Deciding on a business structure can be very confusing for business owners because there are a wide variety of business structures available, and many different benefits and disadvantages to be considered. The way to choose your business structure is to determine what the intentions of your business structure are, for both the short and the long term, and then to discuss the alternatives with a professional advisor to ensure you are making the best choice for your circumstances.
One popular, but confusing, type of business structure in Australia is a trust. A trust differs from the other forms of business structures in that the trust is not a legal entity. A trust must therefore have a trustee, who is the legal entity operating the business, holding the assets and entering into contracts on behalf of the persons entitled to the benefits of the trust, known as the beneficiaries. The trust itself simply refers to the relationship between a trustee and a beneficiary.
Types of trusts
Businesses set up as a trust are typically structured as either a discretionary trust or a unit trust.
Discretionary trust
A discretionary trust is a trust where the division of beneficial interests in the trust property is left to the discretion of the trustee, meaning the trustee chooses what capital is distributed to which beneficiary and may not necessarily be in even proportions.
Unit Trust
In a unit trust, the trust property is divided into equal fixed parts called units. Beneficiaries hold units and are entitled to benefits based on the proportion of units they hold in the trust.
Benefits of running a business through a trust
- A trust structure offers a higher level of asset protection. Ownership of the business by a corporate trustee limits liability in relation to the business, protecting the assets belonging to the trust if the business or any individual in the business encounters financial difficulties. Additionally, beneficiaries do not directly own the trust assets, so they are protected from a beneficiary’s third party creditors. Their units will be available to creditors but the assets remain safe.
- Beneficiaries are not usually liable for any debts of the trust
- Businesses operating through a trust can minimise their tax by nominating which beneficiaries will receive proceeds at the end of each financial year, directing the proceeds towards the members with the lowest incomes, who will pay the least amount of tax. In situations where all the beneficiaries of a trust have significant taxable income in the current financial year, it may be possible to include a corporate beneficiary. In this case, the corporate beneficiary can receive the proceeds, and these will be taxed at the company tax rate of 30%, rather than the marginal tax rate that the other beneficiaries might be charged at (which means a potential saving of 15% on your tax bills).
- A trust has more privacy and fewer regulatory requirements compared to a company
Disadvantages of running a business through a trust
- Establishing and maintaining a trust can be expensive due to set-up costs and ongoing costs such as accountancy
- The complexity involved in establishing a trust often requires the expertise of a solicitor. This also adds to the expense
- The trustee, and therefore the operations of the business, is limited by the terms of the trust deed
- The trustee may be liable for the trust’s debts and obligations if the trustee is not a corporate trustee
- Unlike companies, a trust distributes all income to beneficiaries annually as undistributed income attracts a higher tax rate. This can be particularly problematic for growing businesses
- Losses are not distributable and beneficiaries cannot offset losses against other income
- Borrowing money through a trust structure can be difficult
A professional adviser, such as a solicitor, can assess your situation, weigh up the options and help you select the most appropriate business structure.