Renewed interest in family trusts: HLB Mann Judd Sydney

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Family trusts are still an attractive approach for those looking to build wealth in a tax-effective investment vehicle other than superannuation, despite the ongoing changes to the rules governing such trusts, says Jolyon Dare of HLB Mann Judd Sydney.

Family trusts are still an attractive approach for those looking to build wealth in a tax-effective investment vehicle other than superannuation, despite the ongoing changes to the rules governing such trusts, says Jolyon Dare, tax partner at HLB Mann Judd Sydney.

“Over the last few years, investors have been wary of family trusts on the basis of negative reports or uncertainty around tax treatment, but this shouldn’t put them off.

“While the mechanics of tax rules have changed and will probably change again, some of the most attractive features are not up for grabs, such as the ability to stream different classes of income to different beneficiaries, and the ability to ‘income-split’.

“Streaming income allows trustees to stream interest and dividends from the trust to a company beneficiary, which then pays tax at the company tax rate of 30 percent, but to stream capital gains to individuals so they can enjoy the individual capital gains tax (CGT) discount.

“It is an area where there has been some uncertainty following a recent court case (the Bamford case) into the way that beneficiaries in a trust are taxed.

“However, the government has now allowed streaming as a stop-gap measure for the time being and, while the trust tax laws are set to change again at some point, streaming is a feature that is proposed to stay.

“Another major attraction of family trusts is the ability to income-split.  This allows the use of different marginal tax rates to pay less tax.

“For example, when families choose to invest, they will usually choose for the spouse with lower marginal tax rate to hold the investment.

“The problem with this approach is that the investor who has the lower marginal rate this year may not have the same low tax rate next year, and changing investors will generally involve triggering capital gains.

“Holding the investment through a family trust allows income splitting to be used.  The trustee can choose from year to year which beneficiaries will receive entitlement to trust income, meaning that as the relative marginal tax rates within a family group change, the way a trustee appoints income can change to reflect marginal rates for that year,” Mr Dare said.

He added that he is starting to see more interest from people in such family trust structures as they realise that the benefits outweigh the negativity that has been created by the ATO’s continued focus on trusts.

“As long as trusts are used correctly and in the way that they are intended, they can be a very flexible and tax-effective way of boosting a family’s retirement next egg, particularly in comparison with direct investment.

“They can also be used to rebalance family wealth between spouses.  For example, women often retire with less super than men if they have taken time out of the workforce to raise children. The flexibility of family trusts means that they can take a greater share of trust income in retirement to make up for a smaller super balance, in a tax-effective way,” Mr Dare said.

Under a family (or discretionary) trust structure, investment assets are held by a trustee. Trustees can pass assets or trust income at their discretion to particular beneficiaries, which could potentially include everyone in a family group.

Beneficiaries are taxed on their share of trust income for the year, including franking and capital gains. This can have significant tax advantages where family members have different marginal rates.

Example:

John and Jane are both 40, and have two children aged 9 and 11.  They set up a family trust with all four family members as beneficiaries.

By the time they turn 50, John and Jane are the peak of their earning career and are both on the highest marginal tax rate.  Their trust has $500,000 invested and is yielding $25,000 per annum.  Their children at both at university and earning very little; they don’t pay any income tax.

By appointing, or ‘streaming’, the income from the trust to their children, no tax is payable on this income, and franking credits are refundable in full.

By 65, John and Jane have retired and live off their non-taxable super. Their family trust has $1 million invested and is yielding $50,000 per annum.  Their eldest child is earning a high income and paying the highest marginal rate of tax.  The other is taking time out of the workforce to raise a family.

By splitting the trust income equally between John, Jane and the non-earning child, no tax is payable on trust income and franking credits are refundable.

HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and part of the HLB Mann Judd Australasian Association.

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For more information please contact:

Jolyon Dare – Phone: 02 9020 4224

21 May 2103