As insolvency practitioners we get to see the good, the bad and the ugly of business structures. And our experiences over literally thousands of insolvencies, allows us to make judgements about the efficacy of various types of structures. Or at least those associated with failed enterprises.
Those involved in starting a new business need a positive attitude. They must have faith in their venture and believe that it will be successful. But business owners and their advisors must also be pragmatic, recognising that all businesses involve an element of risk and that, sadly, some businesses do fail.
Applying a pragmatic approach and accepting that failure is a possibility means that business structures should be about loss minimisation as much as about tax planning, simplicity of operation and cost effectiveness.
Business structures which utilise trusts are common, no doubt because of their perceived tax advantages. But in this connection it is worth remembering that offsetting of current tax losses to even out past taxable incomes is not possible for a trust.
In our May 2013 e-Update we included an article about the number of recent personal insolvencies that we have seen arising out of individuals acting as trustees. With that in mind we thought a refresher on just what a trust is, and is not, and the risks faced by trustees might be useful for some of our less experienced readers.
Accountants talk all the time about trusts; we say that “the trust owns assets” or “the trust has that liability”. We even produce financial statements for the trust showing trading income and expenses “of the trust”. Also trusts can have tax file numbers and ABN’s. All of this talk of the trust trading and holding assets or owing that debt, or being registered here ohere, is strongly suggestive of a trust being a legal entity.
But a trust is not a legal entity it is only a concept, or a set of obligations. A trust cannot be sued, liquidated or made bankrupt. But the trustee can.
Every trust must have a trustee to function so:
- A trust cannot own assets nor can it have creditors, it is the trustees who carries out each function.
- Trading is by the trustee.
- Trust property is owned by the trustee on trust for the beneficiaries.
- Trust creditors are creditors of the trustee.
- A trustee is personally liable for trust debts.
- A trustee is generally protected by an indemnity which may or may not be sufficient.
- A trustee can be a natural person or a company.
We emphasise that when a trustee properly incurs a debt on behalf of a trust, he she or it, is then personally liable for that debt, no if buts or maybe’s. The existence of an indemnity from the trust assets might be useful in paying the debt, but the creditor will look to the trustee to pay the bill and won’t care if the funds come from trust assets or private assets.
We can think of very view instances where we would recommend that an individual should act as a trustee. We think that the best structure comprises the use of a discretionary trust with a corporate trustee. It is true that incorporating a company and paying for its upkeep costs dollars but that cost is small compared to the potential down side risk.
Although understanding what a trust is and how it works is not all that complicated, when a trustee becomes insolvent any number of practical difficulties can arise. Watch this space as we will discuss some recent and somewhat conflicting case law on trusts.