In the last few tutorials in this series, we’ve taken a look at two of the four main business structures in Australia – the Sole Trader business structure, and the Partnership business structure. Now it’s time to look at another business structure – the Trust. The main benefit of operating a Trust is that it gives you flexibility in how income is distributed.
Now, If you need a quick recap on what “business structure” actually means (and why it’s legally imperative!), make sure you take a look at one of my previous tutorials. Then, once you’re ready, it’s time to look at Trusts.
But before we go any further, I need to remind you that any information presented on this blog is solely for informational purposes only. I make no guarantee that any of the information on this blog is accurate or complete. I cannot be held responsible for any loss or damage caused by reliance on any of the information or advice provided on this blog. If you are serious about your business, please consult a solicitor, accountant, or business consultant for advice. This blog is NOT LEGAL ADVICE! Any use of the information here is SOLELY at your own risk. For more information about this, please read my disclaimer.
I would also like to make a few more important points before we continue.
Firstly, this tutorial is not about every type of Trust. Trusts are a complicated legal area, and I am not suggesting that everything you need to know about the law of Trusts will be found in this post.
Instead, I will be primarily focusing on using Trusts as part of RUNNING A BUSINESS. So if you’re looking at Trusts for other purposes (eg. family and domestic purposes only, and NOT business), then I encourage you to look elsewhere. Having said that, you still might get some general information here that might apply.
Secondly, this tutorial does not intend to provide a comprehensive outline of the tax benefits of operating your business as a Trust. Tax planning is an area that you REALLY should get expert advice on. Everyone’s circumstances are different. The aim of this tutorial is to simply give you a general idea.
Lastly, I always mention the importance of consulting a lawyer, accountant, or other business consultant when dealing with any sort of business legal issues (hence the disclaimer I have at the start of every one of these types of tutorials). But I must say this – out of all the possible business structures, a Trust is probably the structure you would be REALLY unwise to try setting up without the assistance of a lawyer or other paid advisor.
Why do I say that?
Well, because if you don’t set up a Trust properly, chances are you will accidentally destroy the advantages that Trusts have over other business structures (and you may very well have the Government knocking on your door too …). This will all make more sense by the end of this tutorial, but I REALLY want to reiterate it here. Setting up a Trust without the services of a lawyer is probably going to end up in tears … but at least this tutorial should save you some time and money by giving you an understanding of the way Trusts work, before you go and consult a professional advisor.
What is a Trust?
Trusts are a VERY complex area. Even the basics of it can be difficult to understand. So we’ll break it down now, and try to simplify it as much as possible.
Basically, a trust is a LEGAL RELATIONSHIP between one person and another person (or persons). The first person is called “the Trustee”, while the second person is called “the Beneficiary” (or “Beneficiaries” if there are more than one). The Trust is set up by a person called “the Settlor”.
Don’t you just love legal terms!
So, the TRUSTEE holds and deals with property (eg. this could be assets, income, etc) in a certain way for the benefit of the BENEFICIARIES. Think of the Trustee as a “middleman” in this equation.
Some Trust definitions
Before we continue, let’s briefly define some of these fancy legal terms further:
The Settlor: The person who established the Trust (usually a lawyer, but could also be a close friend). The Settlor should avoid being the Trustee or Beneficiary, otherwise some serious legal questions will be raised!
The Trustee: The person to whom property is conveyed in Trust for another. The Trustee can be a “natural person” (eg. you or me), or a “body corporate” (eg. a Company). The Trustee holds property as the legal owner of it, but the Trustee holds the property for the ultimate benefit of the Beneficiaries.
It is actually fairly common for the Trustee to be a Company (corporate Trustee) for asset protection purposes (more on that later). The additional benefit of having a corporate Trustee is that it allows more than one individual (eg. the directors of a Company) to make decisions about how income/capital is to be divided among the Beneficiaries.
