As a business owner, an important decision is whether to structure your business as a company or a trust, a fiduciary arrangement where a trustee holds assets to benefit beneficiaries, as what you decide will have significant financial and legal consequences.
Choosing the appropriate business structure will directly influence tax, personal liability, and costs. Therefore, it pays to carefully consider the immediate consequences of each choice for your business and the future company vision and objectives.
We have compared the two options to help you determine which is best suited to your circumstances, making your decision easier.
Understanding Business Structures
When setting up a business in Australia, one of the most important decisions you’ll make is choosing the right business structure. The two most common business structures in Australia are companies and trusts. Understanding the differences between these two structures is crucial to making an informed decision that suits your business needs.
A company is a separate legal entity from its shareholders, whereas a trust is a fiduciary relationship where a trustee holds assets to benefit beneficiaries.
Companies are taxed on their profits, while trusts are taxed on the income distributed to beneficiaries. Shareholders of a company have limited liability, whereas trust beneficiaries have no liability for the trust’s debts.
Business Structure Options
When it comes to choosing a business structure, there are several options to consider, each with its unique advantages and disadvantages. Two of the most common structures are companies and trusts.
A company is a separate legal entity that can enter into contracts, own assets, and incur liabilities independently of its shareholders. This separation provides a level of asset protection, as the company’s financial obligations do not directly impact the personal assets of its shareholders.
On the other hand, a trust is a fiduciary relationship where one party, known as the trustee, holds assets on behalf of another party, the beneficiary. Trusts are often used for estate planning, asset protection, and tax minimisation. The trustee is responsible for managing the trust assets in the best interest of the beneficiaries, providing a flexible way to distribute income and assets.
When deciding between a company and a trust, it’s essential to consider factors such as asset protection, tax benefits, and the level of control desired. Companies often offer more straightforward mechanisms for raising capital and expanding business operations, making them suitable for growth-oriented businesses.
Trusts, however, provide significant tax benefits, such as the ability to distribute income to beneficiaries tax-efficiently and access to the capital gains tax discount for assets held over 12 months.
Ultimately, choosing a business structure should align with your business goals and circumstances. Consulting with legal and financial professionals can help you navigate the complexities and make an informed decision that best suits your needs.
What Is a Company Structure?
A company is a separate legal entity. It is owned by a shareholder, controlled by a director, and often operated by a manager.
Companies in Australia are taxed as separate legal entities at either a 25% or 30% corporate tax rate. This rate differs from the tax obligations of individuals and can offer potential tax benefits, especially for small businesses and family trusts.
The shareholders’ agreement indicates the rights and responsibilities of shareholders, and specific legal duties bind directors.
Because a company is a separate legal entity, it can exist independently of its directors or shareholders. Therefore, companies have perpetual existence without being limited to the statutory time limit of 80 years, affecting trusts.
How Being a Separate Legal Entity Offers Asset Protection
Because a company is a distinct legal entity, it allows for separating personal and business assets, ensuring that the company’s financial challenges do not jeopardise personal finances.
As a result, the debt it creates doesn’t become a personal liability for the shareholders involved, and their personal assets are protected. Individual shareholder responsibility is restricted to their unpaid shares.
Therefore, the limited liability makes choosing a company structure attractive for high-risk businesses.
Why a Company Business Structure Has Tax Benefits
Companies pay tax at different corporate tax rates, generally lower than the tax fees on individual profits. This rate differs from the tax obligations of individuals and can offer potential tax benefits, especially for small businesses and family trusts. A sole trader is liable to pay their business tax from their individual income distribution, whereas company tax is filed separately to any of its shareholders.
Individual tax rates can be up to 45%, whereas the set company tax rate is 30% and 26% for small businesses turning over less than $50 million.
Unfortunately, capital gains concessions don’t apply to companies. Assets held for longer than a year are allowed a 50% discount when capital gains occur. However, they do apply to eligible small businesses.
Unlike companies, family trusts can benefit from a 50% capital gains tax discount on assets held for more than 12 months, providing significant tax flexibility.
Why Establishing a Company Structure Can Be Complex
A company is subject to specific legal obligations that must be enforced:
- The Corporations Act sets out duties for directors regarding the company and its employees. Directors must act with care and diligence in good faith, and they can’t take personal gains from exploiting their position or misusing information.
- The company must lodge a company tax return annually, pay super guarantee contributions, and comply with all regulations imposed by the Australian Taxation Office.
- The Australian Securities and Investments Commission (ASIC) requires companies to keep financial records and notify ASIC of any key changes within the company.
