When starting a business, decisions need to be made regarding the most effective business structure. Such a decision must consider the goals, nature and circumstances of the individual business. The four most common structures are sole trader, partnership, company and trust. The last two business structures will be the focus of this article.
The key difference between a company a trust is that a company is an entity created by the law while a trust is an entity created by private agreement. This difference is reflected in their respective regulations, liability and taxation.
Companies are registered through ASIC and are regulated by the Corporations Act 2001 (Cth). As a distinct legal entity, all assets are owned by the company, and shareholders have an interest in the company itself rather than directly in assets owned by the company. This means that a company can hold profits, and this will be taxed separately from the personal income taxes of the shareholders at the company rate of 30%, which is lower than the individual rate. Bear in mind that when profits are later distributed to individual shareholders, they may be taxed again. The difference between the company and individual taxes is either paid or refunded, depending on the individual’s marginal rate.
The directors of a company are responsible for managing the company’s assets, and both directors and shareholders have limited liability, meaning that creditors cannot claim their personal assets. An exception to this is when directors trade while the company is insolvent, they will be directly liable.
Unlike a trust, the company’s assets are not protected. This comes with the advantage that banks are more willing to lend to companies.
Unit trusts are a common alternative to companies. They are created privately by a trust deed and are regulated only by its provisions. Unit trusts can therefore be easier to create and manage, provided legal professionals are involved. With a trust, all the assets remain with the property of the unit holders, with the trustee responsible for managing the assets.
A trustee merely holds property on behalf of its beneficiaries. As a result, it must distribute all income to unit holders at the end of each financial year and income is taxed at the individual rate. Unlike companies, trusts are eligible for the 50% capital gains discount for the sale of assets that were held for more than 12 months.
The trustee has extensive discretion regarding investment and other financial decisions of the trust. The trustee may have personal liability for the trust’s debts, subject to exemptions laid out in the deed or legislation. Unlike a company, the assets held in trust are protected from creditor’s claims. This arrangement may attract unit holders but deter lenders. Commonly, a company is a trustee to afford some protection to the trustee’s personal assets.
Trust deeds cannot exist forever and cease to exist after 80 years. Otherwise, they may be wound up in according to the provisions of the deed.