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Tax & Accounting Series: Business Structures


There are many factors that contribute to the financial success of your business in Australia, and one of them is the type of business structure you choose.

The business structure you need depends on many factors for example, the type of business you have, whether you plan to hire employees or team up with a partner and how you plan to develop your business in the long term.

There are four types of business structures in Australia, and each has advantages and disadvantages.

SOLE TRADER

This is where an individual operates a business under their own name. The advantage of this is that it is simple to set up. All you need to do is register an ABN and if necessary register for GST, PAYG etc. The individual is taxed in their individual tax return on the profit (before drawings) that they make for the year. The biggest disadvantage of this structure is that the sole proprietor is personally liable for the debts of the business. If the business is sued for one reason or other, the individual’s personal assets form part of the assets that can be attached to settle any liability. Their personal assets are therefore at risk.

PARTNERSHIP

This is where two or more people agree to operate a business together and share profits in a particular ratio. The advantages /disadvantages are similar to a sole proprietorship - with the partners being jointly and severely liable for the debts of the business. Any partnership should have a partnership agreement clearly setting out, amongst other items, the responsibilities of each partner, how profits are going to be shared and distributed, the procedure and method of valuing the business should a partner wish to withdraw from the partnership or should a partner be incapable of carrying out his duties due to ill health or death.

COMPANY

A company is a separate legal entity and is taxed as such. Financial statements are prepared annually and a tax return has to be completed. With these costs and the formation costs, it is a slightly dearer structure to operate through. The big advantage of a company is that it is a separate legal entity and therefore does give you protection from creditors. Your personal assets are therefore safeguarded unless you have issued personal guarantees or acted recklessly /fraudulently as a director of the company. The tax rate in a company is presently 30%. Profits after tax can be distributed to shareholders by paying dividends and these are then taxed in an individual’s personal tax return as income. One of the disadvantages of a company is that 100% of any Capital Gain is taxed. Salaries paid to shareholders are also subject to the compulsory 9.25% Superannuation contribution. This percentage is due to increase in the future.

TRUSTS

There are many different types of trust structures, the two most common ones being a Discretionary Trust and a Unit Trust.

Discretionary Trusts are generally utilised for a family business and Unit trusts are generally utilised where there is more than one “partner” in the business. The “partners” in the business can be each partner’s family trust. The Unit Trust gives each partner a fixed entitlement to the profits of the unit trust i.e. if you hold 50% of the units in a unit trust, you will be entitled to 50% of the unit trust’s profit.

The advantage of a trust is that it is generally more flexible than a company. In a Discretionary Trust, profits can be distributed to various beneficiaries in the most tax advantageous way. This would not apply if the income of the trust was personal services income of an individual.

Profits of a trust are distributed to the beneficiaries who then pay tax on this income in their personal tax return. Any profit not distributed to a beneficiary is taxed in the trust at the maximum tax rate, presently 46.5% inclusive of the Medicare Levy.

Another advantage of a trust is that if any Capital Gain is distributed to the beneficiary, only 50% of the gain will be subject to tax as long as the investment held for more than 12 months. Trusts are generally set up with a corporate trustee i.e. a company as the trustee. The “owner” of the business acts as the director of the corporate trustee company. In this way, your personal assets are protected from creditors of the trust. A disadvantage of a trust structure is that any loss incurred by the trust cannot be passed on to the beneficiary for tax purposes. Losses are carried forward in the trust and utilised against future profits. If an investment is going to be negatively geared you will therefore not set it up in a Discretionary trust. It is possible to get the interest deduction in your personal tax return for an investment in a unit trust but this has to be set up correctly and we suggest you see your accountant about this. Hybrid trusts are a combination of Discretionary and Unit trusts and are used for very specific applications. They will have to be carefully set up so as to not fall foul of the tax laws. Shareholders /members in company or Unit trust structures should always enter into an agreement contract with each other which governs inter alias the responsibilities, duties and remuneration of each party. The agreement should also cover the procedure for the sale of a member’s interest and how the share will be valued.

OVERVIEW

It is critical to get the right structure in place before you start your business, e.g. being in a company instead of a trust could cost you 50% more tax when you sell the business. It is therefore important to seek advice early as to the structure that best suits your individual needs. The small cost at the start has the potential to save you lots of tax over the business's lifespan.

The information supplied above is of a general nature and may not apply to your particular circumstance. You should therefore seek advice from your accountant /legal advisor before acting on the above.

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