A business can be operated through a variety of different business structures. Deciding upon one structure over another will depend upon a range of issues and the particular requirements of your client. 1. Sole proprietorship An individual who runs a business without partners or a company structure. 1.1 Advantages Freedom & Flexibility. No formalities to establish, run or close (i.e. no ‘red tape’). Low cost of setting up. Minimal reporting requirements. Total control over business is retained by the sole proprietor/trader. Easy to sell the entire business. Income from business is taxed at a personal rate – this offers a tax advantage to the sole proprietor/trader as tax losses may be offset against other income (for example, negative gearing). Sole proprietor can claim the 50% Capital Gains Tax (CGT) discount provided the sole proprietor has held the asset for at least 12 months (i.e. the sole proprietor will only have to pay CGT on half of the capital gain that they make on the sale of the asset). Sole proprietor can also take advantage of the small business CGT concessions. No need to take the drawings of the sole proprietor into account in respect of ‘compulsory employee’ superannuation contributions because the sole proprietor is not an employee of his or her business. 1.2 Disadvantages Unlimited liability - business debts are mixed with personal assets. No perpetual succession – the sole proprietorship comes to an end when the person running the business dies. Potential lack of resources – both finances and skills; Normally limited growth opportunities. Limited access to finance if the business grows – i.e. cannot raise capital from the public. No flexibility in tax planning – e.g. to vary income of family members from year to year.4 Difficult to conduct estate planning as there is limited opportunity to move income to family members. 2. Partnership Persons carrying on a business in common with a view to profit. 2.1 Advantages Inexpensive to establish – not necessary to have a partnership agreement (although advisable); can also be established by the parties’ conduct. Less formality due to relatively minimal legislative regulation. Partners can self regulate – discuss and resolve problems together Flexibility and secrecy as partners are not required to make public disclosures. Tax losses flow through to partners and can be used immediately by the partners against income from other sources – also useful in the early days when the business loses money because they can deduct losses from their personal income. The partnership can be tailored to vary profits or losses between partners on an annual basis. Partners are able to access the 50% CGT discount as they hold an interest in each partnership asset as an individual. 2.2 Disadvantages Partnership may exist at law as a consequence of the parties’ behaviour, even if the parties did not intend it. Unlimited liability – the partners are all jointly and severally liable for the debts of the firm. Difficult to transfer partner’s personal share in a partnership. Difficult to add or remove partners – have to amend the partnership agreement. Taxable income flows through to partners so high tax rates when business makes money. Limited growth because the maximum number of partners is fixed at 20 – (however, there are exceptions for some fields e.g. legal practitioners). Different Partnership Acts in different States – difficult for interstate partnerships. Partners between themselves can bind each other. CGT disadvantages – for example, because partners hold an interest in each partnership asset as an individual, if a partnership asset is sold then each partner is treated as having disposed of an asset for CGT purposes represented by that partner’s percentage interest. A partnership is an inflexible entity for the purposes of holding appreciating assets.5 3. Joint venture A relationship formed for a specific purpose. May be incorporated or unincorporated. 3.1 Advantages Less formality due to relatively minimal legislative regulation. Inexpensive to establish – not necessary to have an agreement (although strongly advisable). Participants not responsible for acts of other participants. Transfer or assignment of participant’s rights may be able to take place without consent of other participants. Joint venture cannot be sued in its own name and therefore cannot be joined in proceedings although individual participants can be sued (only unincorporated JV’s). Participants do not owe same degree of confidence and mutual trust to each other as partners would and may be able to compete with each other. 3.2 Disadvantages Only exists for so long as joint business is operated. Retirement of one participant may end the joint venture unless reconstituted with new members. Participants are liable for debts of joint venture on several liability (i.e. no limitation of liability). Ambit of business venture restricted – need to amend agreement to “branch out”. The ability to sell the entire joint venture is restricted – same as for a partnership. 4. Differences between partnerships and joint ventures Although there are common interests in a joint venture, liability of participants is individual (“several”). In a joint venture a manager or operator is often interposed between participants and business operation and participants have no authority to bind each other. Participants in a joint venture can dispose of their interest (subject to terms of the joint venture agreement) while partners are only able to assign partnership interest subject to the Partnership Act. Participants in a joint venture receive their shares of profit separately. 5. Company A separate legal entity which is able to hold assets and enter into contracts in its own name.6 5.1 Categories of companies Companies limited by shares. Companies limited by guarantee. Unlimited companies. No liability companies. 