As a business owner, an important decision is whether to structure your business as a company or a trust, as what you decide will have significant financial and legal consequences.
The business structure you choose will directly influence tax, personal liability, and the costs involved. Therefore, it pays to carefully consider the immediate consequences of each choice for your business but also for the future company vision and objectives.
We have made the comparison between the two options to help you determine which is best suited to your circumstances, to make your decision easier.
What Is a Company Structure?
A company is a separate legal entity within its own right. It is owned by a shareholder, controlled by a director and often operated by a manager.
The rights and responsibilities of shareholders are indicated in the shareholders’ agreement and directors are bound to specific legal duties.
Because a company is a separate legal entity, it can keep existing independent of the directors or shareholders. Therefore, companies have perpetual existence without being limited to the statutory time limit of 80 years that affects trusts.
How Being a Separate Legal Entity Offers Asset Protection
Because a company is a distinct legal entity, its profits and debts are not tied to the financials of the shareholders.
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 are generally subject to lower tax fees on profits than an individual. A sole trader is liable to pay their business tax from their individual income, 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 concession of 50% discount when capital gains occur. However, they do apply to eligible small businesses.
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 are required to 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 put into place by the Australian Taxation Office.
- The Australian Securities and Investments Commission (ASIC) has requirements for companies to keep financial records and notify ASIC of any key changes within the company.
- There are initial formation costs and continuous ongoing costs thereafter that companies need to account for. 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 $267.
What is a Trust and What Are Its Key Features?
A trust is a legal binding where a person or entity holds property for the advantage of beneficiaries. Trusts are seen as taxpayer entities for tax administration.
When a trust runs a business, the trust will nominate 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.
A unit trust allows the trustee no discretion. Instead, the trust property is divided into units called fixed and quantifiable parts. Beneficiaries subscribe units the same way shareholders subscribe to shares in a company.
How a Trust Limits Liability
Operating a business through a trust results in having your liability limited.
While a trust’s debts don’t create a liability for the beneficiaries, a trustee can be personally liable for debt. Using a trustee that is a company (corporate trustee) can limit the liability.
And, 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 of the distribution process, whereas a company can’t do that.
Why Establishing a Trust Business Structures Can Be Complex
A trust is a complex business structure because:
- they can become costly. A trust deed must be created to establish a trust, 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 is required to 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 is required to divide its profits between the beneficiaries each financial year. If this isn’t done, the trustee will have to pay the undistributed profits 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 a shareholder than a beneficiary of a trust.
Choosing between a trust or company structure isn’t an easy decision because there are various factors involved that 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 lower 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 lodge a company tax return and pay 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 guide you from a professional standpoint. Contact us today, and we’ll make your decision easier.
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 not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.