What is a Trust?

A Trust is a separate legal entity that also has its own common and tax laws. Because a Trust is an entity on its own the people who benefit from any distributions made by the Trust (the beneficiaries) cannot be held liable for the actions of the Trust. The Trust owns the assets and because there are no shareholders (unlike a Company) there is no “owner” of the Trust.

The major advantage a Trust has over a Company or individual is income splitting (income splitting means simply that you can divert income to people in lower tax brackets).

The recommended way to set up a Trust structure is to have a $2 Company as Trustee and you be the director of the $2 Company.

How a Trust Works

You are the director and shareholder of the Company (that owns NOTHING), which means that you control the Company.

The Company is the Trustee for the Trust (that owns EVERYTHING), therefore, as director of the Trustee, you control the Trust.

The Trust distributes all profits to the beneficiaries, (who you nominate). i.e. yourself, spouse, children, parents, friends, etc.

Benefits of using a Trust

  • You can claim any expense that is incurred in running the business (or investment).
  • You spend before you pay tax.
  • Liability is limited.
  • You divert income to any beneficiary you want (i.e. those on the lower tax rates) and you can change the proportions of income each receives each year.
  • Because a Trust cannot die there are no capital gains tax or stamp duty costs when you die – assets can be passed on generation after generation with no tax implications.
  • Assets are protected. Nobody can take your assets because the Trust owns the assets, not you.
  • Upon the sale of an asset the beneficiary of the Trust pays the reduced rate of capital gain tax.

Income Splitting

As mentioned above, income splitting is a major feature of a Trust. Consider the following examples:

Example 1: 

  • Dad’s highest income is in the 47% tax bracket. Income > $180,000 PA
  • Mum’s income is in the 34.5% tax bracket. Income between $37,001 – $87,000 PA
  • Child No.2 is a full time student and is 18 or older and has no income.

In this scenario, if the Trust made a $30,000 profit the income would be diverted to Child No.2. Child No.2 would get a distribution and would only pay tax of $2,397.

Personal Services Income

Commencing from 1 July 2000 (1 July 2002 for PPS payees) a new regime applies in relation to personal services income is defined as income gained mainly as a reward for the personal effort or skills of an individual whether or not it is gained by the individual or by an entity (Company, Partnership or Trust) and whether or not it is paid under a contract. Such income could include salaries, professional earnings, contract income wholly or principally for the labour or services of a person, income derived by a professional sportsperson or entertainer and consulting income.

The personal services income, which has been earned by an entity, must be included in the income tax return of the person who has provided the services subject only to the following deductions:

  • Normal work related expenses;
  • Entity maintenance deductions such as filing fees, accounting fees etc;

There is an exemption from this requirement if the income is earnings of a personal services business.

If the entity passes the Results Test it will be taken to be conducting a personal services business. To pass the Results Test the entity must:

  • Receive income in return for producing a result;
  • Be required to supply plant and equipment or tools of trade (if any) needed to perform the work: and
  • Be liable for the cost of rectifying any defect in the work performed.

If the Results Test is not passed further tests are available provided 80% or more of the personal services income in an income year does not come from one client,

In this event the entity need satisfy only one of the following tests:

  • Unrelated Clients Test. The entity has two or more unrelated customers or clients and work is gained though advertising to the public.
  • Employment Test. At least 20% of principal work is undertaken by an employee (who could be an associate).
  • Business Premises Test. The entity has exclusive use of business premises, which are physically separate from the service provider’s home and also separate from the client’s premises.

If these tests are not met or you are uncertain whether they can be met it is possible to apply to the ATO for a Personal Services Business Determination. Such an application would certainly be appropriate where the business is commenced during the income year or whether the current year is not representative.

This is a very difficult area and specialised tax advice is recommended.