fbpx
0

Commercial Law: Starting a business? The business trust option

“The secret of getting ahead is getting started” (Mark Twain)

That’s great advice from Mark Twain, so if you are sure that you are cut out for the exciting, hurly-burly life of an entrepreneur, and if you have a viable business concept, take advice now on how to get started.

In our previous article in the series “Choosing the right legal entity for your business” we looked at the private company option. In our final article in this series we consider the plusses and minuses of trading in a business trust.

What is a business trust?

In summary, a trust is a contractual arrangement that allows trustees to hold assets (without owning them) for the benefit of the trust beneficiaries.

Most trusts are not “business trusts” – they are just used to hold assets.  In the case of “living” trusts (the type of trust most likely to be encountered in this context) assets are initially provided by a “founder”, “settlor” or “donor”, and then owned, controlled and managed by trustees in their capacities as such (not in their personal capacities), for the benefit of beneficiaries.  The trustees can, and usually do, acquire more assets for the trust thereafter, again just to hold/control/manage.

With a business trust the trustees go one step further – they trade for profit, again for the benefit of the beneficiaries.

Strictly speaking, trusts aren’t separate legal entities like partnerships and companies, but in practice they are often treated as though they were, and some legislation (tax in particular) specifically defines them as such.

5 advantages of business trusts …

  1. Trusts, like companies, have “perpetual succession”, so they survive the death/incapacity/insolvency/removal of trustees, with all the practical benefits that entails. For example, the business can continue to operate normally after the death of the founder or trustees, rather than be tied up in the process of winding up the deceased estate.  And trusts that are properly created and administered can protect assets from creditors in the event of insolvency, divorce etc of the founder/trustees/beneficiaries.
  1. The trading risks of the business lie with the trust i.e. the trust’s assets are at risk from trading liabilities, not the personal assets of the parties to the trust. Trustees, unless of course they have signed personal suretyship for any trust debts, generally risk personal liability only if they fail to comply with the provisions of the trust deed and other legal requirements. In particular they have very strong fiduciary duties towards beneficiaries, and must always act in their interests. They must also observe the fundamental requirement that trust assets be treated as such, and not as their personal assets.
  1. As is the case with companies, you may find it easier to raise funding for a trust than for a sole tradership or partnership.
  1. Tax: Possibly an advantage … see below.
  1. Savings on death: Trusts have in the past often been used to freeze the value of growth assets as part of an estate planning exercise to reduce estate duty, capital gains tax and executor’s fees. These savings can be substantial, but be aware of factors such as the high tax rates applicable to trusts (see below) and of the various recommended changes to our tax and estate duty laws (such as the Davis Tax Committee proposals) which could – if they are ever implemented – reduce the attractiveness of trusts for this purpose.

… and 3 disadvantages

  1. Formation: Like companies, trusts require formal procedures for formation in the form of drawing up and registration of a trust deed, and appointment of trustees by the Master of the High Court. Factor the resulting delays and costs into your plans.  Don’t take shortcuts here!  An incorrectly worded trust deed for example will cause you all sorts of unnecessary pain.
  1. Costs of administration will generally be higher than with sole proprietorships although typically lower than with companies. But check upfront with your advisors what you will be in for.
  1. Tax: Possibly a disadvantage … see below.

The tax angle

As with all the other possible trading entities you can choose from, it is impossible to give general advice here. But as an overall comment, trusts have lost a lot of favour in recent years as a result of various government “attacks” on trusts, and they are now highly taxed compared to individuals, partnerships and companies.  Apart from generally being subject to higher rates of tax, they are also denied the various tax exemptions and rebates available to individuals.

There are a host of factors to be considered here, and you need to seek advice tailored to your particular circumstances. For instance, it may or may not affect your business trust that the primary residence CGT exemption isn’t available to trusts.

Moreover government has given out strong signals that this “hostile” trend will continue. In 2017 already, interest-free and low-interest loans to trusts have become subject to the risk of being taxed as donations.  Now the “conduit principle”, whereby income can be taxed at personal rates in the hands of beneficiaries rather than in the trust at a flat rate of 45%, is reportedly under threat.

Even more so than with other types of trading entity, it is essential to get specific guidance on whether a business trust is the most tax-efficient entity for your particular situation.

The bottom line is this – take full professional advice on both the legal and the tax implications of using each type of entity (or any combination of entities) before you start trading. 

If you ever wonder why your business is so important to you, read “Entrepreneurs love their companies like parents love their children: study” on MedicalXpress.

This article is for general information purposes and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact us At DKVG Attorneys for specific and detailed advice.

For more information, contact our Commercial Law department

© DotNews, 2005-2017. This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)