Selecting the right business structure is a crucial decision that can greatly influence your business’s success.
Trust vs company are two common choices, each with its unique pros and cons.
This article aims to offer a thorough comparison of these two structures to assist you in making an informed decision when setting up your business.
Key Features of a Trust
A trust is a legal arrangement where a trust owns and operates assets on behalf of the beneficiaries. The key feature of a trust is that the trustee is the legal owner of the assets and has the power to enter contracts and make decisions on behalf of the trust.
The trustee is responsible for managing the trust and ensuring that the assets are used for the benefit of the beneficiaries. They have a fiduciary duty to act in the best interests of the beneficiaries and must make decisions based on this duty.
Pros and Cons of a Trust
Trusts are flexible business structures when it comes to income distribution, but offer less flexibility when bringing in outside partners.
Advantages
Trusts offer a high degree of flexibility in income distribution, allowing you to customise the distribution to your specific circumstances. This flexibility can be particularly beneficial if you aim to provide financial support to nominated individuals or family members.
Trusts also offer potential tax benefits. With careful planning and the appropriate trust structure, you may significantly reduce your business’s tax burden, leading to substantial long-term savings.
Privacy is another advantage of trusts. Trust operations are generally confidential, as they are not required to disclose financial information publicly. This confidentiality can be appealing if you value privacy or wish to keep certain business affairs discreet.
Trusts can also protect your business assets from a beneficiary’s bankruptcy. If a beneficiary becomes bankrupt, the trust’s assets may be shielded from their creditors.
Disadvantages
Despite these advantages, trusts also have several disadvantages.
Trusts can also be more complex to dissolve or alter than companies. Significant changes to the trust structure or its dissolution can involve a lengthy and complicated process, potentially leading to additional costs and administrative burdens.
Borrowing funds can be more challenging for trusts since assets are held in the trustee’s name. Lenders often prefer dealing with companies due to their more established legal structure and security.
Trustees have limited powers and must act in the best interests of the beneficiaries, adhering to the trust deed’s terms. This restriction can limit their decision-making abilities, potentially reducing the business’s flexibility and agility.
You may end up in a situation where profits distributed to beneficiaries may be subject to higher tax rates compared to the company tax rate. For example when your beneficiaries are on higher tax brackets.
Trusts have a limited lifespan, which can impact the long-term viability of the business and may require careful planning for succession or transition to other business structures.
Lastly, trustees of a trust may have personal liability unless the trustee is a company. This means that if the trust is unable to meet its obligations, the trustee may be personally responsible for any debts or liabilities of the trust. This can be a significant risk for individuals acting as trustees.
Pros and Cons of a Company
Companies are a popular business structure choice for many entrepreneurs and business owners. Understanding the advantages and disadvantages of operating as a company can help you determine if this structure is the right fit for your needs.
Advantages
One of the key advantages of a company is the limited liability for shareholders. Shareholders are not personally liable for the company’s debts and obligations. Their liability is limited to the amount they have invested in the company. This means that their personal assets are protected in case the company faces financial difficulties or legal issues.
Another advantage of a company is the tax benefits it offers, especially for small businesses. Companies are subject to different tax rates and regulations than other business structures. This can result in lower tax obligations for the company and its shareholders. Additionally, companies have the flexibility to distribute profits to shareholders in the form of dividends, which can be claimed as personal income for tax purposes.
Furthermore, operating as a company allows for the potential transfer and sale of shares. Shares in a company can be bought and sold, allowing for the entry of new shareholders or the exit of existing ones. This can be beneficial in terms of raising capital for the business or allowing owners to sell their interests in the company.
Disadvantages
However, there are also some disadvantages associated with operating as a company. One of the downsides is the expensive reporting fees involved. Companies are required to meet certain reporting requirements, such as annual financial statements and tax returns. These compliance costs can be burdensome, especially for small businesses with limited resources.
Another disadvantage is that the control of the company is subject to shareholders. Major decisions are typically made by the shareholders, who may not necessarily be involved in the day-to-day operations of the business. This can lead to a loss of control for directors and managers, as they are accountable to the shareholders and may have limited authority.
Additionally, operating as a company comes with stringent reporting requirements for directors and managers. They have legal obligations to act in the best interests of the company and its shareholders. Failure to comply with these obligations can result in legal consequences, such as personal liability for directors.
Differences between Trust vs Company
When deciding on the right business structure for your needs, it is important to understand the differences between trusts and companies. Here are some key distinctions to consider:
Separate Legal Entity: Trusts are not separate legal entities, while companies are. This means that a company can enter into contracts, sue or be sued, and own assets in its own name. On the other hand, a trust does not have legal personality and must operate through its trustee.
Asset Protection and Lifespan: Companies offer better asset protection compared to trusts. As separate legal entities, the liabilities of a company are generally limited to its assets. This protects the personal assets of shareholders from business debts. Additionally, companies have a longer lifespan as they can continue to exist even if the shareholders or directors change.
Tax Obligations: Trusts may have lesser tax obligations compared to companies. The income from a trust is generally distributed to beneficiaries, who are then responsible for paying tax on their individual share of the trust’s income. This can be advantageous for income splitting and potentially reducing the overall tax liability. On the other hand, companies are subject to corporate tax on their profits.
Working Capital and Investor Confidence: Companies have an advantage in generating working capital more effectively compared to trusts. They can issue shares to raise funds for business operations. Additionally, investors are often more comfortable investing in companies because they have a clearer understanding of the corporate structure and legal protections in place.
Income Distribution and Privacy: Operating a business under a trust can be beneficial for income distribution and privacy. Trusts provide flexibility in how income is distributed among beneficiaries, allowing for a more equitable sharing of profits. Trusts also offer a higher level of privacy as the details of the trust deed and beneficiaries are generally not publicly available, unlike a company’s shareholders and directors.
Conclusion
In conclusion, choosing between a trust and a company depends on your specific needs and circumstances. While trusts offer advantages in terms of tax obligations, income distribution, and privacy, companies provide better asset protection, access to working capital, and greater investor confidence. It is important to seek professional advice and carefully consider the advantages and disadvantages of each structure before making a decision.