5.2 Incorporation Private companies Large and small private companies Public companies 5.3 Advantages Limited liability for shareholders – there are some exceptions for directors The company tax imputation system saves companies from being subjected to the traditional double layer of tax (i.e. tax at a shareholder level and at the company level) Contributions the company makes to a superannuation fund on behalf of employees may be claimed by the company as a tax deduction Losses can be transferred from one company to another in a group provided there is a 100% common ownership Companies offer some ability to “split” income among family members Company tax rate is set at a much lower rate (30%) than the highest individual tax rate and there is no requirement to distribute profits Perpetual succession – the company continues after the death or retirement of a shareholder or director Ownership in assets can be transferred in certain circumstances through a company structure without significant stamp duty costs Relatively easy to issue new shares and bring in new ownership/participants without creating a new entity The share buy-back provisions in the Corporations Act provide greater flexibility in cancelling shares or reducing paid up capital 5.4 Disadvantages More expensive to establish More expensive to maintain (annual filing fees, accounting fees and greater accountability have increased complexity and costs) Governed by ASIC rules and Corporations Act - can be onerous7 Where company undertakes negative gearing the tax losses are trapped within the company CGT disadvantages in comparison to holding assets by individuals – i.e. A company is not entitled to claim the CGT 50% discount concession which is available to individuals and superannuation funds The incorporation of an entity means that the principals become employees of that company 6. Trusts A fiduciary relationship where the trustee is obliged with property for the benefit of some other persons. 6.1 Types of trusts Discretionary. Unit/Fixed. Bare. Testamentary. 6.2 Advantages Inexpensive to establish – all you need is a trust deed. Simplicity of operation. Discretionary trusts have enormous flexibility – as the settlor has settled income-earning property on the trustee, it is the trustee who has the “discretion” of management, including choosing to whom a distribution should be made from a range of named beneficiaries, potential unnamed beneficiaries and/or more general “object”. Tax advantages – The discretionary trust is a useful income-splitting device for tax purposes. Trust income is taxed once in the hands of the beneficiary. With a company, unless dividends of a company are paid from income taxed at full company rate, tax is payable on income in the company’s hands and again in the hands of the shareholders. Units in the trust can be transferred. Unit trusts have a fixed annual entitlement to income. Unit trusts have fixed entitlements to “capital” (the value of the units). 6.3 Disadvantages Loss of absolute ownership – the trustee has the legal ownership, which prevails over the equitable ownership of the beneficiaries Loss of control – the trustee may make decision which may not please the beneficiaries Increased liability for directors of corporate trustees Trustee has many responsibilities under the deed creating the trust and the Trustees Act8 All income needs to be distributed each year, or taxed at highest tax rate Complex legal rules not understood by many people Rule against perpetuities (i.e. no perpetual succession although continuity of succession up to perpetuity period – 80 years) 6.4 Unit trust with discretionary trust unitholders: advantages As independent parties each has a fixed interest which can be sold or transferred The proportion of income and capital is fixed so the parties know what they are entitled to The unitholder as a discretionary trust has the maximum flexibility in distributing income amongst the beneficiaries of the family trust There is asset protection as the business interest is held in different entities to the business The unitholders are jointly and severally liable as they would be in a partnership of individuals Individuals can be employed by the unit trust and obtain all the advantages of employment, such as salary packaging and employer sponsored superannuation. 6.5 Company with a non-fixed trust as shareholders: advantages Income is paid at 30% corporate tax rate There is asset protection from the personal assets of the principals There is flexibility for income distribution through the discretionary trust It is easy to understand the workings of a company 6.6 Company with a non-fixed trust as shareholders: disadvantages If the business fails the directors are personally liable for director insolvent trading placing personal assets at risk. 6.7 Partnership of discretionary trusts: advantages The partners are jointly and severally liable but the personal assets of the individuals are protected, as the partners are trusts. It is only the assets of the discretionary trust which are at risk. Each of the discretionary trusts have a fixed interest in the capital and income of the partnership. The flexibility of distribution of income is achieved through the discretionary trusts. Each partner can easily sell its interest in the partnership without affecting the tax position of other partners. The individuals can be employees of the partnership and obtain the benefits of salary packaging and superannuation benefits Losses are distributed to the partners.9 6.8 Partnership of discretionary trusts: disadvantages Each of the partners is jointly and severally liable for losses The structure is more complex than a partnership of individuals and more costly to establish and run than a partnership of individuals 7. Minimising risk, maximising savings Separate assets from trading activities Separate valuable trading assets from at risk trading activities Trusts Superannuation FundsFor more information: Paul Kordic Principal T +61 8 9420 7100 E firstname.lastname@example.org rockwellolivier.com.au We know that close and effective (relationships) matter to you and we offer services that draw on our significant knowledge and our experience.