02/10/2025
Why a Company Structure Isn't Always the Most Tax-Effective Choice for Your Family Business
It's a common piece of advice for new and growing family businesses: incorporate as a company. And for many, this structure offers great benefits, particularly in terms of limited liability and the attractive 25% or 30% corporate tax rate (depending on turnover).
However, when it comes to tax effectiveness for a family business, the company structure is not always the best solution. In fact, for many, it can lead to higher overall tax bills and less flexibility compared to a Family Trust.
Here is a breakdown of why a company might not be the most tax-effective choice for your family enterprise.
1. The Trap of "Trapped" Profits (No Flow-Through)
The single biggest tax difference between a company and a trust is how profits are distributed and taxed:
Company: The company is a separate legal entity and pays tax on its profits at the corporate rate (currently 25% for eligible small businesses). If the company later wants to distribute those after-tax profits to its family shareholders as dividends, the shareholders then pay tax on those dividends at their personal marginal tax rates. While franking credits (credits for the tax already paid by the company) generally prevent double taxation, the profits are locked inside the company until a dividend is declared.
Family Trust: A trust is a "flow-through" entity. It does not pay tax itself (in most cases). The profits are instead distributed to various family members (the beneficiaries) in the year they are earned. These beneficiaries then declare the income on their personal tax returns and pay tax at their individual marginal tax rates.
The Tax Inefficiency: If the primary earners in the family are already on the highest marginal tax rate (currently 45% plus Medicare levy), those distributed profits (even with franking credits) will be taxed at the top rate, effectively pulling profits up to the maximum personal tax rate anyway, just in two steps.
2. The Cost of Accessing Profits: Division 7A
If you run your family business through a company and need to pull money out for personal use, you can’t just "take it." If you do, the ATO may treat that withdrawal as an unfranked dividend or a loan under a complex set of rules known as Division 7A.
Under Division 7A, if the loan is not put under a formal loan agreement and repaid over a set period with interest, the entire amount can be deemed an unfranked dividend. This means the full amount is taxed in your hands at your personal marginal tax rate, with no credit for the tax already paid by the company—a costly mistake!
3. Missing Out on Flexible Income Splitting
This is where the Family Trust truly shines over the company structure.
A company has a fixed ownership structure (shares). While you can issue shares to various family members, once issued, they are fixed, and changing them can be complex and trigger capital gains tax.
A Family Trust (Discretionary Trust) offers unparalleled income splitting flexibility. The Trustee (often the main parents) can decide each financial year how to distribute the trust's profits among a wide range of beneficiaries (spouses, children over 18, and even other entities) to achieve the most tax-effective outcome.
Example: In a good profit year, the Trustee might distribute income to an adult child who is at university and has a low marginal tax rate, reducing the overall family tax burden. In a company, this flexibility doesn't exist; the profits are tied to the fixed shareholder register.
4. Capital Gains Tax (CGT) Concessions
While the Small Business CGT Concessions are generous and available to both structures, a company can present an additional layer of complexity, particularly when using the Retirement Exemption.
To use the Small Business Retirement Exemption (which allows you to disregard a capital gain up to $500,000 when selling business assets, provided the amount is contributed to a super fund), the company must ensure the gain is paid out as a tax-free payment to the eligible individuals. This can be administratively difficult and can sometimes be overlooked.
The Verdict: Talk to Your Accountant First
The decision between a Company and a Family Trust is not a 'one-size-fits-all' choice.
A Company is often best if you:
Need to retain profits in the business to fund significant growth (as the 25% corporate tax rate is lower than the top personal rate).
Need external investors (who usually prefer shares).
A Family Trust is often best if you:
Want maximum flexibility to distribute profits annually among family members.
Don't need to retain large amounts of profit for reinvestment.
Prioritise asset protection (as a Trust provides strong separation).
If you are currently operating a family business through a company and are paying significant amounts in dividends at the top marginal tax rate, it might be time to discuss a restructure with your accounting team. Before making any changes, get professional advice tailored to your family's specific income levels and business goals.
Are you running your business as tax-effectively as possible? Contact us today to review your business structure.
