This article series explores the differences between a sole trader, partnership, a company and a trust.
The is the last instalment of a 4 part series on business structures.
The main practical differences between the business structures involve risk, the ability to share pre tax and post tax income, asset protection/legal ownership, WorkCover insurance for owners and how personal super contributions requirements apply. We also need to take into account the ATO’s personal services income rules, anti avoidance and alienation of income provisions.
The key points of this business structure can be described as follows:
Part 4. Trusts
- Trust structures are many and varied and even include Self-Managed Super Funds*.
- A trust is an obligation imposed on a person – a trustee – to hold property or assets (e.g. business assets) for the benefit of others, known as beneficiaries or unit holders. Trusts generally have finite life specified in their trust deeds, say 80 years, unless it is a South Australian trust.
- All Trusts have a trustee which can be a person(s) or a company(ies).
- Where a business operates as a trust, the trustee is legally responsible for the Trust’s operations. As such, if the trustee is a company (recommended), the company is generally used solely for the purpose of acting as Trustee and does not trade in its own right.
- Formal registration and set up process is complex, involves a formal deed and, if there is a corporate trustee, the process involves ASIC.
- In small/micro business, the most common trusts are Discretionary Trusts and Unit Trusts.
- Unit Trusts have unit holders and all profits are distributed to unit holders, in proportion to the class of units held, at least annually.
- Discretionary Trusts have beneficiaries and all profits are distributed to beneficiaries at least annually, at the direction of the Trustee
- The owners can employ themselves and so are covered under the trust’s WorkCover insurance and are subject to the superannuation contribution guarantee requirements and fringe benefit tax provisions.
For unit Trusts, there is certainty that all income will be distributed, which can be important if the parties are unrelated or need certainly.
In all cases, all income is distributed pre-tax and taxed in the hands of the unit holder/beneficiary and included in their respective tax returns
The unitholders / beneficiaries are not personally liable for all the debts incurred by the Trust
The Trustee’s directors / shareholders and unitholders/beneficiaries can be employees of the Trust
A trustee of a trust can be a company which provides some asset protection
Set up costs for a trust with a corporate trustee (recommended) requires the purchase of a company and a trust deed.
Ongoing compliance costs are higher as there are formal yearly administrative tasks for the trustee to undertake.
Onerous reporting and administrative requirements required by law; need to keep accounts for the Company that comply with the accounting standards and the Corporations Act 2001
Things To Watch For
- Trust deeds generally cannot be changed without triggering a “resettlement” and capital gains tax so it is important to set the trust up correctly at the outset.
- Onerous reporting and administrative requirements for discretionary trusts include determining the distribution of all trust income before the end of each financial year. Best practice is the put this resolution in writing and minute the meeting, otherwise penalty tax rates can be applied to the trust’s income.
- If there are significant distributions made to beneficiaries / unitholders and no income tax is withheld, the beneficiaries / unitholders need to be good with managing money so as to not get caught with a large tax bill.
- Personal Services Income (PSI) rules are commonly applied to micro businesses such as contactors and consultants where 80+% of income comes from one source/client/group. In essence, if the PSI rules apply, the trust structure is ignored allowable deductions are stripped back and treated as if the person earning the PSI were an ordinary wages and salary earner.
- Similarly, there is an increasing focus from the ATO on Personal Services Businesses (PSBs) where the income is generally derived from principal professionals e.g. medicos, lawyers, accountants but distributed to non-income producing unitholders / beneficiaries. The ATO’s view is that, particularly where there is a partnership or sole practitioner involved, without professional equivalent staff ratios, this income should be attributed to the person generating the income. Other ATO guidelines and considerations apply and are available on request.
- ASIC issue an Annual Review statement each year, and the directors of the trustee company are required to signed a Solvency/Insolvency Resolution. Additionally, changes of address, officeholders, shareholders etc. need to be notified to ASIC within prescribe periods and failure to do so can result in stiff fines. Fines also apply for not paying renewal fees on time and can lead to the deregistration of the company by ASIC. Penalties and fines are not deductible.
- Standard GST and, if employing staff, PAYG withholding & super obligations apply.
- The directors of the Trustee are personally liable for unpaid PAYE (employee) tax and superannuation and may be liable for other debts incurred by the company if done so while trading insolently.
- Super payments need to received into the superfunds’ bank accounts before 28th January, April, July and October in order for the trust to claim a tax deduction : There are no extensions or exceptions.
- Fringe Benefits Tax rules also apply to employees, directors/shareholders, unitholders/beneficiaries and their associates
* Self-Managed Super Funds are subject to special rules and regulations and are not covered in this article.