When running your business, there are several operating structures to choose from, including as a:
- sole trader;
- one company structure;
- two-company structure (i.e. a holding company and operating company); or
This article summarises the key aspects of two types of trust you could use to run your business:
- discretionary trust; and
- unit trust.
What Does Running Your Business Through a Trust Look Like?
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.
Firstly, 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 own 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 and Disadvantages of a Trust Structure
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.|
|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 limits a trustee’s powers.|
|You cannot distribute losses (only profits). Therefore, any profits earned will incur increased tax rates.|
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.
You can run your business through a discretionary trust or a unit trust. 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.
Further, if you are looking to bring on investors, they will generally only want to invest in a company structure, rather than a trust structure. Therefore, if you have questions about how you should structure your business, contact LegalVision’s business structuring lawyers on 1300 544 755 or fill out the form on this page.
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