Trust vs Company Structure: Which is Best for Your Australian Business?

Choosing the right business structure — trust vs company structure — is a pivotal decision that can significantly impact your business’s operations, tax obligations, liability, and growth potential.

This blog post will discuss the difference between a trust and a company to help you determine which is best suited for your business needs.

Understanding Trusts

A trust is a legal arrangement where a trustee holds and manages assets for the benefit of beneficiaries. Trusts are commonly used for family businesses, estate planning, and protecting assets.

Types of Trusts in Australia

1. Discretionary Trust (Family Trust): The trustee has the discretion to distribute income and capital among the beneficiaries as they see fit.
2. Unit Trust: Beneficiaries hold fixed units, similar to shares in a company, and income is distributed according to the number of units held.
3. Hybrid Trust: Combines elements of both discretionary and unit trusts, offering flexibility in income distribution and fixed entitlements.

Advantages of a Trust

1. Flexibility in Income Distribution: Trusts allow income to be distributed in a tax-efficient manner to beneficiaries in lower tax brackets, potentially reducing the overall tax burden.
2. Asset Protection: Assets held in a trust are generally protected from creditors. This can be particularly relevant for business owners who want to separate their personal legal identity from the business.
3. Estate Planning: Trusts are effective for estate planning, ensuring assets are managed and distributed according to the grantor’s wishes.

Disadvantages of a Trust

1. Complexity and Cost: Setting up and maintaining a trust can be complex and costly, requiring professional advice and ongoing administration.
2. Limited Liability: Unlike companies, trusts do not provide limited liability protection for trustees unless a corporate trustee is used.
3. Taxation Issues: Trusts can be subject to high marginal tax rates if income is not distributed to beneficiaries.

Understanding Companies

A company is a separate legal entity from its owners (shareholders) and is governed by the Corporations Act 2001. The most common types of companies in Australia are private companies (Pty Ltd).

Advantages of a Company

1. Limited Liability and Access to Capital: A company is a separate legal entity from its owners (shareholders) and offers limited liability protection for shareholders. This structure is also better suited for businesses with a million-dollar net business asset value, as it facilitates easier access to capital through issuing shares.
2. Access to Capital: Companies can raise capital by issuing shares, making it easier to finance growth and attract investors.
3. Perpetual Succession: Companies continue to exist even if ownership changes, providing stability and continuity.
4. Tax Advantages: Companies benefit from a lower corporate tax rate (25% for base rate entities with turnover under $50 million as of 2024) and can retain earnings at this lower rate for reinvestment.

Disadvantages of a Company

1. Complex Formation and Compliance: Establishing a company involves more paperwork, higher setup costs, and ongoing compliance with regulatory requirements.
2. Double Taxation: Profits can be taxed at both the corporate level and when distributed as dividends to shareholders, though franking credits can offset this.
3. Less Control for Owners: Shareholders may have less direct control over business operations compared to trustees in a trust.

Trust vs Company Structure: Key Differences

1. Liability Protection

• Trust: Limited liability for trustees is not inherent and usually requires a corporate trustee.
• Company: Offers limited liability protection for shareholders.

2. Taxation

• Trust: Income can be distributed to beneficiaries, who are then taxed at their marginal tax rates. That said, trusts can help minimise overall tax liabilities by distributing income to beneficiaries in lower tax brackets. However, if income is not distributed and accumulates within the trust, it can incur increased tax rates.
• Company: Pays corporate tax on profits, with potential double taxation on dividends, though franking credits are available.

3. Flexibility

• Trust: Highly flexible in income distribution and asset management.
• Company: Less flexible in profit distribution but offers more structured governance.

4. Regulatory Requirements

• Trust: Fewer regulatory requirements but can be complex to manage.
• Company: More stringent regulatory and reporting requirements.

5. Estate Planning and Asset Protection

• Trust: Excellent for estate planning and asset protection.
• Company: Provides continuity but is less effective for asset protection compared to trusts.

