Like all significant business decisions, deciding between a company vs a trust business structure requires a complete understanding of the advantages and disadvantages of each situation.

Our guide is designed to delve into the pros and cons of both business structures, aiding you in identifying the most appropriate choice for your unique circumstances.

Differences Between Trusts and Companies as Separate Legal Entities

Trusts and companies are distinct in their features, setting them apart as separate legal entities in the realm of business structures:

• A trust is an obligation imposed on a trustee to hold business assets or other property to benefit beneficiaries. At the same time, a company is a separate legal entity that can own assets, incur debts and enter contracts.
• A formal trust deed governs trusts, while companies are regulated by the Corporations Act 2001.
• Beneficiaries of a trust do not own the trust assets, while shareholders own a portion of a company through shares.
• Trusts have a limited lifespan of 80 years, while companies can exist perpetually.

Company Business Structure Advantages

When you incorporate your business, your assets are shielded if the company can’t pay its debts, providing a sense of security. 

There are also tax benefits, with the standard corporate tax rate set at 30%. However, for the 2024/25 financial year, small businesses that are base rate entities with an aggregated turnover of less than $50 million and no more than 80% of their assessable income is passive income is subject to a reduced corporate tax rate of 25%.

Companies are separate legal entities, so they pay their income tax. This means that the business’s profits can remain in the company without paying the owners.

This allows family groups to minimise their tax without paying the highest marginal tax rate, 45%, as individuals.

Pty Ltd Companies are regulated by the Corporation Act of Australia, meaning they follow specific rules and have particular rights for shareholders and creditors. Investors and banks prefer to deal with Pty Ltd companies regarding funding and raising capital as they know their rights and powers are protected.

Other advantages of companies include:

• Limited liability protection for shareholders
• Can retain profits for working capital without distributing to owners
• More accessible to attract investment and financing
• Perpetual existence not limited by an 80-year rule like trusts
• Ownership can be transferred through shares

Company Business Structure Disadvantages

The 50% capital gains discount, unfortunately, does not apply towards companies.

This concession allows for a 50% discount for assets held for more than 12 months or more at the time of sale or when relevant capital gains may occur. This is due to conditions that require you to operate your business as a sole trader, partnership, or family discretionary trust.

Additionally, consider the implications of directorship responsibilities when setting up your company. The Australian Securities and Investment Commission (ASIC) regulates these duties, which should be considered when deciding to establish your business structure.

Other disadvantages of companies include:

• More expensive to establish and maintain with ASIC fees
• Stringent reporting and regulatory requirements
• Profits taxed at corporate rate if retained
• Shareholders have control over critical decisions
• No 50% CGT discount like trusts

Discretionary Trust Business Structure Advantages for Asset Protection

From a tax standpoint, a discretionary trust is one of the most influential business structures.

One of the key benefits of a discretionary trust is its remarkable flexibility in income distribution, empowering you to implement tax-effective strategies. 

A discretionary trust means that business profits can be distributed to a family member(s) so that the lowest possible individual marginal tax rates apply. This may not be evenly distributed and can be changed each time a distribution is made.

A discretionary trust can hold business assets for the benefit of others, such as beneficiaries, providing an additional layer of asset protection and income distribution flexibility.

Discretionary trusts also afford asset protection should your business cease to operate due to its inability to pay its debts.

Creditors of the business do not have any claims against assets that the trust owns. However, creditors directly towards the trust do have claims against these assets.

Additionally, while companies cannot enjoy the capital gains discount concession, discretionary trusts can take advantage of it and pass it on to individual beneficiaries.

Other advantages of trusts include:

• Flexibility to distribute income to beneficiaries in a tax-effective way
• Can access 50% CGT discount, unlike companies
• Can operate with more privacy than companies

Discretionary Trust Business Structure Disadvantages

Trust business structures are a much more complex and expensive process to establish than a company business structure.so 

Any alterations or dissolution of an established trust generally also involves complications, which may result in resettlement and exposure to capital gains tax/stamp duty.

Secondly, a discretionary trust must distribute its profits to beneficiaries each financial year.

Failure to do so results in the trustee paying any undistributed profits at the highest marginal tax rate. This is an issue when the business requires ongoing working capital. A company structure can usually be more appropriate for a business going through a significant growth stage due to lower tax rates on undistributed profits.

Thirdly, discretionary trusts usually involve family members as the parties are comfortable with a trustee having discretion over each beneficiary’s distribution amounts.

If your business is not a family business and operates with independent individuals, these may be less appropriate options. Each party will want to know exactly what will be received rather than the trustee exercising their discretion for distribution.

Lastly, receiving funding is far more difficult if you are looking for outside investment and finance due to the complex structure of a discretionary trust.

Investors prefer to deal with Pty Ltd Companies as they have rights and powers as shareholders. On the other hand, a beneficiary of a trust does not have such perks, and therefore, investors prefer dealing with a Pty Ltd Company vs a trust structure.

Other disadvantages of trusts include:

• Difficult to dissolve or amend without tax consequences
• Must distribute profits each year or pay the highest tax rate
• Trustee powers limited by trust deed
• Losses cannot be distributed to beneficiaries
• 80-year time limit on trust lifespan
• The trustee can be personally liable for trust debts

Discretionary vs Unit Trusts

There are two main types of trusts used for business structures:

1. Discretionary trust: The trustee has discretion on how to distribute income and capital to beneficiaries each year, which allows for tax planning flexibility.

2. Unit trust – beneficiaries are allocated units similar to company shares, which entitle them to a fixed proportion of the trust’s income and capital. There is no discretion on distributions.

Unit trusts with over 20 unitholders may be considered a managed investment scheme subject to additional regulatory requirements.

Factors to Consider When Choosing Business Structure

When deciding between a trust or company business structure, key factors to consider include:

• Asset protection – trusts can provide better protection as beneficiaries don’t own assets
• Complexity and cost to establish and maintain
• Tax effectiveness – trusts allow more flexibility in distributing income
• Ability to distribute income to family members
• Suitability for obtaining investment and financing

Using a Company as a Corporate Trustee

An optimised business structure can involve a company acting as the trustee of a discretionary trust that owns the company’s shares.

This provides a trust’s asset protection and tax benefits while allowing the company to retain profits at a lower corporate tax rate. The company dividends can then be effectively distributed to trust tax beneficiaries.

Holding Company Shares in a Discretionary Trust

Holding the shares of a company in a discretionary trust can provide asset protection, tax planning flexibility and limited liability benefits.

The company operates the business while the discretionary trust owns the shares. This allows profits to be retained in the company at the corporate tax rate, and dividends can be streamed to beneficiaries tax-effectively.

PROS AND CONS OF COMPANY VS TRUSTS IN AUSTRALIA:

Key Takeaways

• Selecting your business structure between a Pty Ltd company vs trust can take time and effort.
• When deciding on the most suitable trust or company structure, it is important to consider your business’s specific needs and goals.
• Each individual business owner’s situation can differ. There is no single best option. What is most suitable is based on the business goals and stage of the business.
• At Box Advisory Services, we always recommend that you consult a relevant accounting advisor to make sure you are making the most suitable decision for your business.
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Disclaimer: 
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is designed to be a partial source of information and should not be seen as legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.