Most people who want to start their own business do not follow through. Starting a business carries many risks. So, it is essential to make smart decisions from the onset to limit those risks. One aspect that many business owners get wrong is choosing an inappropriate business structure for their business. Selecting the correct business structure for your business is extremely important. It can affect how much tax you pay, liabilities you as the business owner are personally liable for and your ability to grow and expand. There are many ways you can structure your business, and one of them is a unit trust structure. This article explores three things you should consider before you decide to set up your business as a unit trust.
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What Is a Unit Trust?
A unit trust is a type of trust arrangement.
A trust is a legal arrangement where a person described as a ‘trustee’ have legal ownership of an asset. Others called ‘beneficiaries’ have the beneficial ownership of that asset. The trustee has legal obligations to act in the best interests of the beneficiaries. Likewise, they must distribute the trust income to them.
In a unit trust, the beneficiaries (called a unitholder) hold a certain number of units in the unit trust. Each unit is a fixed proportion of the beneficial ownership of the trust, very much like shares in a company. A trustee must distribute any income from the trust in proportion to the number of units a unitholder holds in the trust. By contrast, in a discretionary trust, another common trust structure, the trustee has the power to decide whether to distribute a trust income to a beneficiary and how much to distribute.
The following section explores three considerations before choosing a unit trust to structure your business.
Is the Unit Trust Structure Suitable for Your Business?
This is the ultimate question you should ask yourself. Indeed, it is possible to change your business structure later in your business. However, the process can be very complex and may come with tax implications. Thus, it is always best to choose an appropriate business structure from the onset.
A unit trust is often a good business structure where your business is involved in investing or co-owning assets with independent third parties. This is because unit trusts offer various benefits like:
- clarity on the distribution of trust income;
- flexibilities for people to become or cease to be unitholders in the unit trust; and
- certain tax benefits.
However, it is often difficult to grow and expand with a unit trust as the business structure. One reason is that all the income in a unit trust is usually distributed to the unitholders each year. If not, those incomes will be taxed at the highest marginal tax rate. Therefore, it is challenging to hold on to the revenue from the business for ongoing working capital needs. By contrast, a company structure is taxed at a flat rate of 30%. Hence, it is more commercial to hold on to any revenue to use for the business’ expansion and growth.
Continue reading this article below the formIs Your Business Considering Raising Capital by Debt or From Investors?
A business that needs to grow and expand will need capital. Businesses usually raise capital from investors who take part-ownership of the business. Alternatively, lenders can provide a debt to the business on certain conditions, including repaying with interests. If your business wants to expand and have many capital needs, you may want to re-consider if unit trusts are the best business structure for you.
Lenders and investors often see a business structured as a unit trust as complicated. Hence, they may be reluctant to invest or lend money to it. They generally prefer to deal with businesses in a company structure. Company law is well established and is better understood when compared to the law around unit trusts. However, there are exceptions. For instance, a bank may be less reluctant to lend to a property developer who wants to use a unit trust structure for its business if they have successfully completed several projects before.
Tax Implications of a Unit Trust
Most businesses will want to limit the tax it is liable to pay. Saving more money on tax means more capital to reinvest into your business. Therefore, you should understand the tax implications of a unit trust before choosing this as your business structure.
As noted above, any trust income not distributed to the unitholders is taxed at the highest tax margin. This is 45%. This provides the trustee with a solid incentive to distribute all trust income to its unitholders each year. Any distributed income is taxed at the tax rate applicable to that unitholder. A unit trust also offers a 50% discount to unitholders for any capital gains gained from an asset that the trust has held for more than 12 months (subject to certain conditions).
Key Takeaways
A unit trust is a type of trust arrangement where the trustee has obligations to distribute any income from the trust to the beneficiaries of the trust (called unitholders) in proportion to the number of units they hold in the trust. Often, you can structure your business through a unit trust. However, while it can offer many benefits, there are some considerations to note before choosing a unit trust as your business structure, including:
- whether a unit trust structure is suitable for your business;
- the limitations a unit trust have in attracting capital by investment or debt; and
- the tax implications of a unit trust structure.
For more information on unit trusts and how they can help your business, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
Frequently Asked Questions
A unit trust is a type of trust arrangement. In this arrangement, the beneficiaries or unitholders hold a certain number of units in the unit trust. Each unit is a fixed proportion of the beneficial ownership of the trust. A trustee must distribute any income from the trust in proportion to the number of units a unitholder holds in the trust.
A discretionary trust is a different type of trust arrangement. Here, the trustee has power (or discretion) to decide whether to distribute trust income to a beneficiary and how much to distribute.
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