Choosing a legal structure for your business: Trusts

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This article is useful reading for anyone wishing to set up a company, buying or selling a company. Net Lawman hosts a further two articles on ‘business structures’. These are:

  • Companies: ins and outs
  • Partnerships: ins and outs

Introduction to trusts

A trust is a relationship or association between two or more persons whereby one party holds property on trust for the other. The property could be land, shares, money or personal property. The first party is vested with property. The holder of the property is called the trustee. The other party (for whom the property is held) is called the beneficiary. Trusts may be made expressly in writing or implied from the circumstances. A company, for example, may trade as trustee of a trust.

Accounting and records

Trusts and companies have two different accounting and reporting requirements. The main reason for a trust to keep accounting records is for taxation purposes. Trusts allow for a great deal of flexibility in the distribution of funds and allocating of losses. The way funds are distributed and to whom should be clearly recorded for income tax purposes. Any losses should also be properly recorded for tax deduction purposes.

Contracting

Trusts enter into agreement via the trustee. However, a trustee may only enter into an agreement on behalf of a trust if the trustee has the power to do so under the trust deed.

When entering into an agreement, it is important to ensure that a trustee has the power to enter into an agreement and thereby bind the trust.

Obligations and powers of trustees

The primary obligation of a trustee is to act in the best interests of the beneficiary or beneficiaries under the trust. Sometimes the trust deed will specify other duties and obligations on trustees. Certain powers are also normally given to trustees under the trust deed. Federal legislation allows trustees to:

  • Invest proceeds of the trust
  • Sell, mortgage or lease trust property
  • Take out insurance; and
  • Give advances to beneficiaries out of trust property

Whether these or any other powers are available to a trustee will depend on the type of trust and the provisions within the trust document.

Rights of beneficiaries

A beneficiary is the person who benefits from the trust. This might be a grandchild for example, if a grandparent left them money on their death. A beneficiary has the right to compel a trustee to obey the terms of the trust deed – it is in the beneficiary’s best interests.

If a trust is discretionary - that is, it allows trustees to exercise their own judgment in dealing with trust property - a beneficiary can compel a trustee to act with reasonable care.

Once a beneficiary becomes entitled to a share in the trust property, the trustee must pay them their entitlement. The trust deed may provide additional rights for beneficiaries.

Setting up and terminating a trust

A trust is set up when a person decides to put aside some property for the benefit of another person. The property may be anything, for example money, land or a business.

Trusts do not need to be in writing but usually are. The document which records the trust is called the trust deed. The trust deed will record necessary details such as those of the trustees, beneficiaries and the property under the trust.

A trust ends when its purpose is fulfilled, that is the trust property is completely used up for the benefit of the beneficiaries. Alternatively, a trust can be terminated by the person who set up the trust. Often the trust deed will set out the circumstances in which a trust terminates.

Tax issues

Tax on trusts is determined according to "present entitlement". Simply put, for any income which is received by the trust, if the beneficiary or beneficiaries are entitled to receive that income, they will be taxed on it. If they are not entitled to receive the income then the trustee is taxed.

There are further tax rules which apply to incorporated trusts. Net Lawman advises you should be aware of the effect the Goods and Services Tax may have.

Advantages of a trust

  • Ownership of the business by a corporate trustee provides asset protection and limits liability in relation to the business;
  • Trusts are very flexible for tax purposes. A discretionary trust provides flexibility in relation to the distribution of income and capital gains among beneficiaries. You and your business partners or family members could be the directors and shareholders of the trustee company and could dictate when and where income or capital is distributed;
  • Beneficiaries of a trust are generally not liable for the debts of the trust, unlike sole traders or partners in a partnership;
  • Beneficiaries of a trust pay tax on income they receive from a trust at their own marginal rates;
  • Generally speaking, the eventual sale of any capital assets of a trust (such as your business premises) will attract capital gains tax (CGT) on any positive difference between the cost of the capital asset and the proceeds received on disposal. However, trusts receive a discount on the amount of CGT payable on capital assets which have been held for more than 12 months.

Disadvantages of a trust

  • The costs of establishing a trust are significantly more than for establishing sole traders and partnerships;
  • A trust is a complex legal structure, which must be set up by a solicitor or accountant;
  • Operation of the business is limited to the conditions outlined in the trust deed;
  • As with a company, there are extensive regulations with which a trust must comply;
  • Losses derived in a trust are not distributable and cannot be offset by beneficiaries against other income they may have;
  • Unlike a company, a trust cannot retain profits for expansion without being subject to penalty rates of tax.

Please note that the information provided on this page:

  • Does not provide a complete or authoritative statement of the law;
  • Does not constitute legal advice by Net Lawman;
  • Does not create a contractual relationship;
  • Does not form part of any other advice, whether paid or free.
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