Companies need to account for initial formation costs and continuous ongoing costs thereafter. Formation costs include registering the business name, legal fees, and professional advice fees. The administrative costs to ensure the company is legally compliant are ongoing, such as submitting company tax returns and paying the annual ASIC Review Fee of $321.
What is a Trust and What Are Its Key Features?
A trust is a legally binding agreement in which a person or entity holds property for the benefit of beneficiaries. For tax administration, trusts are seen as taxpayer entities.
When a trust runs a business, it nominates a trustee (an individual or a company) as the legal entity to own the assets and enter into contracts on the trust’s behalf.
A discretionary trust allows the trustee discretion to distribute income or capital to different beneficiaries. Family trusts are often discretionary trusts, where the parents are trustees of a family’s business or assets, and the children are beneficiaries.
One benefit of a family trust structure is that distributed amounts are taxed at a reduced rate. Another significant tax benefit is the capital gains tax discount, where assets held for more than 12 months can receive a 50% discount on capital gains.
The family trust business structure offers unique ownership, control, taxation, and asset protection characteristics. It is managed by a trustee with complete control over assets, differing from the shareholder model of companies.
A unit trust allows the trustee no discretion. Instead, the trust property is divided into units called fixed and quantifiable parts. Beneficiaries subscribe to units the same way shareholders subscribe to shares in a company.
How a Trust Limits Liability
Operating a business through a trust results in limited liability.
While a trust’s debts don’t create a liability for the beneficiaries, a trustee can be personally liable for the debt. Using a trustee, which is a company (corporate trustee), can limit liability.
The business is protected if a beneficiary becomes bankrupt, as beneficiaries don’t own the trust assets.
How a Trust Gives You Control Over Distribution of Profits
While a company is a taxable entity, a trust isn’t. The beneficiaries of a trust pay income tax on the profits that are distributed to them.
Control of the distribution of profits is flexible depending on tax rate policies and thresholds. A trustee from a discretionary trust has discretion in the distribution process, whereas a company can’t do that.
Why Establishing a Trust Business Structure Can Be Complex
A trust is a complex business structure because:
- They can become costly. A trust deed must be created, and legal services must be paid for.
- Incorporating a corporate trustee comes at a cost. Legal obligations will be drawn up in favour of the beneficiaries that the trustee must comply with, such as preserving the trust property, maintaining financial records, securing due diligence and reasonable care, and producing information as requested.
- A discretionary trust must divide its profits between the beneficiaries each financial year. If this isn’t done, the trustee must pay the undistributed earnings at the maximum marginal tax rate.
- Discretionary trusts often involve family members, but those that operate with independent individuals might experience turmoil because each party could want to know how much will be received instead of the trustee using their discretion for distribution.
- Outside investors generally prefer working with Pty Ltd Companies as their structure is less complex than a discretionary trust, and they have more power as shareholders than beneficiaries of a trust.
Family trust business structures also add to the complexities and costs, especially when setting up the trust deed and incorporating a corporate trustee. These structures offer excellent asset protection and have different taxation implications for beneficiaries compared to company shareholders.
Tax Treatment for Trusts and Companies
The differences between trusts and companies regarding tax treatment can significantly impact your business’s financial health. Companies in Australia are taxed as separate legal entities, with a corporate tax rate of either 25% or 30%, depending on the company’s size and activities. This means that the company itself is responsible for paying taxes on its profits, separate from its shareholders.
On the other hand, trusts operate differently. Trusts are not taxed directly; instead, the income or capital gains generated by the trust are distributed to the beneficiaries, who then pay tax at their marginal tax rates. This can offer flexibility in income distribution, allowing for strategic tax planning.
In Australia, trusts can also benefit from the small business capital gains tax (CGT) concessions if they meet specific criteria. Additionally, if a trust holds an asset for at least 12 months, it can access the general 50% CGT discount, a benefit not available to companies.
When deciding between a trust and a company structure, it’s crucial to consider these tax implications. A company structure might be more advantageous for businesses seeking specific tax benefits. In contrast, a trust structure could be more suitable for those seeking flexibility in income distribution and capital gains tax discounts.
Comparison of Trust and Company Advantages
your specific needs and goals. Here are some key advantages of each structure:
Trust Advantages:
- Asset protection: Trusts can protect assets from creditors and lawsuits.
- Tax efficiency: Trusts can minimise tax liabilities by strategically distributing income and assets.
- Flexibility: Trusts can be used to distribute assets and income in a flexible manner.
- Estate planning: Trusts can be used to plan for the distribution of assets after death.
- Control: Trusts can provide control over the distribution of assets and income.
