If you’re about to start a business you have a choice about how to structure it. Structuring means how you set up the legal instruments (i.e. trust deeds and contracts) and entities (companies, partnership, joint ventures) to conduct the business. One option is to trade through a company that is the trustee of a trading trust. It is a popular structure and the Productivity Commission estimated in 2013 that there were 254,000 trading trusts in Australia (Business Set-up, Transfer and Closure Report).
What is a trust? A legal device where a trustee holds property on behalf of beneficiaries for a purpose defined by its governing legal instrument (i.e. trust deed)
What is a trading trust? A trust over the goodwill and assets of a business where the trustee conducts the business in accordance with a legal instrument (i.e. trust deed)
What are the different forms of trading trust? You can set up a unit trust or a discretionary trust
What are the advantages of a trading trust?
- Confidentiality of trading information
- A trust is not a taxable entity
- There is flexibility to deal with changing circumstances, such as changing trustee or beneficiaries
- Trust property is generally not available to creditors in the event of insolvency (caveat to this point discussed below)
What are the disadvantages of a trading trust?
- Tax advantages may be illusory for small-to-medium sized enterprises because of administration costs
- The asset protection advantage may be pierced
- Under the Family Law Act trusts may be pierced
- Disentangling a structure may be expensive and problematic
What is the value of a trading trust for asset protection?
The famous company law Professor Harold Ford commented: The fruit of the union of the law of trusts and the law of limited liability companies is a commercial monstrosity. The scope for frustrating creditors is considerable.
The value of a trading trust as an asset protection device is limited by the following:
- A trustee has a right to indemnity from trust assets for debts properly incurred on behalf of the trust
- A trust deed may expressly exclude a right of indemnity against beneficiaries
- There is no specific right for creditors of trusts to enforce judgments against trust assets because this may be frustrated by changing trustees
- There is only a limited right of recourse against directors of trustee companies pursuant to section 197 of the Corporations Act
- If the trustee company goes into liquidation then it is unlikely, unless there are substantial assets, that the liquidator will prosecute proceedings against an incoming trustee