There’s a conversation that happens in accountants’ offices all over Australia, and it goes something like this: you’re starting a business, so you should think about a discretionary trust. Asset protection. Flexibility to distribute income to family members in lower tax brackets. Access to the 50% CGT discount that companies don’t get — though that one now comes with an expiry date. For a café, a consultancy or a family property portfolio, that’s often perfectly sensible advice.
For a startup that intends to raise venture capital, it’s usually the first structuring mistake the founders will later pay to unwind. If your ambition is outside investment, employee equity and an eventual exit, the boring answer — an Australian proprietary company, ideally from day one — is almost always the right one. Here’s why.
A Discretionary Trust Has Nothing to Sell an Investor
Venture investment is the purchase of a fixed slice of the upside: a number of shares, carrying defined rights, recorded on a cap table. A discretionary trust is the opposite of that by design. Beneficiaries of a discretionary trust don’t own a proportionate interest in anything — they hold a mere expectancy that the trustee might distribute to them. There is no instrument an investor can buy, no percentage they can hold, no option pool you can carve out, and no register that functions like a cap table.
Unit trusts get closer, because unitholders do hold fixed, proportionate interests — we’ve written a primer on how unit trusts work. And in fairness, the venture capital tax legislation contemplates them: an ESVCLP or VCLP can, in principle, make an eligible venture capital investment in a unit trust as well as a company under Subdivision 118-F of the Income Tax Assessment Act 1997 (Cth). In practice, almost no Australian VC does. The entire standard documentation stack — term sheets, subscription agreements, shareholders’ agreements, employee option plans — assumes a company limited by shares, and a fund that invests in your unit trust inherits a bundle of trustee-law complications its investment committee has no appetite for: a trustee whose first duty is to beneficiaries rather than to a negotiated shareholders’ agreement, a trust deed that can often be amended in ways a constitution can’t, and a vesting date lurking decades out.
The Startup Tax Concessions All Assume a Company
The deeper problem is that Australia’s startup incentives are drafted around companies, and trusts are locked out of most of them:
- R&D tax incentive. Only an “R&D entity” can claim, and an R&D entity must be a body corporate — trusts are generally not eligible, with the narrow exception of a corporate trustee of a public trading trust. For a deep-tech startup, running the business through a trust can mean walking away from a 43.5% refundable offset on R&D spend (for companies with aggregated turnover under $20 million).
- ESIC tax incentives. The early stage innovation company incentives in Subdivision 360-A — a 20% non-refundable carry-forward offset (capped at $200,000 a year for an investor and their affiliates combined, and lost entirely by retail investors who put in more than $50,000 in a year) and a CGT exemption for gains on qualifying shares held for at least 12 months and less than 10 years — apply to newly issued shares in an Australian-incorporated company. A trust can’t qualify as an ESIC, which makes your earliest angel cheques materially more expensive to attract.
- Employee equity. An “ESS interest” under Division 83A is a beneficial interest in a share in a company, or a right to acquire one. The startup concession that makes Australian employee option plans workable simply has no trust equivalent — a trust cannot grant options over itself in any standard way.
- Retained earnings. Startups reinvest every dollar. A company pays tax on retained profits at 25% or 30%; a trust that accumulates income instead of distributing it has that income taxed to the trustee at the top marginal rate under section 99A of the ITAA 1936 — currently 47% including the Medicare levy.
- Losses. Early-stage losses are trapped in the trust. They can’t flow out to beneficiaries, and carrying them forward requires satisfying the trust loss rules in Schedule 2F of the ITAA 1936 — rules that are particularly unforgiving for discretionary trusts without a family trust election.
A trading unit trust that solves the “fixed interest” problem by taking on many unitholders then runs into Division 6C: a public trading trust is taxed as a company anyway, at which point you’ve recreated company taxation with none of the ecosystem benefits.
Add the personal dimension — a director of a corporate trustee can be personally liable under section 197 of the Corporations Act where the trustee’s right of indemnity from trust assets is lost through a breach of trust, the trustee acting outside its powers, or a term of the trust deed, one of the traps we covered in our piece on how founders actually lose limited liability — and the case for running a venture-scale startup through a trust effectively collapses.
Where Trusts Do Belong in a Startup Structure
None of this means trusts have no place. The structure you’ll see on sophisticated cap tables everywhere is a company operating the business, with individual founders holding their shares through family discretionary trusts. Done properly, that can deliver real benefits at exit: flexibility to stream a capital gain among family beneficiaries, the CGT discount for value accrued to 30 June 2027 (the discount is legislated to end for individuals and trusts for CGT events on or after 1 July 2027, replaced by cost base indexation and a 30% minimum tax on capital gains), and potentially the small business CGT concessions — all while keeping the operating entity investor-ready. It needs care (trustee shareholders still sign the shareholders’ agreement, and deal documents must accommodate them), and it’s best set up before your shares are worth anything, because transferring founder shares into a trust later is itself a CGT event.
Already in a Trust? There’s a Path Out
Founders who started in a trust aren’t stuck, but the unwind is technical, and the available relief depends heavily on what kind of trust you’re in. For unit trusts, Subdivision 124-N of the ITAA 1997 provides CGT rollover relief where the trust transfers all of its assets to a company and ceases to exist within six months, with unitholders taking shares proportionate to their units. The rollover’s conditions — including that CGT event E4 must be capable of applying to all of the interests in the trust (section 124-855) — mean it is effectively confined to unit trusts and other fixed trusts; a discretionary trust generally cannot use it. Founders running a business through a discretionary trust are usually looking instead at the small business restructure rollover in Subdivision 328-G (whose ultimate-economic-ownership test a discretionary trust typically satisfies only with a family trust election in place), the small business CGT concessions, or a restructure that simply wears the tax cost. Related relief — like Subdivision 122-A for individuals and some trustees — covers neighbouring scenarios. Stamp duty, GST and the trust deed’s own terms all need checking before anything moves, and the restructure should be complete well before a term sheet shows up, because investors will not price around a half-finished one.
Getting the structure right at formation is cheaper than any restructure. It’s a conversation our business setup and structuring team has with founders every week, and as startup lawyers in Sydney we’ve unwound enough trust structures mid-raise to know exactly what the avoidable version of that bill looks like.
This article is general information only, not legal advice — the right structure depends on your business, your tax position and your plans, and structuring decisions should be made with both legal and tax advice. Viridian Lawyers advises Australian startups, founders and investors on company structuring, restructures and capital raising. If you’re choosing a structure or stuck in the wrong one, get in touch.