The Beneficiaries: Persons who do not hold the legal title of the property held in trust, but for whose benefit the legal title is held by the Trustee. Note that the Trustee CAN also be a Beneficiary, but CANNOT be the only one (otherwise, again, you will face some serious legal questions!).
A Beneficiary can also be a body corporate (eg. a Company) to provide further taxation benefits.
The Beneficiaries are generally not liable for the debts and liabilities of the Trust.
Legal obligations of a Trustee
There are many laws that govern the way a Trustee MUST behave and perform his/her obligations in a Trust. The law also outlines the “duties” the Trustee owes to the Beneficiaries. These types of duties are called “fiduciary duties”. They are special duties, and they are VERY serious. In many ways, they are also similar to some of the duties you would have as a Company Director or a partner in a Partnership. Basically, what this all means is that you can’t just do what you want!
So as a Trustee, you actually have the following legal obligations and duties (among others):
- to act in good faith
- to avoid conflicts of interest
- to make full disclosure to Beneficiaries
- to not make a secret profit or gain
- to keep proper accounts
- to act in the best interests of the Beneficiaries
The last duty mentioned above really sums up the entire relationship. As a Trustee, your obligation is to place the interests of the Beneficiaries FIRST. Your interests (as a Trustee) are only secondary in this relationship. You MUST remember that.
Additionally, a Trust is usually governed by an instrument (not musical, obviously …) called the Trust Deed. This Deed is a written, legal document (usually created by a lawyer) that outlines how the Trustee must perform their obligations in the specific Trust arrangement that has been set up. So apart from having to act in accordance with various Trust laws and fiduciary duties, as a Trustee you must always operate within the confines of the Trust Deed.
So to set up a Trust, you WILL need a Trust Deed. This legal document will outline the purpose of the Trust, the property involved (eg. assets, income, etc), the rights and obligations of the Trustee and Beneficiaries, the rules within which the Trust must operate, and the way assets and income will be distributed to the Beneficiaries.
Generally speaking, it is probably unwise to consider setting up a Trust Deed without the services of a lawyer. However, there are websites that allow you to create your own Trust Deed through a guided template. Naturally, it is your decision if you choose that sort of option. I haven’t provided any links to such websites here, because I do not wish to be seen to endorse any particular website.
Trusts in business
Okay, so now you know what a Trust is, and you have some basic information about what’s involved. But I’m guessing you’re probably thinking, “what the hell does this have to do with running a business?!”.
On the face of it, it might look like setting up a Trust is completely irrelevant to running a business. But that’s not necessarily true.
Sure, Trusts are often created for other reasons (eg. family Trusts), but Trusts can also be used to carry on a business (or can form part of a more complicated business structure that incorporates a Company structure).
Let’s look back at the equation I mentioned a little earlier:
The Trustee holds and deals with property in a certain way for the benefit of the Beneficiaries.
Let’s replace the word “property” with “assets” or “income” (as an example).
So now we have something like this:
The Trustee holds and deals with assets and distributes income in a certain way for the benefit of the Beneficiaries.
So, realising that, and looking back at some of the definitions earlier (which indicate that the Trustee CAN be ONE of the Beneficiaries), we can see that it’s possible to set up certain beneficial arrangements. For example, you could run a business as the Trustee, and have several family members or business partners (including yourself) as the Beneficiaries of the profits.
Why would you do that, you wonder? What is the point?
We’ll look at advantages shortly (as well as disadvantages …), but primarily it’s important to realise the main benefit of operating a Trust. A Trust gives you flexibility in how income is distributed.
That’s really it.
This means that a Trust gives you the kind of tax planning flexibility that other business structures don’t. A Trust can also provide a form of asset protection (especially if the Trustee is a body corporate instead of a natural person), in that assets and income are technically held for the benefit of the Beneficiaries – which means that they can’t be touched by creditors, etc. HOWEVER, there are some exceptions to that statement. It’s NEVER that black and white!
