It is critical to a new business’ success first to understand the different business structures available to you. Doing so enables you to choose a business structure that best suits you and your business’ needs, and will facilitate your future growth.
In our Business Structure Series, we take each structure and put it under a microscope to explain its advantages and disadvantages. Already, we have looked at sole traders, partnerships and companies so this week, we turn to running your business as a trust and the associated advantages.
What is a Trust?
Unlike a company, a trust is not a separate legal entity. A trust is a relationship in which a person or company (the trustee) holds the title to property (the trust property) for the benefit of others (the beneficiaries). A trust separates control and legal ownership from beneficial ownership. This is because the trustee agrees to hold and manage the trust property in a way that will benefit the beneficiaries.
There are two main types of trust: discretionary trusts and unit trusts. As the name suggests, the trustee in a discretionary trust has discretion as to which beneficiaries receive distributions from the trust. The Trustee must exercise their discretion in compliance with the trust deed. Family businesses commonly use discretionary trusts.
When more than one family is involved, it is sensible to consider a unit trust. Here, interest in the trust is divided into units, similar to shares in a company. Each unitholder has units in the trust, and each unit represents an entitlement to a certain proportion of the income and/or capital of the trust.
There are certain advantages to running a business through a trust, and we address these in turn below.
If an individual or a corporation sue a beneficiary, or if they incur debts, the trust protects the property from creditors and any litigation. This is because the trustee, rather than the beneficiary owns the trust property.
A trust can exist without an explicit intention by the parties to create one. The necessary relationship between the parties, not formalities, forms the trust. Although, generally written trust deeds govern modern trusts. These set out:
- How to create the trust,
- How to maintain it,
- The rights and obligations of the parties; and
- How to distribute income from the trust property.
The trustee of a discretionary trust has discretion as to which beneficiary to distribute the trust’s income. Each beneficiary who receives a distribution must pay income tax on it at its marginal rates. Having the flexibility of being able to choose whose income to distribute is helpful for tax planning purposes. The trustee can distribute income to the beneficiaries with the lowest marginal tax rates to minimise the aggregate tax payable by the beneficiaries.
The trust model provides more privacy than a company.
The 50% discount on any capital gains made on the disposal of assets held by the trust for over 12 months applies to discretionary trusts where the potential beneficiaries are all individuals (not companies). Companies receive no such exemption.
If parents die and leave all of their assets to one son who is bankrupt, their entire estate will be lost to the trustee in bankruptcy. Had the parents left their estate to a discretionary trust established for the benefit of their son and his family, the estate would have been saved.
There are advantages to running your business through a trust, especially concerning tax planning and personal asset protection. There are, however, also disadvantages that we will consider in our next article.
If you are looking into how to set up your business or are considering changing your business structure to one that is more beneficial to you, get in touch with us on 1300 544 755. LegalVision’s business structuring experts can provide you with comprehensive and tailored advice. We can also assist you in setting up your business structure and advising you on what other needs your business may have.