difference between a trust and a company?

Articles > Small Business

What is the difference between a trust and a company?

November 23, 2020         Kristine Tran

Establishing your business with the appropriate business structure can set you up for long-term success. Depending on the size and nature of your business, your business may be suited under a trust, sole trader or company structure. It is therefore essential that you consider these different types of business structures when deciding a particular business structure. Ultimately, this article will outline the key differences between a trust and a company to help you decide which structure is suitable for your business. 

Trust

A relationship between a trustee and the beneficiaries, defined in a trust deed.

Advantages

  • More options for income distribution
  • Can be advantageous for minimising tax
  • Operate the business with more privacy
  • Protects the business from a beneficiary’s bankruptcy

Disadvantages

  • More expensive
  • More complex
  • Complex to dissolve
  • Difficulty with borrowing funds
  • Trustee’s powers are limited by the trust deed
  • Losses cannot be distributed; profits can incur increased tax rates
  • A trust can only exist for 80 years
  • Trustees are personally liable for all debts (although trustee can be a company)

Company

A separate legal entity, controlled by shareholders and operated through managers, directors or agents.

Advantages

  • Limited liability
  • Tax benefits
  • Business can own property in its name
  • Ability to transfer and sell shares

Disadvantages

  • Expensive reporting fees
  • Control of company subject to shareholders
  • Reporting requirements on directors, managers etc

What are the key features of a trust?

When you run your business under a trust, this generally means that the trust owns and operates the assets, distributes the business’ income and must comply with the trust deed obligations. These responsibilities are executed by the trustee who can be an individual or a company. Most importantly, the trustee of the trust is the legal entity who owns the assets and is able to enter into contracts on behalf of the trust’s behalf. 

There are two different types of trusts:

  1. Discretionary trust – The trustee has discretion as to what income or capital can be distributed to which beneficiary.
  2. 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 to shares in a company. 

Advantages of a trust 

Operating your business under a trust allows you to: 

  • Distribute income at your own discretion with the lowest marginal tax rates to minimise the aggregate tax beneficiaries pay
  • Operate the business with more privacy 
  • Protects the business from a beneficiary’s bankruptcy because the beneficiaries do not own the trust assets. However, a unit trust will be treated the same way as any other asset and can be available to a creditor or trustee in bankruptcy. 

Disadvantages of a trust 

However, a key disadvantage of running your business under a trust is that there is a mandatory distribution of income annually. Each financial year, a trust must distribute its profits to the beneficiaries, and failure to do so may cause the trustee to pay tax on any undistributed income at the highest marginal rate. They must also apply for a tax file number and lodge an annual trust return. 

Other disadvantages include: 

  • Trusts are costly to establish  and complex to maintain 
  • Issues may arise when attempting to dissolve or alter an existing trust
  • Difficulty 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
  • A trust can only exist for 80 years
  • Trustees being personally liable for all debts, but if the trustee is a company then they will have limited liability. 

Would a company structure be a better alternative? 

Depending on the nature and scope of the business that you wish to operate, a company may be more suitable if you wish to have limited liability and better tax benefits.

What are the key aspects of a company?

Unlike a trust, a company is a separate legal entity that has a perpetual existence (can last forever) and is not limited by the statutory time limit of 80 years. Companies are controlled by its members and shareholders and operated through managers, directors or agents. This means that the company can continue to exist, regardless of the circumstances that may arise with the directors or shareholders. As explained above, this structure allows the company to be subject to its debts and liabilities, and gives the company the right to retain property in its name. 

Advantages of a Company 

Having a company structure may be super beneficial for businesses that wish to avoid liability and experience tax benefits. This structure also allows the business to retain property in its name. Other key advantages of using this business structure is the ability to transfer and sell shares. 

Disadvantages of a Company 

Despite the advantages, the company structure may have negative implications for your business because:  

  • The reporting fees may be too expensive and can be difficult to maintain 
  • Control of the company may become subject to the shareholders 
  • Reporting requirements are very stringent and thus onerous for directors, managers etc.

How are trusts different to companies?

A 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, as well as a longer life span. While a trust may have lesser tax obligations, a company is generally a more effective structure to generate working capital, especially since trusts are taxed at higher rates when profits are generated. As such, companies are a more appropriate structure if you wish to have capital raising through external parties because investors tend to be more comfortable with a company structure than a trust. 

Lastly

  • Operating a business under a trust can be super beneficial if you wish to distribute income at your discretion, operate the business with more privacy and protect the business from a beneficiary’s bankruptcy. 
  • However, a trust may be difficult and costly to maintain in the long-run, where losses cannot be distributed and there is unlimited liability depending on whether the trustee is a company or not. 
  • Ultimately, a company may be a better alternative to a trust, because it can allow your business to generate working capital that is tax effective. 
  • Furthermore investors are more likely to invest in companies than trusts, and there are greater tax benefits with operating a company. 

As such, whether you decide to operate a trust or company structure, it is essential that you weigh up the pros and cons of each type of business structure. 
If you require legal advice on setting up your business, please contact our team at Open Legal on 1300 337 997.

About Kristine Tran

Kristine is a legal intern at OpenLegal. She is a fifth year UTS law student nearing the final stages of her law degree. She has previously worked for a boutique law firm and volunteered as a paralegal with the Refugee Advice and Casework Services (RACS).