Trust or Company Structure? Choosing the Right Structure

When deciding between a trust and a company, consider the following factors:

1. Business Goals and Objectives

• Trust: Ideal for asset protection, estate planning, and income distribution flexibility.
• Company: Suitable for businesses aiming for growth, investment, and limited liability protection.

2. Tax Considerations

• Trust: Beneficial for distributing income to lower tax bracket beneficiaries.
• Company: Advantageous for retaining earnings at a lower corporate tax rate and reinvesting profits.

3. Complexity and Cost

• Trust: Involves higher setup and maintenance costs, requiring professional advice.
• Company: Higher initial setup costs and ongoing compliance but offers clear liability protection.

4. Risk and Liability

• Trust: Offers asset protection but requires a corporate trustee for limited liability.
• Company: Provides limited liability for shareholders, reducing personal risk.

5. Future Growth and Investment

• Trust: May be limited in raising capital.
• Company: Better suited for businesses seeking external investment and growth opportunities.

Conclusion

Choosing between a trust and a company structure depends on your specific business needs, goals, and personal circumstances. Trusts offer flexibility in income distribution and strong asset protection, making them ideal for family businesses and estate planning. Companies provide limited liability, easier access to capital, and structured governance, making them suitable for growth-oriented businesses.

Consulting with legal and financial professionals is crucial in making an informed decision. They can provide tailored advice based on your unique situation and help you navigate the complexities of Australian business regulations.

For expert guidance on selecting the most suitable business structure and maximizing your business potential, contact Grey Space Advisory today. Our team of experienced professionals is here to support you in making informed decisions that drive your business forward.

Frequently Asked Questions

1. What is the responsibility of a trustee?

A trustee manages and administers assets in a trust for beneficiaries. The trustee’s powers are limited by the trust deed. Key legal and financial responsibilities include:

1. Fiduciary Duty: Act in good faith, with loyalty, avoiding conflicts of interest.
2. Asset Management: Prudently manage and invest trust assets, maintaining detailed records.
3. Compliance: Follow the trust deed, legal, and regulatory requirements, including tax obligations.
4. Impartiality: Treat beneficiaries fairly and resolve conflicts equitably.
5. Communication: Keep beneficiaries informed and provide regular reports.
6. Asset Protection: Safeguard trust assets and ensure proper insurance is in place.

Trustees must understand their duties and seek professional advice when necessary to fulfil their role effectively.

2. Does the capital gains tax (CGT) discount apply to trusts?

Yes, the CGT discount does apply to trusts in Australia. Here’s a brief overview:

1. Eligibility: Trusts are eligible for a 50% CGT discount on capital gains from assets held for over 12 months.
2. Beneficiary Distribution: The CGT discount is passed on to beneficiaries when the capital gain is distributed. Beneficiaries can apply the discount to their tax returns.
3. Types of Trusts: The discount applies to various trusts, including discretionary, unit, and hybrid trusts.
4. Conditions: Trusts must comply with the 12-month holding period rule and other ATO regulations to qualify for the discount.

Consult a tax professional to understand how the CGT discount can specifically benefit your trust and its beneficiaries.

3. Who can apply for a tax file number (TFN) in Australia?

In Australia, the following individuals and entities can apply for a Tax File Number (TFN):

1. Australian Residents:
   • Individuals born in Australia.
   • Permanent residents.
   • Individuals with valid visas allowing work rights.
2. Foreign Residents:
   • Individuals planning to work or earn an income in Australia.
   • Individuals applying for an Australian Business Number (ABN).
   • Individuals requiring a TFN for tax purposes, including the lodging of tax returns.
3. Businesses:
   • Companies.
   • Partnerships.
   • Trusts.
   • Superannuation funds.
4. Other Entities:
   • Non-profit organizations.
   • Government bodies.

Applying for a TFN is essential for engaging with the Australian tax system, including lodging tax returns, applying for government benefits, and ensuring correct tax withholding. Applications can be submitted online, via mail, or through certain post offices.