- Private: Trusts can maintain the privacy of family assets and income.
- Long-term: Trusts can be used for long-term planning and wealth management.
- Capital gains tax discount: Trusts can benefit from a 50% discount on capital gains for assets held for over 12 months.
Company Advantages:
- Separate legal entity: Companies have a separate legal identity from their shareholders.
- Limited liability: Shareholders have limited liability for company debts.
- Tax benefits: Companies can claim tax deductions for business expenses.
- Flexibility: Companies can issue shares to raise capital.
- Credibility: Companies can establish credibility and reputation in the market.
- Growth: Companies can grow and expand through mergers and acquisitions.
Exit strategy: Companies can provide an exit strategy for shareholders through sale or IPO.
Disadvantages of Trusts and Companies
While both trusts and companies have advantages, they also have disadvantages. Here are some key disadvantages of each structure:
Trust Disadvantages:
- Complexity: Trusts can be complex to establish and manage.
- Potential for disputes: Trusts can be subject to disputes among beneficiaries.
- Limited access to capital: Trusts may have limited access to capital.
- Tax implications: Trusts can have tax implications for beneficiaries.
Company Disadvantages:
- Complexity: Companies can be complex to establish and manage.
- Potential for disputes: Companies can be subject to disputes among shareholders.
- Limited flexibility: Companies may have limited asset distribution and income flexibility.
- Tax implications: Companies can have tax implications for shareholders.
Business Assets and Liability
When it comes to business assets and liability, companies and trusts have distinct characteristics that can significantly impact your business operations and financial health. A company, being a separate legal entity, means that its assets and liabilities are distinct from those of its shareholders and directors. This separation provides a robust level of asset protection, ensuring that the company’s financial difficulties do not jeopardize the personal assets of its shareholders.
In contrast, a trust operates as a fiduciary relationship where the trustee holds assets on behalf of the beneficiaries. The trust assets are not owned by the trustee but are held for the benefit of the beneficiaries. This arrangement offers a different kind of asset protection, as the trust assets are safeguarded from the personal financial issues of the beneficiaries.
Regarding liability, companies generally offer more protection. Companies can be sued and held liable for their debts and obligations as separate legal entities. Still, this liability does not extend to the personal assets of the shareholders and directors. This limited liability is a significant advantage of the company business structure, making it an attractive option for high-risk ventures.
Trusts, however, provide a different level of liability protection. The trustee can be personally liable for the trust’s debts and obligations, although this risk can be mitigated by appointing a corporate trustee. A corporate trustee, being a company, benefits from the same limited liability protections, thus enhancing the overall asset protection of the trust.
In summary, choosing between a company and a trust will depend on your specific needs and goals. Companies offer robust asset protection and limited liability, making them suitable for businesses seeking to minimise personal financial risk.
Trusts provide flexible income distribution and significant tax benefits, making them ideal for estate planning and asset protection. Consulting with a lawyer and an accountant is crucial to determining the most appropriate business structure for your unique situation.
Business Structure and Compliance
Compliance requirements are another critical factor when choosing between a trust and a company structure. Companies must adhere to a range of regulatory obligations, including holding annual general meetings, maintaining minutes of directors’ meetings, and complying with various reporting requirements set by the Australian Securities and Investments Commission (ASIC). These requirements ensure transparency and accountability but can add to the administrative burden.
In contrast, trusts have fewer regulatory requirements but still necessitate ongoing management and compliance. For instance, trustees must ensure that the trust deed is adhered to, maintain accurate financial records, and distribute income according to the terms of the trust.
As a separate legal entity, a company structure offers robust asset protection and limits personal liability. However, this also means companies are subject to more complex compliance requirements. While providing flexibility in income distribution and asset protection, trusts may require more intricate management and compliance efforts.
When deciding between a trust and a company, it’s essential to weigh the compliance requirements of each structure. A company structure may be more suitable for businesses seeking a separate legal entity and limited liability. In contrast, a trust structure might be better for those prioritising income distribution and asset protection flexibility.
Business Structure and Growth
The choice of business structure can also influence your company’s growth potential. As a separate legal entity, a company structure can be more attractive to investors and facilitate capital raising. Companies can issue shares to raise capital, providing a straightforward mechanism to fuel business expansion and growth.
In contrast, a trust structure might limit access to capital and growth opportunities. Trusts have different mechanisms for raising capital than companies, which can disadvantage businesses looking to scale quickly. However, trusts offer flexibility in income distribution and asset protection, which can support sustainable growth over the long term.
