
When the family trust has no sole
If you are an employee, or a contractor without machinery, the creation of a family trust will not be of much help. Effectively the attempt to divert taxable income away from you, as a person, to a family trust will be ineffective for tax purposes. So while their might be business reasons for operation through a family trust or a family trust with a company beneficiary, for tax purposes, the entire profit you make while trading will be shown in your personal tax return.
There is a series of rules surrounding the alienation of personal services income including the results test, the 80/20 rule and others like the employment test – however the best test is the “sniff test”. If your family trust has no real purpose or reason for generating the income – if it is simply a piece of paper – then the family trust will not give you any tax benefits.
When the family trust is losing money
We often encounter high net wealth individuals, like medical practitioners or mining executives who are wanting to start a real estate portfolio through a family trust.
If the investments in your family trust cost more to own than they generate in income these assets are referred to as “negatively geared”. And a negatively geared asset in a family, without any other income, will become “trapped” in the family trust for future years. This compares to situations where the tax loss, if held personally, can potentially be allocated against the taxable income from salaries and wages.
When the business needs money to survive
Every business needs money to survive. The profits from a business are often needed to be invested back into the business to support the increasing level of trade debtors, stock, cash float or equipment purchases.
A family trust does not pay income tax. It is a “fiscally transparent” tax entity. So the profits, technically, of a family trust are allocated to a person (say Mum and Dad), that person then pays tax, and the left over money is then lent back into the business to support the investments. So if the parents are paying a high amount of tax, in personal financial difficulty or in conflict – the desire to relend the money back to the family trust, and help the business operate – might simply not be there.
When you want to engage a SMSF
If you own residential real estate in a family trust and you want to sell that asset to a self managed superannuation fund the family trust might not be the way to go. If your longer term strategy for investing in a family trust is to pay down the debt and then transfer the asset to your SMSF then the better tax structure might be consider a unit trust where you can transfer the units to the SMSF later on.
When you have a few family members operating together
The great benefit of a family trust is the tax flexibility and succession flexibility within the family group. And if you have different family members who want a clear and definite interest in the interest of a family trust then the flexibility of a family trust covering all of the different family members might be a downside.
In this instance we have seen families operate through a partnership of family trusts, a company or a unit trust. We have also seen family charters work well with large assets controlled by a family trust – and sometimes – no matter how robust the charter is – a family member will want a legal and clear claim to an asset. And a family trust is not great at giving a fixed interest to shares of the assets in the trust.
When you want it simple
A family trust is not actually a “thing”. A family trust is a trusted relationship between the trustee and the extended family – and the way that relationship is governed and managed is typically contained in a document that ranges from 16 to 60 pages long. And the document outlining every trusted relationship is different depending on which lawyer drafted that document on the day.
The ATO also have started a new attack on family trusts that is top-of-mind for tax advisors.
If you want to operate a family trust and keep it simple there many ways to do so – including cloud accounting technology. However, the simple truth is that family trusts are a complex vehicle and will require more work to create, maintain and shut.
When you have very little taxable income
If you are considering a family trust for the tax benefits it offers then you should consider your current tax profile. That is, if you are not paying tax there will be little tax savings by using a family trust.
When a couple retires the tax benefits within a superannuation fund and also the generous Senior Australians and Pensioners Tax Offset can often mean that moderately wealthy retired family is not paying tax. So, chasing more tax benefits simply is not worthwhile.
When you want to access lower tax rates
The small business company tax rate is now 25%. And a small business is a business with a turnover of less than $50m.
If you are operating through a family trust your trust will not enjoy the small business company tax rate (as it is not a company). And while you can allocate business profits to a company the family trust will ultimately need to pay cash or assets into the company due to the complex operation of tax rules surrounding private company loans.
When you are undertaking research and development
The generous research and development ta concessions, including the R&D Tax Offset, are not available to a family trust. And while you can incorporate a stand-alone company to undertake research and development this option typically adds another layer of cost to the already complex R&D Tax Incentives rules.
Creating a family trust
The creation of a family trust can be a very quick online process through a law firm or a happy accountant. There are many tax reasons for a family trust and a range of reasons why you should have a family trust other than for reducing tax. However, that decision, if not done properly, can have disastrous long-term consequences. At Westcourt our considered and thoughtful tax advisory services for families include giving written advice as to why you structure works and the pros and cons of each choice. We will work with you to listen, understand and tailor out solutions so you get the best long term outcome.
Given the single focus of Westcourt on family owned businesses, our deep commitment to tax excellence and our global reach through Geneva Group – we are a natural choice for families that are looking to create a long term tax and succession strategy for their business wealth and their personal wealth – so call us today.