Choosing the right business structure part 3 – Trusts

Business Structures: Part 3- Trusts

When setting up a business, it’s important to consider the structure of the business right from the start, as it will have ownership, tax and legal obligations. Your chosen structure must also be able to support your long-term business goals.

There are 4 common business structures in Australia, which include:

• Sole Trader
• Partnership
• Trust
• Company

In this series of articles, we have already covered off the Sole Trader and Partnership structures.  This article will cover the structure of Trusts, as well as the main benefits, disadvantages and tax implications. If you’re wondering which is the right structure for your particular circumstances, talk to one of our registered tax agents.

What is a Trust?

A trust is one of the more complex business structures that provides more flexibility than those we have already covered off to date. In a trust, an individual or company holds trust assets either in their own name, or in its own name to benefit a group of beneficiaries. Beneficiaries can either be a group of people, or entities.

Trusts are usually created for tax planning, estate planning or asset protection. The flexibility to distribute income and assets, and the income tax savings make this an attractive business structure.

For a trust to be established, the following criteria must be fulfilled.

• The Trustee- the titleholder who is obligated to deal with the property on behalf of the beneficiary or object of the trust
• Trust property – which must be identifiable and capable of being held on trust

If a trust is set up to run a business, it will normally have a trust deed that sets out the powers of the trustees and interests of the beneficiaries in the trust.

Types of trusts

There are many types of trusts outlined below. The most popular one being discretionary and unit trusts.

• Discretionary trust -The trustee can use their discretion to distribute the net income amongst beneficiaries. Good to use when the taxpayer wants flexibility in distributing income and capital to different beneficiaries to lower the overall tax rate. A popular option for small family trusts.
• Unit trust – This is a fixed trust, with all beneficiaries holding units in the trust. The income generated is distributed among beneficiaries in proportion to the number of units held. Different classes of units may have different rights or entitlements, such as voting rights, share of income or preferential rights to interests or income. A popular option amongst public offer managed funds
• Fixed trust – the beneficiary’s share in the trust estate is fixed by the trust deed
• Bare Trust – A basic form of trust fund with no trust deed in place. The trustee holds the trust property with no discretionary powers. A common example is a parent holding a bank account for a minor
• Superannuation funds- These all operate under a trust structure

The trust is managed by the trustee who is bound by equitable fiduciary duties, by the provisions of the trust deed and the Trustee Act of each state and territory.

A trust does not pay income tax on profits, provided the profits have been distributed fully to the beneficiaries in that financial year.

Advantages of trusts

• A discretionary trust provides protection of assets and limits all liabilities of a business
• The control of an asset is separated from the owner of the asset, so can be useful in protecting the income or assets of a minor or family unit.
• Beneficiaries are generally not liable for trust debts unlike the other 2 structures of sole trader and partnerships
• Discretionary trusts provide flexibility in the distribution of income and capital gains amongst its beneficiaries
• Tax is paid by beneficiaries at their own marginal tax rates
• The CGT small business concession and 50% CGT discount for sale of assets held by trust is available

Disadvantages of trusts

• A trust is significantly more expensive to establish when compared to a sole trader or partnership structure
• A complex legal structure that must be set up by a legal or accounting professional
• Strict obligations are in place for the trustee to hold and manage property for the benefit of beneficiaries
• The trust deed limits the operation of the business
• Losses are not distributable and can’t be offset by beneficiaries against other income they have
• The trust must comply with extensive regulations
• A trust cannot retain profits for expansion without penalty rates of tax

Key tax obligations of a trust

• A trust must have its own TFN
• A trust must lodge an annual trust tax return, which will include a statement on how income was distributed
• A trust must apply for an ABN
• A trust must register for GST if it has an annual GST turnover of $75,000, provides taxi, limousine or ride sourcing services or want to claim fuel tax credits.
• May be required to lodge BAS
• Must pay super for eligible employees

Trusts are complex to set up and administer when compared to sole traders and partnership structures, however they afford more flexibility and control over the simpler business structures. It’s important to have a trust set up correctly, so if this is something you are interested in, please get in touch. Check back in next week to see the advantages and disadvantages of a company.