There are many reasons why a business owner would consider switching their business structure from sole trader to trust.
You might be growing a sustainable family business, and looking for a more tax-effective business structure. You may also be thinking of your long-term wealth generation, and considering a structure that allows you to protect your family assets for the future.
There’s a lot to consider when changing business structures. We created this guide to help you determine whether changing structures from sole trader to a trust is the right choice for your business.
At Liston Newton Advisory, we provide guidance and support for business owners looking to set up their business for long-term success. Get in touch with us to discuss your current situation.
Sole trader vs trust: the key differences
There are several key differences between sole trading and forming a trust. These are outlined in the table below.
[td]Unlimited personal liability for all business debts[/td]
[td]Limited liability through the trust structure[/td]
[td]Operates under individual tax rates[/td]
[td]Trust don't pay tax. Individuals are taxed on the income they receive from the trust. This enables income to be divided among beneficiaries in the most tax effective manner[/td]
[td]Annual tax return lodgement completed as an individual[/td]
[td]A tax return must be lodged on behalf of the trust, separate to the individual[/td]
[td]No financial reporting obligations required[/td]
[td]Annual financial reporting obligations are required[/td]
[td]Easy setup with minimal fees[/td]
[td]Higher setup and operating costs[/td]
The two common types of trusts
There are two common types of trust that we commonly deal with — family trusts and unit trusts.
Also known as a discretionary trust, the family trust is the most flexible trust structure, and is operated strictly between a single family group.
For the family trust structure, beneficiaries don’t claim a fixed interest. In this case, the entity acting as the trustee has full discretion in how they distribute funds to each beneficiary. This allows for flexible, tax-effective income distribution between family members.
A unit trust, or fixed trust, is a trust structure that allows one or more groups to be involved in the business. In a unit trust, profit is divided according to the unit holding — similar to the way that shares operate—and distributed among the beneficiaries as an agreed percentage.
The advantages of changing from sole trader to trust
Improved liability and decreased personal risk
Compared to a sole trader structure, a trust offers much better security against liability. In fact, when you appoint a company to act as the trustee, this enables you to access the limited liability benefits available under a company structure, with the tax flexibility benefits afforded to a family trust.
Tax-effective income distribution
A sole trader receives their business income directly, and is taxed at an individual rate. Under a trust structure, the trust can assign income in ways that minimise the tax paid by the individual.
Due to their company-like structure, a trust may also be eligible to access small business tax concessions, something that is not generally available to sole traders.
Disadvantages of changing from sole trader to trust
Higher set-up fees
Setting up a business as a sole trader is quick, easy, and involves minimal fees. When registering a trust, due to its more technical nature, it generally costs between $1,500-$2,500 in setup and registration fees.
While this can be interpreted as a good thing, the increased governance adds a level of rigidity that a sole trader doesn’t deal with.
- For example, when operating as a unit trust, income distributions must be made in accordance with the trust deed.
If any business details changes, without consideration being given to the rules outlined in the trust deed, then this could cause resettlement of the trust. This can lead to additional tax and payment obligations.
If it comes to a point where the trust needs to be dissolved, it can be a difficult process given the complex nature of the beneficiaries involved. A sole trader does not have this issue.
Losses can’t be distributed
If a trust incurs a loss in a financial year, these losses are trapped in the trust and can't be used by anyone else other than the trust. This means the trust needs to make a future profit in order for the losses to be utilised.
When to change business structure to a trust
There are a number of situations in which it would be a prudent move to switch from a sole trader to a trust structure.
- Family Trusts are an ideal structure for growing a family business. It enables members of the family to become beneficiaries of the business, and receive an income directly from the trust.
- For added asset protection. If your business is thriving, then switching to a family trust structure can be a beneficial move. This allows business liability to be moved from the individual and onto the trust, thereby protecting the personal and family assets, should the business encounter financial issues.
- Switching to a family trust allows for agreed governance protocols and defined guidance for the future. If you see yourself handing the business on to the next generation, a family trust structure enables a clear succession plan, and a tax effective business transfer.
- If you’re running a business and your average tax rate approaches 30%, a family trust can be beneficial for reducing your tax rate.
- If you’re thinking about making significant personal investments, a family trust can also act as a suitable holding structure. This helps to protect those assets from financial and legal troubles—something that’s not possible as a sole trader.
How switching structures has enabled our client to achieve a multi-million dollar business
Ashleigh McInnes, Founder and Director of Papermill Media, came to us with an issue. Ashleigh needed a solution that would enable her business to grow.
Ashleigh had set her business up under a sole trader structure, but it had since grown to four employees. This meant that 50% of profits were disappearing in tax.
So, we advised her to change her business structure to a trust, and a company. This enabled her to reduce the tax the business was paying, and set the business up for exponential growth. We helped Ashleigh put measures in place that ensured her personal assets were protected, and separate from her rapidly growing business.
Since then Papermill Media has grown to a two-million-dollar business, with a team of 16 employees.
The final word on a sole trader vs trust structure
If you’re looking to change business structures to a trust from a sole trader, there are a number of key questions to ask yourself first.
- Do I expect my business to grow beyond a sole trader structure?
- What is the nature of the trust I'm looking to create?
- Who will I appoint as the trustee?
- What is the extent of the entitlement the beneficiaries receive?
- Am I prepared to keep strict financial records?
When the switch is made correctly, changing from a sole trader to a trust structure is a move that will have positive long-term consequences.
It can help you minimise your tax, protect your family assets, and enable you to create a business you can pass on to the next generation.