Aug 17, 2015

Starting a Business: Company vs. Unit Trust

Traditionally, the formation and use of trusts has had the practical effect of providing an alternative or filling a gap in an otherwise functional yet imperfect arrangement. In medieval England the legal system operated under the common law on the basis of writs.

If someone wanted to make a claim against another, it had to be achieved by invoking a writ, or more familiarly, a cause of action. If a proposed claim fell outside of the acknowledged writs, well, you were “s*** outta luck”.

At the same time in the ye olde feudal network, a need arose to have someone hold the legal title of property (trustee) for the benefit or future title of another (beneficiary). Of course, absent a writ to enforce this fair but confusing logic, recourse was naturally sought via the King of England, or rather his representative, the Lord Chancellor. To cut a long story short, through the Courts of Chancery, a new branch of law developed, aptly named Equity, to govern all things ‘trusts’.

Today, trusts are popularly utilised as a wealth management tool for families, investment, superannuation and as a business structure.

In the past we have published a comparative post evaluating the differences between sole trader and company operations. At a largely more analogous or parallel level, however, are the company and unit trust options. Both are viable legal structures for your business activities. They each have their own advantages and disadvantages with regards to regulation, taxation, liability and overall maintenance.

It is important to bear in mind your intention for creating a business, what you hope to achieve and why, as you research the most suitable structure for your own circumstances.

What is a company?

A company is a legal entity in its own right, created for the purpose of carrying out business activities or for use as a corporate trustee.

Company creation and maintenance is highly regulated. It must be registered through ASIC, to where any changes to company details must also be lodged. It is subject to the Corporations Act 2001 (Cth) and further, must abide by obligations arising from the company constitution and/or replaceable rules.

Proprietary limited companies, such that we register, must have at least one director and one shareholder at first instance. A public officer should also be nominated as a point of contact for the ATO within three months of the company undertaking business activity, though the appointment of a secretary is optional.

A company can exist forever, provided that ASIC’s annual review fees are paid and the company remains solvent.

Though used predominantly for business practices rather than investment, a company can make a profit. This profit can be held and invested by the company and does not require distribution between shareholders at the end of each financial year, as is the case with unit trusts.

A highly attractive feature of the company structure is the limited liability for directors and shareholders. As a legal entity a company can sue and be sued. If held liable for wrongdoing or the repayment of debt, the personal wealth and assets of shareholders are not affected. On that note, a shareholder does not have a direct interest in the company’s assets. When a shareholder exits a company, it is the shares that transfer to another holder, not the physical asset.

The control of a company rests in the hands of its directors. As well as ensuring legal compliance by way of keeping books and records up-to-date and trading only when solvent, a director has a fiduciary obligation to act in the best interests of the company. This includes carrying out duties in good faith, not taking improper advantage of the position or inside information for personal gain and using the same care and skill as a reasonable person in the same position.

The income tax rate for companies is set at 30%, far less than the maximum threshold for individuals, which currently sits around the 46.5% mark.

What is a unit trust?

A unit trust is a sound alternative to a company when creating a legal structure for business activities. In this type of trust unit holders accept or apply for units in the trust in a similar sense to shareholders obtaining shares in a company. A unit holder may contribute to the trust property, which is held and often invested by the trustee on behalf of the unit holders.

A unit trust is created via private agreement, not through a government regulatory authority such as ASIC. Trusts are far less regulated than companies and can be less costly to create and administer, provided that nothing goes wrong. Changes to a trust deed, rather than conforming to ASIC protocol, can be made via a deed of amendment enacted by a legal professional. Of course these alterations must be procedurally consistent with the existing trust deed to avoid the creation of an entirely new trust relationship in the process.

A trust is not a separate legal entity in itself and therefore, cannot make a profit. At the end of each financial year income must be distributed to unit holders proportionate to the amount of units held. The trustee has no discretion in this arrangement and must disseminate funds based on the unit holding structure, which is fixed. This regular disbursal results in a 50% discount on Capital Gains Tax (CGT). Income tax is payable on an individual basis, assessed on the personal tax rate of each unit holder, or the corporate tax rate if a unit holder is a company.

The trustee maintains extensive powers of investment and can be held personally liable for any debt incurred by the trust, yet can also be indemnified for expenses from the trust property. The relationship between the trustee and beneficiaries, or unit holders is recognised as fiduciary in nature, creating an obligation on the part of the trustee to avoid conflicts of interest and not to profit from their role as trustee.

A trust cannot live forever. Where a vesting date has not been set, nor the trust formally terminated, it will cease to exist after 80 years, pursuant to the _Rule Against Perpetuitie_s, operating in all Australian States except South Australia.

On that note, a trust is much easier to wind up than a company. It must be carried out in accordance with the trust deed, by consent of all parties to the trust, once the trust property has been properly dispensed and tax obligations have been met, such as CGT and Stamp Duty payments.

Unit holders must be aware of the high liability and very limited asset protection offered by the unit trust structure. Since unit holders have a proprietary interest in the trust assets, in the event that a unit holder becomes bankrupt, these assets may be sold to make repayments. Similarly, if a corporate trustee becomes insolvent and there is insufficient trust property to satisfy a third party creditor, the creditor may elect to trace a claim against the unit holders. In this way, a unit trust is only as good as its management.

This information is of a general nature only and does not constitute professional advice. You must seek professional advice in relation to your particular circumstances before acting.

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