Is it Time for a Company Structure?

Taxation & Revenue

minutes reading time

DATE PUBLISHED: February 6, 2024

key takeaways

  • There are a number of advantages and disadvantages to operating a business through a trust or company.
  • As taxation and compliance issues increase for trusts, a company structure may be more beneficial for business owners.
  • Clients can have the best of both worlds, by utilising a company structure with a trust as its shareholder – obtaining the advantages of both a trust and company structure.

Why Operate a Business in a Trust?

The trust versus company war has been waged between advisers for decades now.

The main – and often quoted - advantages of choosing a trust to operate a business are:

  • Tax flexibility – business income derived by a trust can be distributed to a range of beneficiaries, including those on lower tax rates, to achieve an overall reduction of the taxation liabilities that could otherwise arise in respect of that income. Income is often distributed to a “bucket company”, for example, to take advantage of the 25% corporate tax rate;
  • Asset protection – the assets of a trust are not available to the creditors of any beneficiaries of the trust, and as such should a beneficiary come into misfortune, the assets of the trust cannot be used to satisfy the debts of that beneficiary;
  • Access to general CGT discount on sale – if the business is sold, trusts can take advantage of the general 50% CGT discount to reduce the taxation implications from the sale of the business’ goodwill (and other CGT assets). Companies cannot apply the general discount, so trusts remain attractive business entities for this reason;
  • Privacy – trust details are not publicly searchable (unlike company details), so the structure can offer a level of anonymity or privacy to the business’ underlying owners and controllers.


What Are the Issues That Arise With Operating Businesses in Trusts?

Trustees of trusts must distribute 100% of their taxable income each financial year to avoid punitive taxation. Often, however, the trust does not have 100% of its taxable income available for distribution to the beneficiaries. This can arise for a range of reasons – due to profits being reinvested in business operations, cash flow and working capital requirements, the making of capital loan repayment and disparities between “real” versus “tax” profits.

Where there is not enough cash available to distribute the net profits, “unpaid present entitlements” arise for those beneficiaries who do not receive their full income distribution.

The main advantage of taxation flexibility is quickly becoming a disadvantage of operating a business structure through a trust. The Australian Taxation Office has focused on the distributions of trust, and they have an arsenal of weapons available to them to challenge the distributions of a trust.

In practice, we are seeing the use of section 100A, part IVA, and section 99B to challenge distributions of a trust, which can lead to adverse outcomes for trustees and beneficiaries.

Quite often, beneficiaries have accrued large unpaid present entitlements. It is commonly forgotten that these are actually assets of those individuals. This means that these amounts may be assets available to a creditor and would be considered an asset of an estate.

If these amounts were called in, it has the ability to cripple the operations of the business, as quite often these amounts have been deployed in the business and there is no ability for repayment to occur.

Further, unpaid present entitlements owed to bucket companies can create Division 7A issues. Often, rising Division 7A loan balances coupled with increasing Division 7A interest rates are a tipping point in the desirability of trust structures.

Other disadvantages of trusts include that it can be more difficult to borrow funds from lenders, you cannot distribute trust losses (they are retained in the trust), and a trustee can be personally liable for the debts of a trust (this is a major issue when dealing with individual trustees). Government organisations are also increasingly indicating a preference towards issuing licenses to companies, and not trusts.

The increasing burdensome tax compliance issues in operating in a trust may have shifted the landscape from operating in a trust to a company.

Why Operate a Business in a Company?

There are a number of advantages to operating a business in a company structure. A business (subject to turnover tests) can access the 25% corporate tax rate and retain the profits in the company (without the need to distribute to its shareholders).

The retention of profits allows the profits to be retained by the company to fund working capital and grow the business as desired by its shareholders and directors. Retained profits are only paid out as dividends (usually fully franked) when the funds are required by its shareholders for their own purposes. This eliminates the unpaid present entitlement problem that occurs in trust structures.

As a company is a separate legal entity, it is the company that is liable for the debts of the business and not the shareholders or directors personally. However, there are a number of provisions now that seek to make directors personally liable for certain actions of the company.

If the owners of the business are looking to sell the business or bring in new owners in the future, this can be easily managed and achieved in a company structure.

One of the main disadvantages of operating through a company is that a company does not have access to the capital gains tax concessions. However, the company will be taxed on its capital gains at the corporate tax rate (25% or 30%) – and the long-term benefits presented by having direct access to the corporate tax rate in the intervening years without profit retention and Division 7A obstacles may neutralize the detriment of losing the general discount.

In any event, if the shares in the trading company are owned by individuals or trusts, the general discount would still be available on the sale of the shares in the company.

Best of Both Worlds?

Clients can have the best of both worlds by utilising a corporate structure with a discretionary trust as its shareholder. This allows for effective profit retention in the company without pesky unpaid present entitlements arising and the ability to distribute dividends when declared to the various beneficiaries under a discretionary trust (maintaining that tax flexibility).

By accessing both the corporate tax rate and maintaining taxation flexibility on the distribution of dividends and reducing risks of section 100A and division 7A issues arising due to unpaid present entitlements, is it time to consider moving to a company structure?

How Can the Business Be Restructured Tax and Revenue Effectively?

There are many options available to advisors and clients to move their business operations from a trust to a company in a tax efficient manner. Stay tuned for our next article on 5 ways to restructure from a trust to a company.

Conclusion

In the ever-changing tax landscape and treatment of trusts by the Australian Taxation Office, it may be prudent now to consider whether business operations should be undertaken in a corporate structure.

With the advantages and disadvantages of both, consideration should be given to the ultimate aim of the business owners and the current and future pain points of clients.

There are options available that can provide clients with the best of both worlds. That is, accessing the corporate tax rate and retaining the taxation flexibility of a trust.

Looking at the advantages and disadvantages of a trust and a company, is it now time to move to a company structure?

how can mcw help?

Contact our Taxation & Revenue team if you wish to discuss the best structure pathway for existing business or assets for the multitude of taxes that may apply, including:

(a) duty;

(b) income tax, including capital gains tax;

(c) research and development tax incentives;

(d) payroll tax;

(e) land tax, and

(f) cattle transaction levy.

Our team can also assist with the following areas involved in restructuring:

(a) special construction law advice on builders' licensing implications;

(b) finance law on dealing with financiers and creditors;

(c) property law advice on dealing with leases and transfer of land; and

(d) insolvency law and bankruptcy advice for effectiveness on structure or transfer of assets.

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