So a Trustee in this sort of Trust arrangement owns the assets of the business, and carries on the day-to-day business activities on behalf of the Beneficiaries.
Naturally, you can see how there is scope here for misuse, and you can start to see why Trusts aren’t always given a good name. It’s true that many people have abused Trusts and have faced the rather serious legal and financial consequences.
I am by no means suggesting that you even attempt to do something that stupid! But it’s important to realise that many types of Trust arrangements can very easily border on illegality (or, at the very least, they might simply be unethical …). This is why it’s SO crucial to consult a lawyer before you contemplate setting up a Trust.
Advantages of a Trust
Generally speaking (and without looking at any SPECIFIC types of Trust), the advantages tend to be:
- flexibility of asset and income distribution
- asset protection
- easier to transfer assets
- can safeguard certain social security payments for Beneficiaries (did someone say “Trust fund babies”…?)
- reduced liability (especially if the Trustee is a body corporate)
- Trustee retains control of management and assets
- great benefits for family (if they are involved in the Trust – eg. family businesses)
- ability to pass wealth from one generation to another
- taxation (facilitates income-splitting, and other tax minimisation strategies)
Disadvantages of a Trust
Not surprisingly, there are also many disadvantages in using a Trust for your business structure:
- expensive to set up and run (you REALLY should use a lawyer, accountant, etc)
- complicated / complex legal structure
- difficult to make changes to the structure once set up
- compliance and running costs
- can be difficult to close down
- lots of paperwork
- lots of regulations and laws to adhere to
- can’t hold onto profits to “grow” the business, as these will incur penalty tax rates
- can’t distribute losses, only profits
- limited life of Trust Deed
- inflexibility since powers restricted by Trust Deed and the law
The advantages and disadvantages mentioned above can be affected by the TYPE of Trust you select.
Types of Trusts
So to complicate matters further, there are several types of Trusts. For the purposes of this tutorial, we will only look at private Trusts (rather than Public Trusts – such as ones created for charitable purposes, or ones that are listed on the stock exchange, etc).
The most common types of Trusts for business purposes include Discretionary Trusts, Fixed Trusts, and Unit Trusts.
This is also called a “Family Trust”. Primarily, people use a Discretionary Trust for the benefit of their families (and this can, of course, involve scenarios such as family businesses).
The primary feature of a Discretionary Trust is that the Trustee determines which Beneficiaries receive income/capital, when, and how. So there is no fixed entitlement for each and every Beneficiary – only the ones selected by the Trustee. In many ways, this type of Trust can be the best option – as it gives the Trustee flexibility in distributing assets and income.
Of course, the major weakness reveals itself when problems begin to emerge in the family unit!
As the name suggests, in a Fixed Trust the Trustee must distribute assets and income in specified proportions to Beneficiaries strictly in accordance with the terms set out in the Trust Deed. The disadvantage of this, obviously, is that there is no discretion whatsoever in the way the Trustee distributes assets or income.
This can be the best type of Trust for non-family businesses. A Unit Trust is usually used for larger trusts. It has some similarities to shareholders holding shares in a company. But here you have Beneficiaries (instead of shareholders) holding “units” (instead of shares) in the Trust (instead of a Company). All units have a pre-determined value (like shares), so that way those Beneficiaries who hold more units are entitled to a greater (and fixed) share of assets and income.
This type of Trust is an excellent solution if you want to have partners in your business (and especially partners who are NOT your family members). It also provides more flexibility for Beneficiaries to enter and exit the Trust. They can transfer their units to others as easily as a shareholder can transfer their shares in a company.
So, how do I set up a Trust then?
Just like some of the other business structures (particularly the Partnership), you will need an ABN, a Business TFN, and a business name for the Trust. For more information about how to apply for these, see the ABN, Business TFN, and business name sections of the Partnership tutorial in this series.
You will also need to set up a Trust Deed (as mentioned previously).