When considering the growth implications of each business structure, it’s essential to align your choice with your business goals. A company structure may be more suitable for businesses aiming to attract investors and raise capital. In contrast, a trust structure might be better for those seeking flexibility in income distribution and robust asset protection.
In conclusion, the decision between a trust and a company depends on various factors, including tax implications, compliance requirements, and growth opportunities. Carefully considering these factors and seeking professional advice can help you make an informed decision that aligns with your business objectives.
Using a Company as a Corporate Trustee
Using a company as a corporate trustee can benefit both trusts and companies. A corporate trustee is a company that acts as the trustee of a trust, holding assets for the benefit of beneficiaries. This structure can provide asset protection, tax minimisation, and limited liability.
By using a company as a corporate trustee, you can:
- Optimise investments and achieve your goals.
- Protect assets and minimise tax liabilities.
- Provide limited liability and ease of ownership transfer.
- Enjoy greater flexibility in terms of shareholding and ownership.
- Access tax benefits and reduce ongoing operating costs.
It’s essential to consult with an accountant or lawyer to determine the best business structure for your specific needs and goals. They can help you navigate the complexities of trusts and companies and ensure you make an informed decision that suits your business needs.
How to Choose Between Trust vs Company for Your Business Structure
When starting a business, one of the biggest decisions is choosing the right structure. Two popular options are trusts and companies. Each has its pros and cons.
Trusts offer asset protection and potential tax benefits in certain situations. However, they can be complicated to set up and limit operational control.
Companies provide a clearer operational framework and make it easier to raise capital. The trade-offs are more regulatory oversight and double taxation.
To choose between a trust or company structure, consider:
- Asset Protection: If asset protection is your top priority, a trust may be better than a company.
- Tax Implications: Consider each structure’s tax benefits and drawbacks. Trusts can sometimes have tax benefits, and companies can have double taxation. For example, trusts can benefit from a 50% capital gains tax discount on assets held for over 12 months, which is unavailable to companies.
- Operational Control: Companies are generally easier to manage and make decisions. Trusts can involve more complex arrangements that limit direct control.
- Setup: Setting up a company is more straightforward than setting up a trust agreement.
- Fundraising: If you’re raising money from outside investors, a corporate structure is more attractive and familiar to potential backers.
So, it’s up to you to consider what matters most for your business and then seek legal and financial advice.
Key Differences of Trust vs Company At a Glance:
Criteria | Trust | Company |
Legal Status | Not a separate legal entity | Separate legal entity |
Liability | The trustee is liable for debts (limited if corporate trustee) | Limited liability for shareholders |
Taxation | Income taxed in the hands of beneficiaries at their marginal rates; 50% CGT discount available | Company taxed at corporate rate (25-30%); No CGT discount |
Control | Controlled by trustee according to trust deed | Controlled by shareholders and directors |
Ownership | Beneficiaries have an interest in trust assets | Ownership is divided into shares |
Cost | Generally more expensive to establish and maintain | It can be expensive due to registration and reporting requirements |
Compliance | Less stringent reporting obligations | Strict reporting and compliance requirements |
Longevity | Usually limited to 80 years | Perpetual existence |
Asset Protection | Protects assets from beneficiaries’ creditors | Provides asset protection from company debts |
Adding Investors | It is difficult to add unrelated investors | Easier to add new shareholders |
Key Takeaways
Choosing between a trust or company structure isn’t easy because various factors need to be considered carefully.
The advantages of having a private company business structure are:
- being a distinctive legal entity offers asset protection and
- there are various tax benefits, such as lower rates and tax fees on profits.
There are complexities to consider with company business structures, too, such as:
- Directors have particular responsibilities to adhere to,
- comply with all tax regulations put into place by the ATO, such as lodging a company tax return and paying super contributions,
- comply with ASIC regulations, and
- pay various costs.
When considering the company vs trust advantages, here are the benefits of having a trust business structure include:
- trusts limit liability and
- they give you control over the distribution of profits.
The complexities to consider with trust business structures are:
- they can be costly,
- there are responsibilities trustees have to comply to
- a discretionary trust must divide its profits between the beneficiaries each financial year,
- discretionary trusts consisting of non-relatives could cause parties to want to know how much is received instead of the trustee using their discretion for distribution and
- investors prefer working with Pty Ltd Companies.
If you require external help with making your decision, KNS Accountants can provide tax advice and professional guidance. Contact us today, and we’ll make your decision easier.
Disclaimer
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is designed to be a partial source of information and should not be seen as legal or tax advice. You should, where necessary, seek your advice for any legal or tax issues raised in your business affairs.