Choosing between a discretionary trust and a company is not simply about finding the lowest tax rate. The structure that may save tax for one business can create extra cost, risk or complexity for another.
The right choice depends on how much profit you expect to make, whether you need to reinvest it in the business, who should receive income, the nature of your assets, and how you plan to sell or pass on the business in future. A structure should support your commercial plan first, with tax considered as part of the overall picture.
How discretionary trusts and companies are taxed
A discretionary trust does not generally pay tax on its income in the same way as a company. Instead, the trustee can usually decide which eligible beneficiaries receive trust income or capital for a financial year, subject to the trust deed and tax law.
Where an adult beneficiary is made presently entitled to trust income, that beneficiary is generally assessed on their share of the trust’s net income. This can create flexibility where there are adult family members with different taxable incomes and genuine entitlement to benefit from the distribution.
A company is a separate legal entity. It earns income, claims deductions and pays income tax in its own right. At the time of writing, a company that qualifies as a base rate entity is taxed at 25 per cent, while other companies are taxed at 30 per cent.
To qualify as a base rate entity, a company must satisfy both of these broad conditions for the income year:
– Its aggregated turnover must be below $50 million.
– No more than 80 per cent of its assessable income can be base rate entity passive income, such as certain dividends, interest, royalties and rent.
The company tax rate can be useful where profits will stay in the business for growth, stock, equipment, working capital or future investment. However, company tax is not necessarily the final tax cost for the owners.
When profits are later paid to shareholders as dividends, the shareholders include the dividend in their taxable income. Franking credits may be attached to reflect tax already paid by the company, but an individual shareholder may still have further tax to pay depending on their personal circumstances.
The important distinction is this:
– A trust can potentially distribute income among eligible beneficiaries each year.
– A company can retain profits at its corporate tax rate, but extracting those profits personally needs to be planned carefully.
When a discretionary trust may be more tax-effective
A discretionary trust can be attractive where a business has stable profits and there are several adult beneficiaries who can genuinely receive distributions.
For example, a family business may have adult beneficiaries with lower taxable income than the main business owner. If the trust deed permits it and the distributions are effective, the trustee may be able to distribute income among those beneficiaries rather than having all income assessed to one person.
That flexibility can be valuable, but it is not unlimited. A trustee cannot simply allocate income to someone who has no real connection with the arrangement or who will not receive the benefit of the distribution. The trust deed, the trustee’s resolution, the beneficiary’s circumstances and the actual handling of the money all matter.
Trust distributions also need to be resolved correctly and on time. For discretionary beneficiaries to be presently entitled to trust income, the trustee generally needs to make the required resolution by 30 June. The deed may impose additional requirements, including notice, record-keeping or particular wording.
A discretionary trust may be particularly worth considering where:
– The business profits are expected to be paid out to family members rather than retained for long-term expansion.
– There are adult beneficiaries with different income levels.
– Asset ownership and business operations need to be separated.
– The business may hold growth assets that could later be sold.
– Succession planning and family control are important.
However, distributing income to adult children or other relatives is not an automatic tax-saving strategy. The ATO closely examines arrangements where income is distributed to one person but the economic benefit is provided to someone else.
The tax rules dealing with reimbursement agreements can apply where a distribution is part of an arrangement designed to reduce tax and another person receives the benefit. If those rules apply, the trustee can be assessed at a punitive rate. This is one reason trust distributions should reflect genuine legal entitlements and be supported by proper records.
When a company may be more tax-effective
A company can be more effective where the business earns more profit than the owners need to spend personally each year.
If surplus profit remains in the company for business purposes, the company tax rate may be lower than the marginal tax rate that would apply if all profit were distributed to an individual immediately. This can create a tax deferral benefit, leaving more cash available inside the company to fund growth.
Common uses for retained company profits include:
– Expanding premises or operations
– Buying equipment or vehicles used in the business
– Increasing stock levels
– Building a cash reserve for seasonal trading
– Funding staff, marketing or technology investment
– Supporting a future acquisition
This is a deferral strategy, not necessarily a permanent tax saving. When company profits are eventually paid to shareholders, the dividend and franking credit position must be considered alongside the shareholder’s personal taxable income.
A company can also be simpler from an ownership perspective. Shares can be issued in set proportions, and shareholders have defined rights to dividends and capital under the company’s constitution and share terms.
For some businesses, particularly those aiming to bring in external investors, sell shares or grow beyond a family-operated model, a company may be commercially more practical than a discretionary trust.
That said, company money is not the owner’s personal money. The company’s bank account, assets and income belong to the company. Using company funds for private expenses, private loans or informal drawings can create tax consequences.
Division 7A is especially important for private companies. Broadly, it is designed to prevent company profits being accessed by shareholders or their associates as tax-free loans, payments or forgiven debts. A non-compliant arrangement can result in an amount being treated as an unfranked dividend.
The common approach: a trust with a corporate beneficiary
For many established family businesses, the decision is not strictly discretionary trust versus company. A common structure uses both.
Under this arrangement, a discretionary trust may operate the business or hold business assets, while a private company is included as a beneficiary of the trust. The trust may distribute some income to the company, allowing tax to be paid at the applicable company rate rather than distributing all income to individuals in a high marginal tax position.
