If you’re starting a new business or looking for more flexibility in your established business, you’ll need to think about your business structure. Creating your business with the right business structure can set you up for long-term success. Depending on the size and nature of your business, your business may be better suited under a trust or company structure.
There are legal and financial obligations for both structures so it’s essential that you speak with your accountant before picking or changing your business structure.
What is a trust?
When you run your business under a trust, you are using a trustee to act on behalf of you and your selected beneficiaries. You set up the rules on what they can and can’t do in the trust deed.
There are two different types of trusts:
- Discretionary trust – the trustee has discretion as to what income or capital can be distributed to which beneficiary. The decision on how the income is split can be deferred until the last month of the financial year, which means the trustee can allocate the income in the most tax-effective way to the eligible beneficiaries.
- Unit trust – the trustee has no discretion and divides the trust property into fixed and quantifiable parts called units. Beneficiaries subscribe units similar to how shareholders subscribe for shares in a company. 1
What is a company?
Unlike a trust, a company is a separate legal entity that lasts forever and is not limited by the statutory time limit of 80 years. Being a legal entity means the company has the same rights as a person and can incur debt, sue and be sued.
Companies are controlled by its members and shareholders and are operated by managers, directors or agents. This means the company can continue to exist, regardless of the circumstances that may arise with the directors or shareholders. The structure allows the company to be subject to its debts and liabilities, and gives the company the right to retain property in its name. 2
What are the advantages of a trust?
Operating your business under a trust allows you to:
- More options for income distribution
- Can be advantageous for minimising tax
- Can operate your business with more privacy, and
- Protects the business assets from a beneficiary’s bankruptcy because the beneficiaries do not own the trust assets. However, a unit in a unit trust will be treated the same way as any other asset and can be available to a creditor or trustee in bankruptcy. 1
Trusts can help minimise tax
Both companies and trusts can access the small business capital gains tax (CGT) concessions if they meet the tests of:
- $2 million turnover or,
- $6 million net business asset value.
If an asset is owned for at least 12 months, Australian trusts can access the general 50% capital gains tax (CGT) discount. This additional discount only applies to trusts and cannot be used by companies. 3
What are the disadvantages of a trust?
Like any structure, there are also disadvantages that come with operating as a trust, and some of them are:
- The trust must distribute its profits to the beneficiaries and failure to do may cause the trustee to pay tax on any undistributed income at the highest marginal rate
- Can be expensive to set up and operate
- Must also apply for tax file number (TFN) and lodge annual trust return
- Difficult with borrowing funds
- A trustee’s powers are limited by the trust deed
- Losses cannot be distributed and any profits earned will incur increased tax rates
- The trust can only exist for 80 years
- Trustees are personally liable for all debts but if the trustee is a company then they will have limited liability, and
- Can be difficult to dissolve or make changes once established. 1
What are the advantages of a company?
A company structure may be more beneficial for businesses looking for asset protection and access to tax benefits. Other advantages include:
- Can cancel or issue shares, and
- Companies generally pay a lower tax on profits than an individual.
Under a company structure, your legal identity is separate from your business and as a result it will be your company, not you personally, that is responsible for your business’ contracts and risks. This means that if the business cannot pay off its debts, the assets of the company owner will be protected. However, if the directors purposely act to defeat creditors or trade when they know they can’t pay their bills, the directors may be liable. 4
What are the disadvantages of a company?
While there are clear advantages of operating as a company, the disadvantages are:
- Can be expensive to operate and maintain
- Losses are trapped in the company name and cannot be passed to individuals
- Shareholders can control the company and vote the directors out, and
- Very strict reporting requirements and can be tedious for the members. 2
What is the difference between a trust and a company?
One key difference between a trust and a company is that a trust is not a separate legal entity.
However under a company, you may be able to have better asset protection, gain greater working capital and investment opportunities (because investors usually prefer a company structure), as well as a longer life span.
Should I run my business as a trust or company?
With any business structure, there are legal and financial consequences for the business. And what business structure you choose will depend on your personal circumstances and what you want for your business.
Before you decide on how to best structure your business, make sure you consult your accounting and tax advisors. Your accountant will be able to help you weigh the pros and cons of each structure and can answer any questions you may have. Get in touch with us today.