There are many ways to run a business and trusts are a method which offer several benefits for businesses particularly in regard to tax, liability, and management. When compared to other systems such as running a business as a company, trusts do have their downfalls. Businesses vary in nature, therefore, it is vital to understand the impacts each method of managing a business will have. This article will look into the advantages and disadvantages that come with running a business as a trust in order to help a business determine the right method for their needs.
Structure of a Trust
A business that operates through a trust will have a trustee who will own and control the business’s assets at their discretion. They can either be an individual or a corporation.
As it is the trustee that runs and controls the assets, they will be personally liable for any loss. This contrasts running a business as a company as the person operating the company will be a separate legal entity to the company.
A trust deed will also be an important element in this trust as it will set out the obligations upon the trustee as they manage the trust’s assets.
Types of Trusts for a Business
There are two types of trusts to use when running a business. These are:
- Discretionary Trusts: Under these trusts, a trustee has discretion and control over how assets are distributed. Commonly used by family businesses as it allows the trustee to vary the distribution amount each family member (beneficiary) receives.
- Unit trusts: these trusts divide the assets in a trust into fixed amounts called units and the beneficiaries are the unit holders. Allows a company to distribute income from the trust in fixed proportions.
A trust allows for a certain level of protection from liability arising from loss or debt incurred in the course of running a business. However, trusts only provide this security to beneficiaries and it is the trustee that will be personally liable as they control the trust. However, having a corporation as the trustee of a trust should mitigate this burden.
Trusts themselves are not taxable entities and can be the most tax-effective option for businesses. The tax structure of trusts leave the responsibility of paying tax upon the beneficiary. If strategised well, profits from a trust can be distributed to beneficiaries in accordance to their total taxable income in a way that results in the lowest marginal tax rate.
This is advantageous against companies that must pay a flat rate of tax of 27.5% if they have a turnover of less than $50 million and 30% if more.
Trusts will also be able to access a 50% discount off the capital gains tax compared to businesses run as companies.
Running a business through a trust can also be advantageous for asset protection. This is because assets within a trust are separate to assets owned by a beneficiary. Therefore, the trust will be protected from any creditors gathering a beneficiary’s assets to pay off debt. This is particularly useful where a business’s debts would mean that the business can no longer operate, the beneficiary will still remain intact with their external assets.
A downfall of running a business through a trust is that loss cannot be distributed to beneficiaries and must remain in the trust until a profit is made. Additionally, trusts are not meant to keep profits. A trustee will need to distribute profits to beneficiaries by the end of a financial otherwise, these profits will be heavily taxed. If a business is experiencing significant revenue and rapidly growing, running the business as a company may be better as undistributed profits will be subject to a lower tax rate.
Establishing a Trust
A trust is set up through a trust deed which may seem like a simple step. However, the cost to set up and maintain a trust can be significantly more depending on the complexity of the trust.
Trusts do have a mandatory wound up date which is usually around 80 years from its establishment. A trust deed can provide for an earlier date, however, setting your business as a company may be preferable if a person does not wish to be restricted by this time period.
For businesses hoping to get external contributors and outside finance, running the business as a trust may be a limitation as people may be discouraged from investing in the business due to the complex nature of a discretionary trust.
Generally, trusts are better suited to small to medium sized businesses who are seeking to take advantage of its tax benefits. Particularly small family businesses that plan to distribute profits to family members in a manner that reduces the overall tax deduction. However, every business is different and not all are suited for trusts. Therefore, it is essential that research is undertaken to properly understand the risks that come with a trust run business and where possible, seek further professional advice.
If you need assistance with a trust for your business or any commercial legal matter in general, then get in touch with us via the contact form or by calling 1300 337 997.