Trusts are a popular vehicle for both investment and business purposes. One effective strategy that trustees often employ is the use of corporate beneficiaries to distribute trust profits. This approach can offer several tax planning advantages. Here’s a detailed look at how this strategy works and its implications.

Understanding Corporate Beneficiaries

A corporate beneficiary is a company designated as a beneficiary of a trust. This company can receive distributions of income or capital from the trust. The primary reason for using a corporate beneficiary is to leverage the lower corporate tax rate compared to individual tax rates.

How It Works

Distribution of Trust Profits

The trustee of the trust decides to distribute some or all of the trust’s profits to the corporate beneficiary. This decision must align with the terms of the trust deed and relevant tax laws.

Taxation

The distributed profits are taxed at the corporate tax rate, which is generally lower than the highest marginal tax rate for individuals.

For the 2023-2024 financial year, the corporate tax rate for base rate entities (companies with an aggregated turnover of less than $50 million) is 25%, while the rate for other companies is 30%. In comparison, the highest marginal tax rate for an individual is 47%.

Retained Earnings

The corporate beneficiary can retain the distributed profits within the company. This allows the company to reinvest the profits into the business or other investments, potentially deferring the tax liability for the individual beneficiaries.

Franking Credits

When the corporate beneficiary eventually distributes dividends to its shareholders, it can attach franking credits to these dividends. Franking credits represent the tax already paid by the company, which can be used by the shareholders to offset their own tax liabilities.

Advantages

Tax Deferral

By distributing profits to a corporate beneficiary, the trust can defer the higher individual tax rates. The company can retain the profits and reinvest them, potentially growing the wealth within the corporate structure.

Income Splitting

If the corporate beneficiary has multiple shareholders, the company can distribute dividends to these shareholders, potentially splitting the income among family members or other entities, which may result in a lower overall tax burden.

Asset Protection

Retaining profits within a corporate structure can provide a level of asset protection, as companies have limited liability compared to individuals.

Considerations and Risks

Division 7A

If the corporate beneficiary is a private company, any unpaid present entitlements (UPEs) from the trust to the company may be subject to Division 7A. Division 7A aims to prevent private companies from making tax-free distributions to shareholders or their associates. Trustees must ensure that UPEs are managed correctly to avoid deemed dividends and additional tax liabilities.

Compliance Costs

Using a corporate beneficiary involves additional compliance and administrative costs, such as company registration, annual returns, and financial reporting.

Franking Account Management

Proper management of the company’s franking account is essential to ensure that franking credits are available when dividends are paid to shareholders.

Tax Law Changes

Tax laws and rates can change, potentially affecting the benefits of using a corporate beneficiary. Trustees and beneficiaries should stay informed about legislative changes and seek professional advice regularly.

Conclusion

Using a corporate beneficiary for the distribution of trust profits can be a valuable tax planning strategy, offering benefits such as tax deferral, income splitting, and asset protection. However, it requires careful management and compliance with tax laws to avoid potential pitfalls. Trustees and beneficiaries should consult with tax professionals to ensure that this strategy aligns with their financial goals and complies with all relevant regulations.