Summary
- Businesses can operate through three main trust structures: discretionary trusts (where trustees have full distribution discretion), unit trusts (where beneficiaries hold fixed units determining their entitlements), and hybrid trusts (combining elements of both).
- Trusts offer tax advantages, including income distribution flexibility to minimise aggregate tax, asset protection from third-party creditors, and potential capital gains tax discounts, but require mandatory annual profit distribution to beneficiaries or face taxation at the highest marginal rate.
- Trustees can be either individual or corporate, with corporate trustees providing an additional layer of asset protection by separating trust assets from directors’ personal assets, though switching between trustee types may have tax implications.
- This article is a guide to trust structures for business owners in Australia, explaining discretionary, unit, and hybrid trusts and their respective advantages and disadvantages.
- LegalVision is a commercial law firm that specialises in advising clients on business structures and commercial transactions.
Tips for Businesses
Consider your business size, investor expectations, and distribution flexibility needs before selecting a trust structure. Seek tax advice before appointing or changing trustees. Review your trust deed carefully, as varying its terms after establishment may trigger capital gains tax and stamp duty consequences.
A trust is a flexible business structure that lets a trustee own assets, distribute income and manage obligations on behalf of beneficiaries. Your chosen structure determines how your business operates, distributes income, and protects assets. For example, a small or family business may decide on one type of structure that is in their best interests versus a large enterprise. When setting up a trust, some factors that you should consider are:
- the nature of your business;
- the intended level of investor control and entitlements;
- the need for flexibility in distributions; and
- asset protection considerations.
This article summarises the key aspects of three types of trusts you could use to run your business: a discretionary trust, a unit trust and a hybrid trust.
What Does Running Your Business Through a Trust Look Like?
A trust is a type of business structure.
Running your business through a trust typically involves a trustee:
- owning and operating the business’ assets;
- distributing the business’ income; and
- complying with the trust deed’s obligations.
Discretionary Trust
Firstly, a discretionary trust gives the trustee discretion over:
- what income or capital is to be distributed; and
- which designated person, company or entity is entitled to benefit from the relevant trust (i.e. a beneficiary).
For example, if you have two beneficiaries, you do not have to distribute 50% to each. The trustee can pay one beneficiary 90% and the other 10%. Likewise, these percentages can change each time there is a distribution.
A discretionary trust may receive a capital gains tax discount on disposal of assets held for more than 12 months. This discount is also available to individuals who hold shares, but not companies that hold shares.
Family businesses more commonly use discretionary trusts as a form of family trust, where family members are comfortable with a trustee having discretion over the distribution each beneficiary receives. This can help with sharing family assets.
Where two or more independent people operate a business, discretionary trusts are uncommon and less appropriate, because you each want to know who will receive what, rather than the trustee exercising their discretion as to your distribution.
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Unit Trust
A unit trust, unlike a discretionary trust, divides the trust property into fixed and quantifiable parts called units. In other words, in this type of trust, the trust instrument (and not the trustee) determines the beneficiary’s interest. Beneficiaries subscribe to units similar to how shareholders subscribe to shares in a company.
Unit trusts provide certainty to unitholders. The money or property from the unit trust is distributed to the beneficiaries in fixed proportions to the units they hold. For example, if you have two unitholders who each own 50% of the units, they receive 50% of the distribution.
To set up a trust, you need to:
- select a trustee;
- have a trust deed drafted;
- have the trust settled by a settlor; and
- pay any applicable stamp duty.
Hybrid Trust
A hybrid trust, as its name suggests, integrates elements of a discretionary trust and a unit trust. Hybrid trusts are often appealing for businesses because they can take advantage of elements from both a discretionary trust (for example, retaining a degree of flexibility in distributions of income and protection of assets) and a unit trust (such as obtaining certainty for unitholders by fixing their entitlements).
