A trust is an obligation imposed on a person (a trustee) to hold property or assets (such as business assets) for the benefit of others, known as beneficiaries. A Solicitor draws up a Trust Deed setting out the rules of the trust and formalises its administration.
The two main types of trusts are Discretionary and Unit Trusts. A Discretionary trusts deed gives discretion to the Trustee as to who in the family group can receive capital and income from the Trust. In a Unit Trust, distributions are calculated by the number of units owned by the beneficiaries.
Trusts can be used to own property, Cash and Share Holdings and in some cases are used as a legal means to move profits from one business to another entity for asset protection. A Trust can also be used to run your business.
It’s important to understand the relationship between the Trust and the Trustee. Unlike a company, a trust isn’t a separate legal entity. The Trustee of the trust is the legal entity who owns the assets and enters into contract of the trust’s behalf. It is the Trustee that can be sued, and it can use the trust’s assets to meet those debts before having to use their own. It is quite common to see a company act as Trustee to limit exposure for this reason. The Trustee is the legal owner of the trust assets, however it own’s them on behalf of the trust.
So why would you set up a trust to run your business?
- Reduced Liability especially if a corporate trustee.
- Assets are protected.
- Flexibility of asset and income distribution. (Mum and Dad, Mum stops work, variable incomes, adult children, self funded retiree parents)
While a Trustee can pay tax on any profits, it is very uncommon and in most instances with a Discretionary trust the trustee will distribute all the profit each year and beneficiaries are required to pay tax on their share of income from the trust. Where two or more independent people or families are involved, a discretionary trust is uncommon and less appropriate as the trustees discretion means that there is no fixed distributions to beneficiaries. A Unit trust is a more appropriate structure in this situation as it fixes the income entitlements by the number of units held.
Some disadvantages to running your business out of a trusts is:
- Can be expensive and complex to establish and administer
- Difficult to dissolve and dismantle or make changes once established, All can be done, just more cost
- Can’t distribute losses.
- Financial Institutions can find it harder to understand the intricacies of the a trust and therefore it can be more difficult to get loans for assets acquisition both personally or for the trust.
- Retained profits – Beneficiaries get a tax bill and ask so I earnt 100K, but where is the money.
- 80 year vesting period.
A Trustee must apply for a TFN and lodge annual tax return for the trust. For a Unit Trust we would suggest a unit holders agreement be done which sets out unit holders rights and valuation methods should they wish to leave the unit trust.
To learn about the other business structures available in Australia click the links below.
Selecting a business structure is one of the key decisions to make when starting a business. The structure that you choose will depend on the size and type of business, your personal circumstances and how much you plan to grow the business in the future.
Find out about the 4 main business structures below.
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