Additionally, depending on the complexity of your Trust, you will probably be advised to register your actual business separately as a Company, and then set up a Trust to protect assets and distribute income in a certain way.
This probably sounds confusing and complicated – and it is. This is why you really should consult professional advisors if you’re serious about using a Trust in your business.
Should I use a Trust for my business?
Obviously, only you can know that. This tutorial is not intended as a full guide to the features of setting up a Trust for business (or any other purpose, for that matter), but hopefully it gives you some idea as to where to go next.
Your decision whether to structure your business using a Trust will most likely depend on the importance you place on the various items listed in the advantages and disadvantages mentioned earlier. Additionally, a Trust will generally be more useful when you are dealing with large amounts of property and money. Why? Because the following factors then become important:
- asset protection (especially if you have substantial assets that you want to protect)
- tax planning (ie. minimising taxation obligations and taking advantage of existing laws)
These are often the two major reasons for choosing a Trust as your business structure.
Regarding asset protection, you could put your business assets in a Trust for added protection, while running the day-to-day operations as a Company. Yes, this involves two structures, but it’s one that potentially maximises the advantages of both. Trusts can also be used as a vehicle for buying and selling other businesses (because it has tax advantages).
Regarding tax planning, the main advantage of a Trust is that it usually pays no tax itself (especially when it distributes all of its profits to the Beneficiaries each year). But there are always exceptions.
Additionally, a Trust allows the Trustee to take advantage of tax-free thresholds and lower personal tax rates for Beneficiaries. So the Trustee can then distribute assets and profits to family members, and/or other business associates in a way that minimises the amount taxed for everyone. In other words, the profits can be distributed to other members using PRE-tax dollars, rather than POST-tax dollars.
However, the above is an oversimplification of the taxation issues involved in a Trust. This is merely a quick summary. Remember, tax can be very complicated, and especially when you start dealing with things like Capital Gains Tax (CGT), etc. Expert advice from a paid professional is absolutely essential!
As you can imagine, the above features of a Trust are what makes them attractive for some people to use for tax evasion (or even money laundering!) schemes. It might seem like a Trust is a great way to siphon funds to yourself, screw creditors, and minimise your taxation obligations. But unless you want to become an accidental television “star” on the news, I’m hoping that you are thinking of creating a Trust for LEGITIMATE reasons!
There are, no doubt, other reasons (besides asset protection and tax planning) why you might (or might not) want to use a Trust for your business. You need to explore those with a professional paid advisor.
But hopefully this tutorial has served as a useful starting point for you – and it might help you understand what the hell your lawyer is talking about!
What if I don’t want to use a Trust?
The above are the basics of structuring a business as a Trust in Australia. Naturally, it’s important that you also consider the merits of the other three major business structures (and especially if setting up a Trust does not appeal to you – it’s definitely not for everybody!). It’s important that you consider your options carefully.
Additionally, you will usually find that using the Trust option will probably require you to ALSO use a corporate structure too (eg. for the Trustee and/or one of the Beneficiaries). A corporate structure (eg. a Company) always has that added level of protection due to its existence as a separate legal entity. After all, a Trust is only a legal relationship. It is NOT a legal entity.
Either way, remember that selecting a business structure is NOT an optional step if you want to ensure your business has been set up PROPERLY and LEGALLY. Some groundwork now will save you a whole lot of potential headaches in future. Besides, having a business structure makes your business look more professional and reputable.
This concludes my series of tutorials. If you’re interested in other business structures, make sure you check out the Sole Trader tutorial and the Partnership tutorial too. I haven’t written a tutorial specifically for the Company structure, but you can read about that here.
UPDATE: Please note that due to an overwhelming number of email enquiries and blog comments over time, I’ve had to disable all contact methods. I am unable to offer any further assistance or advice. If the above article hasn’t answered all your questions, I encourage you to look through the archived comments below. You’ll find frequently asked questions there. Thanks.