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Advantages and Disadvantages of a Trust Structure
| Advantages | Disadvantages |
Income can be distributed at the trustee’s discretion to beneficiaries with the lowest marginal tax rates to minimise the aggregate tax beneficiaries pay. The trust’s beneficiaries pay tax on income they receive at their own marginal rate. | Typically, a trust structure is more expensive and complex to establish and maintain than a company structure, so may be difficult for a small business to maintain. |
| The trustee can distribute income at their discretion. | Problems may arise when trying to dissolve or alter an established trust. Varying the trust’s terms or objects could amount to resettlement and liability for capital gains tax and stamp duty arising. |
| The trust model provides more privacy than a company. | It may be difficult to borrow funds based on the intricacies of loan structures. |
| The beneficiaries do not own the trust assets, so there is scope for protection from a beneficiary’s third-party creditors. However, in a unit trust, if a person becomes bankrupt, their units will be treated in the same way as any other asset and can be available to a creditor or trustee in bankruptcy. | The trust deed provides for and limits a trustee’s powers. Consequently, strict obligations are imposed on the trustee to ensure proper performance of the trust. |
| You cannot distribute losses (only profits). Therefore, any profits earned will incur increased tax rates. The losses can, however, be carried forward to offset against the trust’s assessable net income in future years. | |
A trust must distribute its profit/income to beneficiaries each financial year. Otherwise, the trustee must pay tax on any undistributed (i.e. accumulated) income at the highest marginal rate. Therefore, if the business requires any working capital, a company structure is more appropriate as you only pay tax on undistributed company profits at the company rate. | |
| After you establish a trust, it continues for a period set out in the trust deed and up to a maximum legal term. For example, in New South Wales, a trust’s life is limited to 80 years. | |
| Trustees can be personally liable for the trust’s debts (subject to the trust deed providing that the trust’s assets indemnify the trustee). However, if the trustee is a company, its liability will be limited. |
Trustee: Individual Trustee vs Corporate Trustee
There are two different types of trustees that you must choose between when operating a trust. You can have either:
- an individual trustee; or
- a corporate trustee is responsible for fulfilling its duties under the trust deed.
You will need to decide which type of trustee you wish to have control over the trust before setting up the trust.
If you choose to have an individual trustee or a corporate trustee, you can change your mind later on. This will involve moving the shares from an individual trustee to a corporate trustee, or vice versa, through the transfer of shares. However, it is essential to seek tax advice from your accountant, as this transfer may have tax implications.
Individual Trustee
An individual trustee is a person who holds the shares on behalf of the beneficiaries. They have the responsibility of distributing the profits to the beneficiaries in accordance with the terms of the Trust Deed. You can appoint an individual trustee only where the trust has more than one beneficiary. You cannot appoint an individual trustee if the trustee is the sole beneficiary.
Corporate Trustee
A corporate trustee is a company that has been incorporated with the sole purpose of being a trustee of the trust. It is not an operating company and will generally have a very low value as it only exists for the trust. A corporate trustee may be the appropriate trustee if there is only one beneficiary of the trust. It also adds another layer of protection as it separates the trust’s assets from the personal assets of the directors and shareholders of the trust, if you are looking to further mitigate risks.
Key Takeaways
You can run your business through a discretionary trust, a unit trust, or a hybrid of the two. While running your business through a trust has tax advantages, the biggest disadvantage is distributing any profit or income to beneficiaries each financial year. Running a growing business with this restriction is difficult. Furthermore, if you are seeking to attract investors, they will typically prefer to invest in a company structure rather than a trust structure.
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Frequently Asked Questions
A discretionary trust is a trust where the trustee has the discretion as to how to distribute the income and capital of the trust.
A unit trust, unlike a discretionary trust, divides the trust property into fixed and quantifiable parts, called units. Beneficiaries subscribe to units similar to how shareholders subscribe to shares in a company.
A corporate trustee adds an extra protection layer by separating trust assets from directors’ personal assets. An individual trustee suits trusts with multiple beneficiaries but cannot act as the sole beneficiary.
While running your business through a trust has tax advantages, distributing any profit or income to beneficiaries each financial year is the biggest disadvantage.
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