Using a trust to run your business
When you’re deciding how to run your business you can choose from a number of structures, including a sole trader, partnership, company or trust.
A trust is a business structure that doesn’t have an owner or owners in the traditional sense. The trust imposes an obligation on the trustee, which is a person or, more normally, a company, to hold and operate the business assets for the benefit of others, the beneficiaries.
If you choose to run your business through a trust then the trustee owns and operates the assets of the business, distributes the income the business makes and must comply with the trust deed’s obligations.
It can be expensive to set up and operate, having higher ongoing compliance and accounting costs. The trustee must undertake formal yearly administrative tasks.
A trust itself, is not a separate legal entity. The trustee however is the entity that is legally responsible for the operation of the trust and legally liable for the debts of the trust.
A trust can be tax effective because of the flexibility of its asset and income distribution. It doesn’t distribute losses, only profits.
The beneficiaries have limited rights and control over the business.
There are two mainstream types of trusts. A discretionary trust and a unit trust. The main indifference between the two is in a discretionary trust the trustee decides what income or capital is distributed to which beneficiary. And, this can change each time there’s a distribution. Family companies more commonly use discretionary trusts as a form of family trust where the family members are comfortable for a trustee to have discretion on what distribution each beneficiary receives.
A unit 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 they hold, in strict accordance with the Trust Deed.
A trust has its own advantages and disadvantages compared to other business structures.
Trust advantages
Income can be distributed at the trustee’s discretion to beneficiaries with the lowest marginal tax rates to minimise tax.
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 do not own the trust assets, so there is potential 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.
Trust disadvantages
Usually, 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.
You cannot distribute losses (only profits).
A trust must distribute its profit/income to beneficiaries each financial year in the year that it is earned, which is not necessarily in the year in which it is paid out. Otherwise, the trustee must pay tax on any undistributed income at the highest marginal rate.
Therefore, if the business requires a large amount of working capital, a company structure is perhaps 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.
If you would like more information or have questions please contact me paul@congdonfuzi.com.au