One of the most common questions that I get asked as a Tax Agent and Business Structure Adviser is: What is the right business structure for me?
Whilst it might seem like a very simply question, what is important to remember is that no two businesses look the same and no two owners’ circumstances look the same (e.g. number of children, married, single, renting, mortgage, investment mix, related parties, etc).
The most important questions to consider when setting up a business structure are:
- What will my business do?
- How much will I earn?
- What is my exit strategy (i.e. am I building an asset or am I creating self employment)?
- Unless you know where you and your business are going, it will be very hard to know what structure is right for you and your individual needs.
Once you have a clear idea of where you are going and what you want from your business, then we can look at the specific questions of business structure.
It is vital that the decisions made at the start of a business venture are made well and the choice of the business structure will determine (and perhaps limit) the tax planning that can be done during the lifetime of the venture or business.
No one can foresee the future so it is really important that the initial structure is flexible enough to change as the business structure needs change.
When looking at the structure of a business, here as some of the things we at Accounting for Small Business consider.
What needs to be considered when choosing a structure?
There are 5 key factors to consider
a) protection of the assets of the owner
The business should have enough assets to cover borrowing by the business structure otherwise the owner’s private assets may be at risk. Creditors should be limited to attacking the assets of the business venture.
b) protection of the business or investment assets
The business assets must be protected from the personal creditors of its owners.
Certain structure ensure that assets are not controlled by the owner to protect against events such as Bankruptcy and Divorce
Income Tax Effective Management
The aim is to minimise the rate at which income sources are taxed which can be achieved by -
utilising low marginal tax rates or lower tax rates available in certain business structure, distribution of the income tax to low rate taxpayers and deferral of payments to a later time and potentially lower marginal income tax rates.
We need to be aware of the anti avoidance legislation including
- part IVA which relates to the General Anti Avoidance provisions targeting tax minimisation “schemes”
- alienation of personal services income – which is vital to look at for all contractors or people paid on an hourly rate basis (Lucky for you that one of the team members at Accounting for Small Business structure specialises in giving advice on Personal Services Income - make sure you always speak to a specialist in this area)
- Division 7A loans (Loans to Shareholders of Companies)
- Non commercial payments (Payments at non-market values, for example payments to your spouse at above market wage rates)
- Capital Gains Tax Minimisation
- 50% general discount
- CGT small business structure concessions
- utilising past capital losses
- Ease of Administration
- the cost of purchasing the entity
- the cost of initial registrations
- the cost of ongoing renewals
- the cost of accounting and tax return requirements
- what are the benefits compared to the administrative burden
- ease of structural or ownership change
- ability to borrow funds or mortgage assets
- succession planning
- implication of superannuation
- protection of the assets of the business.
- Unrelated Parties
- Sole Trader
- simplest form of structure
- simple establishment with more emphasis on practical considerations such as the choice of premises rather than legal considerations
- least cost administratively and simplest legal procedures in implementation
- full access to CGT concessions
- small business capital gains discounts available
- losses can be offset
- full control retained by practitioner
- practitioner entitled to all profits
- easy to sell or discontinue.
- unlimited liability of the practitioner for debts and other liabilities (e.g. negligence, personal injuries)
- success and continuity depend on continued good health of practitioner
- only the management skills of the practitioner can usually be called upon on a day-to-day basis
- limitations on the range of services that can be offered
- expansion is limited.
- succession planning is difficult
- unlimited liability
- The statutory test to determine whether a partnership exists is the carrying on of business in common with another legal person with a view to profit.
- In a partnership all partners are agents of all other partners and can therefore bind the other partners in contractual arrangements. Partners are also liable for the torts or wrongful acts committed by their partners.
- It is important to note that Incoming and outgoing partners may be liable for debts incurred by the partnership before or after they leave the firm if they do not adequately advise creditors of the time of membership of the partnership.
- All partners have a right to participate in the management of the partnership unless they have agreed not to participate. All partners are entitled to remuneration and all partners must agree on the introduction of a new member.
- In management issues, disagreements are settled on the basis of the majority view.
- This may be overturned by a Court if the partners are not acting in good faith towards each other.
- relatively inexpensive to form
- additional skills of partners available to practice
- can cover the short-term illness of one or more partners.