This approach can provide a combination of:
– Distribution flexibility through the discretionary trust
– Potential deferral of personal tax through the company
– A vehicle for retaining funds for business or investment purposes
– More options for succession and asset separation
But the structure is not a simple tax shortcut. If the trust distributes income to a corporate beneficiary and does not pay that amount to the company, an unpaid present entitlement may arise.
Where funds represented by that entitlement are used for the benefit of the company’s shareholders or their associates, Division 7A may apply. The ATO’s view is that financial accommodation can arise in these circumstances, potentially producing a deemed dividend outcome.
In practical terms, this means a “bucket company” needs active management. The accountant should track:
– Trust distribution resolutions
– Amounts owing to the corporate beneficiary
– Cash actually paid to the company
– Any sub-trust or loan arrangements
– Private use of funds by shareholders or associates
– Dividend declarations and franking account implications
A corporate beneficiary can be useful, but it should be part of a properly documented strategy, not a year-end journal entry with no follow-through.
CGT, business sale planning and asset ownership
Tax on a future business sale is often more important than the tax saved in a single profitable year.
A discretionary trust can have an advantage where it owns assets likely to increase in value. Trusts can generally access the CGT discount for qualifying assets held for at least 12 months, while companies cannot access the CGT discount.
For an eligible trust, the standard CGT discount is generally 50 per cent. The precise outcome for beneficiaries depends on the type of gain, the trust deed, the trustee’s distribution decisions and the specific CGT rules applying to that gain.
Small businesses may also be able to access the small business CGT concessions. These can potentially apply to a business, business assets, shares in a company or interests in a trust, but the conditions are detailed and should not be assumed.
The basic tests can involve matters such as:
– Whether the relevant asset is an active asset
– Whether the entity is a CGT small business entity, broadly using a $2 million aggregated turnover test
– Whether the maximum net asset value test is met, currently $6 million across the relevant entity, connected entities and affiliates
– Whether participation and significant individual requirements are satisfied
– Whether additional conditions apply to shares or trust interests
The concessions can include a 15-year exemption, a 50 per cent active asset reduction, a retirement exemption and a rollover concession. The retirement exemption has a lifetime limit of $500,000 for an individual, subject to the relevant rules and any previous use of that limit.
These concessions can be available to both companies and trusts in appropriate circumstances. However, the ownership structure, control history and distribution records can materially affect the result.
For example, a business owner may operate through a company because retained profits and external investment are priorities. If they later sell shares in that company, the company itself cannot use the general CGT discount on its own gains. By contrast, where individuals sell shares they personally own, or a trust sells qualifying business assets, different CGT outcomes may be available.
There is no universal “best” structure for a future sale. Exit planning should start well before a sale is on the table.
A practical example: growth now, flexibility later
Consider a business run by two family members. The business is profitable, but most of its cash is needed for new staff, inventory and a larger premises. The owners also expect profits to grow over the next few years.
Operating through a company may allow more profit to remain available for business expansion after company tax. The owners can draw a commercially appropriate salary, and future dividends can be considered when their personal income needs and tax positions are clearer.
Now consider a different business where the owners expect to distribute most profits each year to adult family members who are active in, or financially supported by, the family group. A discretionary trust may offer more flexibility, provided the trust deed permits the distributions and the arrangements are genuine and properly documented.
A third option may be a discretionary trust with a corporate beneficiary. This can provide flexibility to distribute some income to individuals and retain other amounts in a company. However, it also creates more administration and requires careful Division 7A management.
The tax result in each case depends on the actual numbers, cash needs and people involved. The structure should not be selected based only on a headline tax rate.
Other factors that matter beyond income tax
Tax is important, but it is not the only consideration.
A company is a separate legal entity, which can provide a degree of separation between business liabilities and personal assets. However, that protection is not absolute. Directors may face personal exposure in some situations, and lenders, landlords and suppliers may request personal guarantees.
A trust does not itself have legal personality in the same way as a company. Its trustee owns and manages trust assets for beneficiaries. Many businesses use a corporate trustee to create clearer separation between trust assets and the people involved.
Administration also differs. A company has ongoing corporate obligations, including maintaining registers, meeting director duties and complying with ASIC requirements. A discretionary trust requires careful management of the trust deed, trustee decisions, beneficiary classes and annual distribution resolutions.
Changing structures later can be expensive and complicated. Moving assets from a sole trader, trust or company can trigger income tax, CGT, GST and state or territory duty issues. The duty outcome depends on the relevant jurisdiction and the assets being transferred, so it should be checked before any restructure is implemented.
The key takeaway
A discretionary trust may provide stronger annual income-distribution flexibility and potential CGT advantages. A company may be more effective when profits need to remain in the business for growth, or where a clearer ownership structure is commercially important.
For many business owners, the best answer may involve both a trust and a company. However, the additional flexibility comes with additional compliance responsibilities, particularly around trustee resolutions, corporate beneficiary entitlements, dividends and Division 7A.
This article is general information only and is not personal financial or tax advice. Before choosing or changing a business structure, speak with a registered tax agent or accountant, such as, about your specific circumstances, business plans and long-term goals.