When running your business, there are several operating structures to choose from including a sole trader, partnership, a one company structure, a two-company structure (i.e. a holding company and operating company) or running your business through a trust.
Running your business through a trust involves a trustee owning and operating the business’ assets, distributing the business’ income, and complying with the trust deed’s obligations. Importantly, trusts, unlike companies, are not separate legal entities. The trustee of the trust is the legal entity who owns the assets and enters into contracts on the trust’s behalf.
Below, we summarise the key aspects of two types of trust you could use to run your business – a discretionary and a unit trust.
- A discretionary trust gives the trustee discretion over what income or capital is distributed to which 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%, and these percentages can change each time there is a distribution.
- A discretionary trust is entitled to a discount on any capital gains made on the disposal of any assets the discretionary trust holds for more than 12 months. This discount is also available to individuals who hold shares, but not companies who hold shares.
- Family Companies more commonly use discretionary trusts where the parties are comfortable for a trustee to have discretion on what distribution each beneficiary receives.
- 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.
- 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.
- 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 that they hold. For example, if you have two unitholders who each owns 50% of the units, they receive 50% of the distribution.
- Whether money distributed to unit holders in a unit trust is taxable depends on the money’s character held by the trustee before 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.
Advantages of a Trust Structure
The main advantages of a using a trust structure to run your business are:
- 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.
- The trustee can distribute income at their discretion.
- The trust model provides more privacy than a company.
- The beneficiaries don’t 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.
Disadvantages of A Trust Structure
- Typically, a trust structure is more expensive and complex to establish and maintain than a company structure.
- 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.
- It may be difficult to borrow funds based on the intricacies of loan structures.
- The trust deed limits a trustee’s powers.
- With a trust structure, losses cannot be distributed (only profits can) therefore any profits earned will incur increased tax rates.
- A trust must distribute 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. If the business requires any working capital, then a company structure is more appropriate as undistributed company profits are only taxed at the company rate.
- After a trust is established, it continues for a period set out in the trust deed, and up to a maximum term as prescribed by law. 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.
Despite tax advantages to running your business through a trust, the biggest disadvantage is distributing any profit or income to beneficiaries each financial year. Running a growing business with this restriction is difficult. Further, if you are looking to have investors invest in your business, they will generally want to invest in a company structure, not a trust structure.
Questions about the most appropriate structure for your business? Ask our business structuring lawyers on 1300 544 755.