Choosing the right structure for your business is important. Two business structures you may be considering are a trust or a company. There is no hard rule on choosing the best structure for your business. The ideal structure for your business will depend on factors such as the:
- unique nature of your business
- industry you are operating in; and
- business’ future plans
It is therefore useful to understand the different types of business structures and their benefits to make an informed decision. This article will discuss the key differences between operating your business as a company or through a trust.
Operating Your Business Through a Trust
Trusts are not often used to run a business. They tend to suit family businesses with no plans to acquire third-party investment.
It is important to distinguish between fixed unit trusts and family trusts. In a fixed-unit trust, the amount of income a beneficiary receives from the trust is fixed. In contrast, a family trust gives the trustee the discretion or power to distribute varying amounts of income to different beneficiaries each year.
Unlike a company, a trust is eligible for the 50% Capital Gains Tax (CGT) discount when it sells or transfers its assets. This is on the condition that the trust has held the assets for more than 12 months. However, there are some exceptions to this rule.
Unlike a company, you are not required to disclose your personal information to the public when you operate a trust. Rather, only the parties to your trust will have information on the trust.
A trust may also protect the business’ assets. In the case of a beneficiary’s bankruptcy, creditors of the beneficiary have no claims against the assets of the business. The trust’s assets are only at risk from creditors who have a direct claim to the trust.
A trust is not a separate legal entity. This means that if anything goes wrong with the trust, the trustee may be personally liable to direct creditors of the trust. Often, you can eliminate this risk by nominating a company to act as the trustee of your trust.
Another disadvantage of running your business through a trust is that you may not be able to retain profits to reinvest in the business. If there is any undistributed income sitting in your trust in a given year, the trustee must pay tax on that amount at the highest marginal tax rate (currently at 49% or 45% excluding levies).
A trust is a more complex structure than a company and may be less attractive to a lender or investor. If you are a start-up with aggressive growth plans, a trust structure may not be appropriate for you. The reason for this is that people are less familiar with this structure. Unlike a company, a trust is not a separate legal entity.
Operating Your Business as a Company
It is very common to run a business as a company. A company structure is especially suited to businesses with aggressive growth plans and is more investor and lender friendly.
A company is a separate legal entity, which means that your personal assets are protected from creditors of the business. In a dispute with another party, your company will bear the legal responsibility and not you personally. This is true unless you have breached your director duties.
A company has a flat tax rate of 30% (or 27.5% for small businesses) on the profits it makes. This may be advantageous for individuals with a marginal tax rate greater than 30% if they are looking to reinvest those profits back into the company. When these profits are distributed to company shareholders in the form of dividends, the shareholders may receive a franking credit. This franking credit represents the amount of tax the company has paid on those dividends. If a shareholder’s marginal tax rate is less than the company tax rate, they can get a refund of franking credits equal to the difference in tax rates.
It tends to be easier to obtain credit from a lender or capital from an investor with a company structure. Company structures are simpler and more well-known. Investors are also more likely to invest in ‘shares’ as it is a quantifiable asset as compared to the rights they have as a beneficiary of a trust. Shares are also more easily traded.
A company structure offers no flexibility when distributing profits to its shareholders. Your company has a choice of whether or not to pay dividends each year, however, you are not able to control how much each shareholder will receive. When your company declares a dividend, each shareholder will receive an amount proportional to their percentage of ownership.
The 50% CGT discount on the selling or transfer of assets is also not available to companies. This means that if your company sells or transfers an asset it has held for more than 12 months, the company will have to pay tax on 100% of the capital gains it makes. Capital gains are the profits from the sale of a property or investment.
When you form a company, you will need to pay an initial government fee to the Australian Securities and Investments Commission (ASIC) as well as an ongoing maintenance fee. You also have to submit your personal details to ASIC which will be made available to the public on its website once your company is incorporated.
There are both advantages and disadvantages to running a business through a trust or a separate company. A trust is more suited to family businesses with no plans to acquire third-party investment, while a company is more suited to start-ups with aggressive growth plans. The key reasons for choosing one business structure from another is also often tax-motivated. It may also be a good idea to keep your personal assets separate from your business assets. If you decide to run your business through a trust, it may be a good idea to set up a separate trust to the one where you hold your personal assets. If you have any questions about the differences between business structures, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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