Should I Operate My Business Through a Trust or a Separate Company?

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Table of Contents

• What is a Trading Trust?
• What is a Company?
• What Factors Should Business Owners Consider When Structuring a Business? 
• Key Takeaways

When deciding what business structure is appropriate for your business, there are a range of factors to consider. For example, you might think about what business structure can protect your assets best or minimise tax liability. Two business structures you can operate your business through are a trading trust or a company. This article will outline the various factors to consider when deciding whether to operate your business through a trading trust or a company. 

What is a Trading Trust?

A trading trust is a business structure that involves a trustee who owns the business assets and enters into contracts on behalf of the trust. The trustee is an entity that can either be an individual or a company. The trustee can decide to:

• purchase assets; 
• sell assets; and
• distribute trust assets to beneficiaries/unitholders. 

You should note that a trust is not a separate legal entity. Rather, the trustee is a legal entity that is: 

• responsible for the operation of the trust; and 
• legally liable for the debts of the trust. 

Commonly, however, the trustee is a company, which can reduce the liability of the owners of the business.

There are several types of trusts relevant to business operations, including:

• Discretionary trusts: Offer flexibility in distributing income and capital
• Unit trusts: Similar to companies, with unitholders instead of shareholders
• Fixed trusts: Have predetermined beneficiaries and distribution amounts
• Hybrid trusts: Combine features of discretionary and unit trusts

What is a Company?

A company is another type of business structure. A company is a separate legal entity separate from its directors and shareholders. Nevertheless, a company has the same legal rights as a person. This means the company can purchase assets and enter contracts in its name. When the company incurs a debt, the debt is generally the company’s to pay as opposed to its directors or shareholders. 

What Factors Should Business Owners Consider When Structuring a Business? 

There are six main legal and commercial factors that business owners should consider when structuring a business. 

1. Asset Protection

One of the main benefits of running your business through a company is asset protection. Directors of a private company limited by shares are generally not liable for their company’s debts. As the company is a separate legal entity, the company’s debts are generally the company’s. 

In practice, this means that if the company faces financial difficulties, the personal assets of shareholders and directors are generally protected, subject to certain exceptions such as personal guarantees or breaches of directors’ duties.

As a director, one of your most essential directors’ duties is to prevent insolvent trading. If you allow the company to trade while insolvent, you will be in breach of your directors’ duties. If you breach your directors’ duty to prevent insolvent trading, you may be legally responsible for the company’s debts during this period of insolvent trading.

The benefit of asset protection extends to businesses run via a trust that uses a corporate trustee rather than an individual trustee. However, this is subject to the terms of your trust deed, so it is essential to seek legal advice when establishing your trust. 

In saying that, where your trading trust has an individual as the trustee, that trustee may be personally liable for the trading trust’s debts, and your personal assets could be used to satisfy debts the trading trust has to pay. 

2. Capital Gains Tax

A trading trust may be able to access the small business capital gains tax (CGT) concessions. To qualify for the concession, your business must have a:

• $2 million turnover; or
• $6 million net asset value.

The small business CGT concessions allow you to reduce, disregard or defer some or all of a capital gain from an active asset used in a small business.

It’s important to note that the 50% CGT discount is available to individuals and trusts, but not to companies. This means that if a company sells an asset and makes a capital gain, it cannot access this discount and will pay tax on the full amount of the gain

Consider the following example:

3. Tax

A trading discretionary trust is often one of the most tax-effective methods of running a business. Profits of the business can be easily distributed amongst family members and other beneficiaries. They can be distributed in such a way that tax is paid at the lowest available individual marginal tax rate (subject to various rules). 

It is far more common to see a trading unit trust. This is because each ‘investor’ or ‘owner’ of the unit trust holds a certain number of units in the unit trust, much like shares in a company. This means the proportions of distributions are fixed in proportion to each unitholder’s units. 

In contrast to trading trusts, companies that are ‘base rate entities’ pay tax at 25%. A company is a ‘base rate entity’ if:

• the company’s aggregated turnover for that income year is less than $50 million for that income year; and
• it has 80% or less of its assessable income in that income year that is base rate entity passive income.

It’s worth noting that companies can distribute franked dividends to shareholders, which can provide tax benefits. Franking credits represent the amount of tax the company has already paid on its profits. When shareholders receive franked dividends, they can use these franking credits to offset their own tax liabilities, potentially reducing their overall tax burden.

Additionally, different business structures may have varying impacts on state-based taxes. For example, payroll tax thresholds and land tax obligations can differ depending on whether the business is operated through a trust or a company. It’s important to consider these state-specific tax implications when choosing a business structure.

4. Working Capital

From year to year, companies are able to retain any profit in the company and use those profits to grow the business. Alternatively, the company can pay out a dividend to shareholders. However, the company is not required to do so. 

Broadly speaking, a trust itself does not have to pay income tax. Unlike a company, a trust does not have to pay the corporate tax rate on its net income every financial year. Generally, if the trust distributes the trust assets to beneficiaries, the cash, for example, is taxed in the hands of the beneficiary/unitholders. 

However, suppose your trading trust has net income for the year and does not distribute all the income to the beneficiaries/unitholders. In that case, the trustee has to pay tax on behalf of the trust at the highest individual marginal rate.

5. Investment, Debt Financing and Commercial Suitability

If you anticipate or intend for your business to raise capital through equity or debt financing, it may be more appropriate to opt for a company structure. This is because investors and institutional lenders are typically more comfortable investing in companies rather than trusts. 

Additionally, as a startup, you may want your business to: 

• qualify as an Early Stage Innovation Company (ESIC);
• receive a Research and Development tax incentive; or
• implement an employee share option scheme.

Choosing to run your business through a company will likely be a more suitable arrangement. For businesses with international operations or aspirations, it’s important to note that company structures are generally more widely recognised and understood globally than trust structures. This can simplify international transactions and partnerships.

6. Managed Investment Scheme

Suppose your business is operating through a trading unit trust. Suppose your unit trust surpasses 20 unitholders, and those unitholders do not have a say in the day-to-day operations of the business. In that case, you must register the unit trust as a managed investment scheme. Nevertheless, there are fines for the trustee if the unit trust is not registered as a managed investment scheme when it must do so.

7. Compliance Costs

It’s essential to consider the ongoing compliance costs and administrative burdens associated with each structure. Companies generally have more formal record-keeping requirements and may need to lodge more frequent reports with regulatory bodies. Trusts, while potentially offering tax benefits, can have complex administration requirements, particularly around distribution decisions and maintaining trust records.

8. Succession Planning

The choice between a trust and a company structure can significantly impact business succession planning and intergenerational wealth transfer. Trusts can offer more flexibility in this regard, allowing for smoother transitions of control and assets to the next generation. Companies, on the other hand, may require more formal processes for transferring ownership, but can provide a clear structure for ongoing management and control. 

Here is a simple comparison table summarising key differences:

Key Takeaways

Both companies and trusts have their advantages and disadvantages. Before you decide on how to best structure your business, make sure that you obtain tax, legal, and accounting advice. Companies provide strong asset protection and are generally more attractive to investors for equity and debt financing. Trusts offer significant flexibility in distributing income and may be more tax-effective for family businesses. However, trusts do not provide the same level of asset protection as companies unless a corporate trustee is used. Additionally, trusts may need to be registered as managed investment schemes under certain conditions, adding regulatory complexity.

If you have any questions about how to structure your business, our experienced business structuring lawyers can assist you as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.