What’s the core legal difference between a family trust and a company?

A company is a separate legal entity that owns assets and enters contracts in its own name. A trust is not a separate legal entity; instead, the trustee holds assets and manages obligations on behalf of the beneficiaries.

How does liability compare between a trust and a company?

A company offers limited liability to its directors and shareholders. In contrast, a trust can expose the trustee to personal liability unless a corporate trustee is used, which offers stronger protection.

How do distributions and retained earnings work in each structure?

Companies can retain profits or pay dividends. Trusts must distribute income to avoid the trustee being taxed at the top marginal rate on undistributed income.

Which structure is better for raising capital?

Companies are generally more suitable for attracting investors and accessing government funding schemes. Trusts are less commonly used for equity investment and may pose complexities for external investors.

Do unit trusts have additional compliance obligations?

Yes. If a unit trust has more than 20 passive investors, it may be deemed a managed investment scheme and be subject to ASIC regulation.

Which structure provides stronger asset protection?

Companies inherently separate business and personal assets. Trusts can offer similar protection when managed with a corporate trustee and a well-drafted trust deed.

When should I consider using both a trust and a company?

Using a company as a corporate trustee of a family trust combines tax flexibility and CGT advantages with stronger asset protection and professional structure for business operations.

Choosing Your Business Structure: Family Trust vs. Company - What Works Best for You?

Q: Which is better for tax planning and capital gains?

Trusts offer flexible income distribution and can access the 50% CGT discount. Companies are taxed at a flat rate (usually 25%) and cannot access the individual CGT discount, but allow profits to be retained or paid as dividends.

Sunnie Doan
Mar 20, 2024
5 min read

Updated: 6 hours ago

Family Trust vs Company: Key Considerations When Choosing the Right Business Structure. Selecting the right business structure involves considering various factors such as asset protection and tax implications. Among the options are operating through a trading trust or a company. This article will explore the key considerations when making this decision.

Understanding Trading Trusts

A trading trust involves a trustee managing business assets and contracts on behalf of the trust, which can be an individual or a company. While a trust isn't a separate legal entity, the trustee assumes responsibility for the trust's operations and debts. Typically, using a corporate trustee can lessen owners' liability.

Exploring Companies

Companies are distinct legal entities from their directors and shareholders, granting them legal rights like individuals. Companies can acquire assets and enter contracts independently, with debts primarily belonging to the company rather than its directors or shareholders.

Factors for Business Owners to Consider:

1. ASSET PROTECTION

Opting to operate your business through a company offers significant asset protection benefits. Directors of a private company limited by shares are protected from the company's debts, given the company's status as a separate legal entity.

As a director, safeguarding against insolvent trading is a priority. Failure to prevent the company from trading while insolvent constitutes a breach of directors' duties, potentially rendering you legally liable for the company's debts during such periods.

Shareholders, however, generally bear no legal responsibility for company debts beyond any unpaid share amounts.

This asset protection advantage can extend to businesses structured as trusts, particularly when using a corporate trustee. Yet, the specifics depend on the terms outlined in the trust deed. Seeking legal counsel during the trust establishment phase is crucial.

If an individual serves as the trustee in a trading trust, personal liability risks emerge. In such cases, the trustee may face personal liability for the trust's debts, possibly leading to the use of personal assets to settle the trust's obligations.

2. CAPITAL GAINS TAX

Operating through a trading trust opens up the possibility of accessing small business capital gains tax (CGT) concessions, subject to specific criteria:

- A $2 million turnover; or

- A $6 million net asset value.

These concessions offer options to reduce, disregard, or defer capital gains from active assets used in small businesses. For instance:

If your business generates a profit from selling an asset, typically, you'd owe CGT on that gain. However, if your business meets the requirements—owning the asset for at least 12 months and being an Australian tax resident—you could qualify for a 50% CGT discount.

Notably, if your business operates as a company, it's ineligible for this discount. In contrast, a trading trust can leverage the 50% CGT discount, potentially providing significant tax advantages.

3. TAX EFFICIENCY

Using a trading discretionary trust often proves to be a highly tax-efficient approach to business management. Profits can be readily distributed among family members and other beneficiaries, allowing for distribution in a manner that minimizes tax obligations, typically at the lowest individual marginal tax rate, subject to specific regulations.

