An important decision a business must make is whether it should structure itself as a company or a trust. This decision has significant legal and financial consequences. For example, your business structure determines your tax, personal liability, and the fees required to be paid. It is valuable to compare and weigh the advantages and disadvantages of both.
Table of Contents
Company
A company is a legal entity. A director controls a company while a shareholder is the owner of a company. A director is bound by the legal duties of a director while the rights and obligations of shareholders are determined by a shareholders’ agreement. The Corporations Act 2001 (Cth) regulates the actions of a company.
Notably, a business may begin as a sole trader or a partnership but later incorporate itself. This decision would require considering the risks, the equity held, the tax considerations, and the investors, as provided in our guide here.
Advantages of Setting Up a Business as a Company
Limited Liability
A company is a distinct legal entity. The profits/debts of a company are not the profits/debts of the shareholders. Therefore, the debts incurred by a company will not create personal liabilities for its shareholders.
Tax
Corporate tax rates are often preferable to individual tax rates. Companies generally pay a lower tax on profits than an individual. For example, a sole trade will pay tax on their business out of their individual income. A company will pay tax separately.
Disadvantages of Setting Up a Business as a Company
Complexity
A company is subject to various legal obligations. Firstly, the Corporations Act creates duties for directors to the company and to the employees. They include a duty to act with care and diligence, to act with good faith, and not to make personal gains from improperly using information or their position as a director. Secondly, the company must comply with the tax and super regulations enforced by the ATO. They include lodging an annual company tax return and paying super guarantee contributions for eligible workers. Thirdly, a company must also comply with ASIC’s information requirements such as keeping financial records and notifying ASIC about key changes within the company. One of our specialists can assist you in navigating through the various legal requirements for registering a company.
Costs
Companies are subject to formation costs and ongoing costs. Formation costs refer to the costs of incorporating a business as a company. They include costs to register a business name, professional advice fees, and legal fees. Ongoing costs include the administrative costs required to comply with legal requirements for a company. For example, the cost to submit personal and company tax returns can be several hundreds of dollars annually. The annual ASIC Review Fee is $267 in 2020 for a private company.
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Trust
A trust is an arrangement where a party (the trustee) is responsible for managing the assets of the trust. The law requires that the trustee acts in favour of others (the beneficiaries) and not itself.
Discretionary vs Unit Trusts
A trust may be a discretionary trust or a unit trust. In a discretionary trust, the trustee has discretion to determine the amount distributed to a beneficiary. Family trusts are usually discretionary trusts. They usually involve a family business or a family’s assets, the parents as trustees, and the children as beneficiaries. A benefit of a family trust is that distributed amounts are taxed at a lower tax rate. In a unit trust, the trustee must distribute the income to the beneficiaries based on the units held by them. Unrelated parties with an interest in a business usually use a unit trust. The parties can raise investment from other investors by issuing additional units in the trust.
Advantages of Setting Up a Business as a Trust
Limited Liability
Similar to a company, a trust limits the liability of operating a business. The debts of a trust do not create a liability for the beneficiaries. However, a trustee can be personally liable for the debts. As a result, trusts often use a corporate trustee (a trustee that is a company) to limit the liability.
Control Over Distribution of Profits
A trust is not a taxable entity unlike a company. Instead, the beneficiaries pay income tax on the profits that the trust distributes to them. A trustee in a discretionary trust has a discretion over the distribution process. This offers a form of control over the distribution of profits. As a result, amounts may be distributed flexibly according to policies relating to tax rates and thresholds. Other business structures like a company, sole trader or a partnership are unable to do that.
Disadvantages of Setting Up a Business as a Trust
Complex and Costly
Similar to companies, trusts are complex business structures. Legal assistance is necessary to create a trust deed in order to create a trust. While this can be expensive, Lawpath offers free templates for a unit trust deed and a discretionary trust deed. Corporate trustees are often used for trusts. This can require incorporating a trustee at a cost.
For a trustee, the trust structure creates legal obligations in favour of the beneficiaries that the trustee must comply with. A trustee’s duties include preserving the trust property, ensuring due diligence and reasonable care, keeping financial records, and providing information when requested.
Conclusion
In conclusion, the structure of a business can have legal and financial consequences for the business. While a company limits the liability of its shareholders, it is also complex and costly to set up. A trust also limits the liabilities for its beneficiaries and can also be complex and costly to set up. However, a discretionary trust allows for a discretion to determine the distribution of profits that a company does not. But, discretionary trusts are usually used where the parties are related. A unit trust is used where the parties are not related.
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