Trusts are widely used for investment purposes or as tax shelters. There are many different types of trusts, ranging from managed investment trusts to family trusts. A trust is an obligation imposed on a person or entity to hold property. The trustee will hold the asset(s) for the benefit of the beneficiaries. In legal terms a trust is a relationship not a legal entity. However, trusts are treated as taxpaying entities for tax administration purposes. However most trusts still have to pay tax and it’s important to understand these obligations. The Australian Tax Office offers further detail concerning all matters related to trusts.
How do trusts work?
Although there are a diverse range of trusts there are a few common characteristics. The terms and conditions under which a trust are established and maintained are set out in its deed.
One of the key benefits of a trust is that the trustee can distribute income earned by the trust. This allows a distribution of tax obligations and can also be used to protect an entity’s assets. They are also able to pass on assets quickly and privately.
Capital gains tax
A capital gains tax even refers to when someone sells or otherwise disposes of an asset. These events incur either a capital gain or loss. When these events provide a positive return they are typically accompanied with a requirement to pay capital gains tax.
However, not all capital gains tax events are the same. For example when exchanging an asset for a replacement asset. In these instances you can defer or roll over any capital gain until another capital gain tax event. This allows you to maintain capital until you sell off the asset and are able to make a return.
Beneficiaries and trustees tax
The trustee(s) (there may be more than one) of a trust may be a person or a company. The trustee holds the trust property for the benefit of the beneficiaries. In contrast, beneficiaries have an entitlement to trust income or capital that is set out in the trust deed. In either case, the trustee must be legally capable of holding trust property in their own right. However, a trustee can also be a beneficiary but not the sole beneficiary.
For the majority of trust structures adult and company beneficiaries pay tax on their share of the trust’s net income. The entity will subsequently pay the relevant tax rate. However, most trust distributions to minors are subject to higher rates of tax.
Generally, the trustee is taxed on the trust income at the highest marginal tax rate. There are some exclusions to this. For instance, modified tax rates apply to deceased estates.
Conclusion
Ultimately, the perception that many have that trusts do not pay tax is false. This is important to note before entering a trust as a beneficiary or trustee. Because trusts are not a separate legal entity the parties to a trust can be liable for failure to pay tax. Subsequently, it is advisable to contact an estate planning lawyer or a commercial lawyer. This will ensure you properly create a trust deed and properly understand all your obligations before entering a trust agreement.
