The wrong business structure can be a disaster. At Guardian Accounting we can help you choose the correct structure for your needs. The choice of business structure is a vital issue for anyone running a business. We are experienced in all legal and tax structures and have a practical working knowledge and application of the fundamental characteristics, benefits and potential traps.
Please take the time to review the various structures outlined below. If you have any questions we are more than happy to answer them so please call us on 1300 881 772 or email us from our Contact Us page.Sole TraderCompanyFamily Discretionary TrustUnit TrustHybrid Trust
A sole trader is a person who trades in their own name. It is the simplest way to operate a business. If you are trading under your own name you do not need a registered business name. A registered business name is only required if you want to trade under a business name that is not your name. For example, I can trade as Ross Johnston, but I cannot trade as Ross Johnston Accounting, without registering the business name. To begin trading as a sole trader the first requirement is an Australian Business Number (ABN). You use your current Tax File Number (TFN) and you may or may not be required, or want, to register for GST. If you are employing someone else you will need to register for PAYG Withholding and Workers Compensation. The advantage of trading as a sole trader is that it is relatively inexpensive and quick to establish.
The disadvantages of trading as a sole trader are many. All profits are taxed in your name at your marginal tax rate. You cannot employee yourself and so may be missing out on some tax benefits of being an employee. You have absolutely no asset protection, in that your business, investment and personal assets are all liable to be lost if you declare bankruptcy or are sued for any matter to do with your business, investments or personal life. You are not a separate legal entity to the business, you are the business. This may preclude you from accessing some tax benefits that are only available for separate legal entities. Partnership
A business operated by two or more persons must form a partnership for taxation purposes. From a legal point, each state has its own Partnership law which defines the default provisions applying to all legal partnerships established within the state and these provisions will prevail unless a valid partnership agreement overrides the law. In other words, if you don’t have a formal partnership agreement then the law will determine the partnership rules. Most Mum and Dad partnerships don’t have formal agreements and thus are covered by the law and are treated as a 50/50 entitlement in most respects.
The practicalities of establishing a partnership are virtually identical to that of a sole trader with respect to the various tax registrations required, i.e. TFN, ABN, PAYG, GST, Workcover, business name, etc.
Family partnerships are an effective structure to split income between Mum and Dad, are inexpensive to establish and dissolve, and can provide some asset protection from the activities of the other partner.
But, partnerships are inflexible, lack the ability of income streaming, provide very little asset protection, cannot employ any of the partners, are inflexible to deal with future changes in circumstances of the partners or their family, and can be potentially costly if a substantial alteration to the partnership is required, such as admitting or retiring partners.
The private company, or Pty Ltd, is a separate legal entity. It has rights and obligations to much the same extent as a real person. It can sue and be sued, enter into contracts and borrow money in its own name. In practice though, a company can’t manage itself so the directors of the company manage the company, and the shareholders own the company. Often the directors and shareholders are the same person, and so the people effectively own and control the company as if it was their own.
It is okay to run the company this way, but it must be kept in mind that company is a separate person and the assets and income of the company are its own until they are distributed to the shareholders by dividend. Failure to appreciate this separate existence can be expensive on the tax side as there are many tax laws that deal with keeping the company and directors/shareholders separate.
A company is an ideal structure to run a business, especially if that business is likely to be sold in the future. The basic tax benefit of a company is that tax is limited at 30 per cent, but this could be a disadvantage if the earnings are less than $75,000 and no dividends are paid. As a company is a separate entity it can employ the owners and there can be some substantial tax benefits of being an employee of your own company, such as a company car.
A company provides a good level of asset protection. If the company is sued, the shareholders are not liable. The company directors are also not liable unless they were acting dishonestly or incompetently, or trading whilst insolvent. But from a personal liability view a company is not so good. If the shareholder is sued then their shares, as an asset, are available to creditors.
From our experience for most small businesses and investors, a company is most suitable to acting as a trustee of a trust. Tax issues are generally much simpler and asset protection is enhanced.
Family Discretionary Trust
A family trust and discretionary trust are in most cases one and the same, although a discretionary trust may not be family trust and a family trust may not be a discretionary trust. For our purposes, we will refer to a family trust and discretionary trust as the same entity, unless stated otherwise.
A trust is a legal relationship between a settlor and trustee to hold property on trust for the benefit of the beneficiaries of the trust. In most cases the settlor provides a nominal sum, $10, to the trustee to hold on trust for the beneficiaries. This is known as settlement of the trust. The trustee is bound by the trust deed which defines the rights and responsibilities of the trustee, the trust, the settlor, the appointor, and the beneficiaries. Trusts are also subject to the state Trustee laws.
Once the trust is established the trustee manages the business or investments of the trust. The trustee may be one or more people or a company. The trustee has effective control and legal title over the trust assets, but does not own the assets nor can benefit from the assets unless the trust deed allows.
A discretionary trust has two main advantages over any other structure. Firstly, asset protection. The trust assets are not owned by any beneficiaries, nor have any beneficiaries any right to the assets or income of the trust. Thus, if a beneficiary becomes bankrupt or is otherwise sued, the creditors have no access to the assets or income of the trust. And vice versa if the trust is sued. Family law provisions may override some of these aspects of the trust.
The second main aspect of a discretionary trust is the discretion of the trustee to distribute income and assets. The trustee has full discretion to distribute the income and/or assets of the trust to which ever beneficiary the trustee decides. This allows the trustee to take advantage of lower tax rates and any other matter that will benefit the beneficiary. This is the ultimate in income streaming. No other structure can boast this ability to stream income and classes of income with total discretion.
The cost of establishment is the main obstacle to clients when deciding on the most appropriate structure. Although a trust may be more expensive to establish, the ongoing taxation benefits usually outweigh the cost in the first year. Ongoing accounting and tax fees will be higher but once again usually outweighed by the tax benefits.
At the minimum, if you have three children under 18, you should save at least $430 in tax every year. If you should ever need the protection of your assets, you will thank your lucky stars that you set up a trust. Just look at the protection provided as a form of insurance… hopefully you will never need it but if you do it will have paid for itself many many times over.
A unit trust issues units to unitholders which entitles them to a fixed proportion of the income and/or assets of the trust, depending upon the class of unit. A unit trust is similar to a company with regard to the right of unitholders to receive income or capital. Although, at year end the trustee must distribute all income in proportion to each unitholders unit holding.
Therefore a unit trust has no discretion and thus the tax benefits are minimal by itself. A combination of unit trust and discretionary trust is ideal for obtaining income and capital discretion. Asset protection for the unitholder is also diminished compared to a discretionary trust. As the unitholder, has a fixed entitlement to income and/or capital then this is effectively an asset that is liable to be lost if sued. But protection of unitholder assets are still protected if the trust is sued.
A unit trust is an ideal trust for a business that has unrelated parties involved, such as two families or friends.
In essence the hybrid trust is a combination of a discretionary and unit trust, and so provides the benefits of both trusts in one trust. Generally, the hybrid trust is ideal for those wanting to use a trust for negative gearing, and it is also appropriate for a business that wants some flexibility with the distribution of income to employees. On the downside, the hybrid trust provides similar asset protection to a unit trust.
As the hybrid trust is a difficult concept to grasp, there are various versions available, there are many differing opinions upon the use of the trust, and the Australian Tax Office has released some opinions on the tax effectiveness of some hybrid trusts it is best to speak to us personally about whether or not the hybrid trust is suitable for you.