There are a variety of structures a business can operate under. These structures include sole trader, partnership, company and trust. A business’s structure is dependent on its growth prospects, the number of members and owners and the potential liability of key members of the business.
An often complex and misunderstood business structure is a trust.
What is a trust?
Trusts are commonly used to protect business assets for beneficiaries. In a trust, the trustee is responsible for carrying out the operations of the business on behalf of the beneficiaries. Trusts require a Trust Deed that outlines the responsibilities of the trustee and details how the trust will operate. A Trust Deed should be drafted by a solicitor.
Who is involved in a trust?
The following parties are mandatory in a trust business structure:
- The settlor: The person or entity who sets up the trust and nominates the beneficiaries.
- The trustee (or trustees): An individual, company or otherwise who administers the trust and has control over the assets. The trustee is legally responsible for managing the trust’s income and tax liabilities.
- The beneficiary (or beneficiaries): The person or entity who benefits from a share of the trust.
Trusts may also include an appointor who has the power to appoint or remove a trustee.
Advantages of a trust
The benefits to using a trust structure include:
- Separation of the beneficiary and the trustee. Separating these actors is useful if a beneficiary suffers from a condition that impairs decision making or if they do not wish to be actively involved in managing the business operations.
- Greater flexibility in income tax management. The trustee can choose to distribute profits in a manner which minimises income tax payable if there are discretionary powers in the Trust Deed.
- The trust structure can provide more privacy than a company.
Disadvantages of a trust
Though there are several benefits to setting up a trust, there are also a number of limitations to consider:
- Expensive and complex. Trusts are expensive to set up and require the trustee to undertake formal yearly administrative tasks. Once established, it can be difficult to dissolve or make changes to the trust.
- Difficulties with loans. Due to the additional complexities of loan structures, it may be difficult for trustees to acquire a loan.
- Strict distribution of losses and profits. Profits must be distributed to beneficiaries each financial year otherwise the trustee must pay tax on undistributed income. Losses cannot be distributed so the trustee is personally liable for the debts of the trust.
Types of trusts
There are two main types of trusts that can be used by businesses:
- In a Discretionary Trust, the trustee can vary the Trust Deed to decide how the income of the business is distributed to the beneficiaries. This means that income and even capital distribution is flexible and can be tailored to the needs of the beneficiaries. Undistributed income, however, is taxed at the highest marginal rate which means that trustees are at risk of being liable for debts.
- In a Unit Trust, the property is divided into defined shares called units. Like a company, the beneficiaries are entitled to the income and capital of the trust in proportion to the number of units they hold. Losses, however, cannot be transferred to other entities and beneficiaries are subject to PAYG calculations.
Registering a trust
Before registering a trust, it is best to speak to a business adviser, lawyer or accountant to ensure a trust structure is appropriate for your business objectives. It is also crucial that you have a Trust Deed prior to registering which details your trustees, beneficiaries and the distribution of assets. Accordingly, you should be aware of the tax obligations of your chosen trust structure before registering.
To learn more about trusts and other business structures such as sole trader, partnership and company, please visit our website.
If you are planning on registering a trust or are needing to adjust an existing trust, we recommend seeking professional advice. If you would like to discuss your business with a legal professional, please contact us on (02) 9963 9800 or via our online contact form.