When choosing the best way to structure your business, several options are available to you – a sole trader, partnership, company, or trust.  Importantly, there are legal and taxation requirements to consider. In particular, running your business through a trust can be advantageous fortaxation purposes and asset protection.

This article explores the key aspects of two types of trust you could use to run your business:

1. unit trust; and

2. discretionary trust.

What is a Trust?

A trust is a type of relationship where one party manages property for another party’s benefit. A trust is generally governed by a trust deed. This document details the conditions, terms, and rules for creating and managing a trust. It will usually list the fund’s objectives and identify the key players to a trust.

There are four key_players to a trust, namely the:

1. appointer, who is in charge of appointing and removing trustees under the trust deed. The appointer does not have control over the day-to-day running of the trust.

2. Settlor, who is responsible for setting up the trust. The settlor names the appointer, trustee and beneficiary and places property into the trust. Generally, the settlor has no further involvement in the trust after the initial settlement.

3. trustee, who is the legal owner (but not the beneficial owner) of the trust’s assets. They can either be an individual or corporate entity responsible for managing the trust and distributing its income or assets according to the trust deed.

4. beneficiary, who is the beneficial owner of the trust’s assets, who enjoys the benefit of the trust’s income or capital.

Likewise, it is possible to own and run a business through a trust. This structure is an excellent way to safeguard particular assets and take advantage of tax benefits. However, consider the two different types of trusts before deciding to run your business through a trust.

1. Unit Trust

A unit trust is a type of fixed, express trust. Notably, the trust property is divided into defined shares called ‘units.’ Beneficiaries subscribe to these units in a similar way to the way in which shareholders subscribe to shares in a company. The trustee will then distribute money or property to beneficiaries (unitholders) in fixed proportions according to the units that they hold. Ultimately, unit trusts give the beneficiaries certainty.

For example, if you have two unitholders who each own 50% of the units, they each receive 50% of the distribution.

Remember, a trust is not a separate legal entity, unlike a company. Therefore, it cannot make a profit. So, at the end of each financial year, a trust must distribute its income to unitholders (limited to the proportion of units they hold). Indeed, this proportionate amount is fixed with no room for discretion. Further, income tax will be payable on an individual basis. This means that the amount of tax paid depends on each unitholder’s personal tax rate. This can also be a corporate tax rate if a unitholder is a company.

If a trustee fails to distribute the accumulated profit, they must pay tax on any undistributed income at the highest marginal rate.

2. Discretionary Trust

A discretionary trust is a different type of express trust. As the name suggests, the trustee has the flexibility and discretion to manage the trust’s assets. The trustee can choose which beneficiaries will receive distributions and to what extent (if any).

For example, if you have two beneficiaries, you do not have to distribute 50% to each. The trustee can pay one beneficiary 10% and the other 90%.Likewise, these percentages can change each time there is a distribution. Discretionary trusts are commonly used to distribute a family’s assets or to conduct a family business. Accordingly, they are also known as ‘family trusts.“

Additionally, the flexibility of discretionary trusts allows the trustee to consider the tax attributes of the various beneficiaries from year to year. As such, they can then determine where to distribute the trust income in the most tax-effective manner.

Can I Run My Business Through a Trust?

Yes. Notably, it is more common for sole traders or members of the same family to run their business through a discretionary trust. However, if you are looking to enter business with two or more people, perhaps not from the same family, a unit trust may be more ideal. As stated, trust income and assets are divided into defined units, giving each unitholder entitlements to receive their fair (and proportionate) share of business profits.

If you are running a business through a trust, you will need to apply for an Australian Business Number and a Tax File Number for the trust. You should also consider whether you are required to register for GST and PAYG.

In a trust structure, beneficiaries do not own the trust assets. So, suppose a beneficiary is a corporate entity that deals with third parties like creditors. If this business were to land in financial trouble, the creditors could not touch assets held on trust or order the business to sell those assets to repay a debt. Therefore, there is scope for protection from a beneficiary’s third-party creditors.

However, in a unit trust, if a person becomes bankrupt, their units will be treated the same way as any other asset and can be available to a creditor or trustee in bankruptcy.

Since trustees can distribute income according to their discretion, they can be especially selective. They may choose to distribute more assets to beneficiaries who fall within the lowest marginal tax rates to minimise the aggregate tax beneficiaries pay. Ultimately, the trust’s beneficiaries pay tax on income they receive at their own marginal rate. Management Likewise, a trust does not need to pay tax. A trustee can sell an asset that has been held on trust for over 12 months, making the trustee eligible for a 50% discount on any capital gains made. This applies where the potential beneficiaries are all individuals (not companies). Companies receive no such exemption.

A trust is set up with the intention that beneficiaries will receive an interest in the trust’s assets.

Advantages of a Trust

• Asset Protection – In a trust structure, beneficiaries do not own the trust assets. So, suppose a beneficiary is a corporate entity that deals with third parties like creditors. If this business were to land in financial trouble, the creditors could not touch assets held on trust or order the business to sell those assets to repay a debt. Therefore, there is scope for protection from beneficiary’s third-party creditors. However, in a unit trust, if a person becomes bankrupt, their units will be treated the same way as any other asset and can be available to a creditor or trustee in bankruptcy.
• Tax Management – Since trustees can distribute income according to their discretion, they can be especially selective. They may choose to distribute more assets to beneficiaries who fall within the lowest marginal tax rates to minimise the aggregate tax beneficiaries pay. Ultimately, the trust’s beneficiaries pay tax on income they receive at their own marginal rate. Likewise, a trust does not need to pay tax. A trustee can sell an asset that has been held on trust for over 12 months, making the trustee eligible for a 50% discount on any capital gains made. This applies where the potential beneficiaries are all individuals (not companies). Companies receive no such exemption.
• Beneficiary Income – A trust is set up with the intention that beneficiaries will receive an interest in the trust’s assets.

Disadvantages of a Trust

• Setup Costs – A trust structure is more expensive and complex to establish and maintain than a company structure. This may be challenging for a small business to maintain.
• Liability of Trustees – Trustees can be personally liable for the trust’s debts (subject to the trust deed providing that the trust’s assets indemnify the trustee). The law also imposes trustees with fiduciary duties towards beneficiaries. Fiduciary duties involve a trustee acting in the best interests of the beneficiaries when managing trust assets, and placing the beneficiary’s interests above their own. Failure to do so can lead to legal consequences.
• Growth and Investment – As mentioned, a trustee must distribute any profit or income from the trust to beneficiaries each financial year. Therefore, the lack of working capital can make it difficult to grow as a business. In this case, running your business as a company may be more appropriate.

Key Takeaways

There are many ways you can run your business, one of which is through a trust structure. Notably, you have the option of choosing between a unit trust or discretionary trust. A unit trust is a fixed type of trust where income is distributed according to each beneficiary’s proportionate interest, i.e. how many ‘units’ they hold. A discretionary trust gives the trustee the flexibility to choose how to manage and distribute the trust property.

Running your business through a trust offers advantages like asset protection, tax management, and beneficiary income. However, there are disadvantages to consider, like setup costs, the liability of trustees and limited options for growth.