- access to CGT small business concessions
- capital gains and assessable income flows directly to partners
- unlimited liability for the partners
- potential for disputes and the loss of mutual trust by the partners
- problems relating to the death, retirement and admission of new partners
- problems relating to the holding of partnership property.
- the partnership itself is not taxable, only the individual members
- individual only liable for tax on their own share of the net income
- allows for effective tax planning
- distributed profits are taxed at the beneficiary’s individual marginal tax rate
- can employ principals and provide salary packaging
- income can be streamed to low income tax beneficiaries
- asset protection is available through correctly drafted trust deed
- can cover the short-term illness of one or more partners.
- capital gains and assessable income flows directly to beneficiaries
- retained income is taxed in the trust at the top marginal rate
- losses are trapped in the trust and cannot be transferred to other entities
- trustees are personally liable for trust debts
- varying the terms or objectives of the trust can have CGT and stamp duty implications
- ATO considers trusts as “Tax avoidance entities” and may target the trust for audit.
- Investment of family monies to stream income to low income beneficiaries
- Service Trusts to divert income from main business structure and from high income entities
- Asset holding vehicles for high risk business and commercial activities
- Small enterprises to fix the entitlements of the parties but still retain CGT discount
- Companies have an existence separate from their owners, can own property, sue and be sued in their own right, and have perpetual succession.
- They are relatively complex organisations and are governed by the Corporations Law.
- The liability of members is usually limited to the amount of their shareholding or guarantee.
- The day-to-day control of the company is vested in the directors. Only the directors have a say in the management of the firm.
- There are a number of formalities that must be attended to in the administration and running of a company.
- perpetual succession
- limited liability
- flexibility in the way the practice is organised and controlled
- taxation benefits.
- profits can be retained in the company (unlike trusts).
- taxed at a flat 30%
- can utilise FBT (Fringe Benefit Tax) and salary packaging
- more expensive to form and maintain and has corporate obligations
- possible loss of control.
- payment of wages to associates limited to a reasonable amount
- complex rules on using and carrying forward losses
- difficult to stream dividends
- no CGT discount available
- dividends can be franked to avoid double taxation
- flat rate of income tax lower than that applicable to the higher marginal income tax rates of individuals.
- Unrelated parties in business together
- Where high degree of commercial or business risk
- Where accessing R&D concessions
- Desiring to list on stock exchange
If the business structure makes a capital gain it will be useful if it can access the concessions and discounts currently available under the CGT legislation such as
In general the more complex a structure the harder it is to administer and the more costly for the owners or beneficiaries – factors to consider include
Other factors that need consideration are
Will you be going into business with someone other than your spouse or partners?
Are you looking to bring in business partners or investors in the future?
If so, you need to ensure that your structure allows for this and protects both you and your partners.
The Business Structure specifics:
There are 4 main business structures used in Australia:
Each structure has their advantages and disadvantages as we outline below.
The business and the owner are one and the same – i.e. a sole individual undertaking a business in their own name (maybe using a registered business name) for their own benefit
Tax is payable based on your taxable income at the normal income tax rates, essentially the more you earn, the more you are taxed. The scale of income tax you pay is between 0% and 46.5%.
Tax offsets can also be applied to reduce the tax payable such as the low income offset. Senior Australians and people with dependants
Partnerships like sole traders are relatively simple and easily understood by most people.
A brief summary is given below:
Trusts are established by a Deed and exist as a separate entity from the trustee/s and beneficiaries. The trustee can be an individual or a company.
There are various forms of trust such as Discretionary, unit, family, hybrid and testamentary and careful consideration must be given as to the appropriate type of trust as well as the beneficiaries and the choice of trustee.
the trust distributes profit to its beneficiaries who pay tax at their individual marginal rates any profit that is not distributed is taxed at the highest marginal rate
There are other structures available which are more complex and will not be covered here.
Again it must be stressed that advice should be taken to ensure the structure that you use for your new business structure is the right one for you and is one that can move forward with you as your business expands.
Please note that this page should be read in conjunction with our disclaimer. This is not our disclaimer however we wanted to remind all readers that you should always seek the expertise of a business structure specialist when consisting which business structure will be best for your business.