However, the prevalence of trading discretionary trusts is relatively low due to the trustee's discretion in determining distribution proportions, particularly when unrelated beneficiaries are involved.

In contrast, trading unit trusts are more common. In this structure, each investor or owner holds a defined number of units, similar to shares in a company. Consequently, distributions are fixed in proportion to each unitholder's units.

Regarding companies classified as 'base rate entities,' tax obligations are set at a rate of 25%. A company qualifies as a 'base rate entity' if its aggregated turnover for the income year is less than the aggregated turnover threshold for that income year, and 80% or less of its assessable income for that year constitutes base rate entity passive income.

4. WORKING CAPITAL

Companies have the flexibility to retain profits annually and reinvest them into business growth or opt to distribute dividends to shareholders, albeit without any obligation to do so.

In contrast, trusts operate differently regarding tax obligations. Unlike companies, trusts are not subject to corporate tax rates on their net income each fiscal year. Typically, if a trust distributes assets to beneficiaries, any resulting income—such as cash—is taxed at the beneficiary or unitholder level.

However, if your trading trust accrues net income for the year but doesn't distribute it entirely to beneficiaries or unitholders, the trustee becomes liable for tax payments on behalf of the trust. This liability entails taxation at the highest individual marginal rate.

5. INVESTMENT AND FINANCING

Choosing a company structure might be preferable if you anticipate raising capital through equity or debt financing. Investors and institutional lenders tend to favor companies over trusts, perceiving them as more secure investment options.

In addition, as a startup, you may consider your business to:

Qualify as an Early Stage Innovation Company (ESIC)
access Research and Development tax incentives, or
establish an employee share option scheme.

Operating as a company is often the more favorable choice.

6. COMPLIANCE WITH REGULATIONS

If your business operates via a trading unit trust and exceeds 20 unitholders, with these unitholders lacking involvement in daily operations, registering the unit trust as a managed investment scheme becomes mandatory. Failure to register when required incurs fines for the trustee.

FAQs – Family Trust vs. Company Structure

1. What’s the core legal difference?

A company is its own legal entity—owning assets, entering contracts, and bearing debts separately from its directors/shareholders.
A trust isn’t a separate entity—the trustee manages assets and liabilities. Opting for a corporate trustee can add layers of protection.

2. How does liability compare between the two?

In a company, liability is limited to the company’s debts—directors/shareholders generally aren’t personally liable unless illegal trading occurs.
With a trust, especially if an individual is trustee, there could be personal liability for debts. Choosing a corporate trustee is a safer option.

3. Which is better for tax planning and capital gains?

Trusts (e.g. discretionary trusts) offer flexibility in distributing profits to beneficiaries, which can minimize overall tax. Also, they can access the 50% small business CGT discount for qualifying assets.
Companies are taxed at a flat (base‑rate) rate — typically 25% for small businesses — but can’t access that CGT discount.

4. How do distributions and retained earnings differ?

Companies can retain profits for reinvestment or distribute them as dividends—there's no forced distribution.
Trusts must distribute income to beneficiaries, or the trustee is taxed on undistributed income at the highest individual rate.

5. Which structure supports fundraising and investment best?

Companies are generally preferred by investors and lenders, offering clearer equity structures, access to schemes like ESIC or R&D incentives, and the ability to issue shares.
Trusts can be structured for investment, but they’re less familiar to institutional investors and more complex for equity financing.

6. Are there extra compliance obligations for unit trusts?

Yes. If a unit trust has over 20 passive unitholders, it may need to register as a managed investment scheme and comply with associated regulations.

7. Which structure offers stronger asset protection?

Companies provide separation of personal and business assets by default.
Trusts can offer similar protection if a corporate trustee is used—but this depends on how the trust deed is drafted and whether a corporate trustee is in place.

8. When should I consider a hybrid approach?Many businesses employ a company as trustee for a trust. This combines the asset protection and investment-friendly aspects of a company with the tax flexibility and CGT benefits of a trust.

Both trusts and companies offer unique benefits and drawbacks. Seeking professional advice from tax, legal, and accounting experts is crucial in determining the optimal business structure. For personalized assistance, do not hesitate to contact the Lynden Group.