Business Structures
For an overview go to Quick Comparison Table
Sole Trader -
Partnership -
Discretionary Trust -
Unit Trust -
Company -
Superannuation Fund
SOLE TRADER
This is where one person operates a business in his or her own name.
They must pay tax on the whole taxable income of the business.
Taxable income is equal to Gross income Less
Tax deductions.
SET UP PROCEDURE
- Register for ABN.
- Register for GST (if applicable).
- Register a Trading name with state authority (if applicable).
- Register for PAYG (if applicable).
- Public Liability and Professional Indemnity is
Recommended.
COMPLIANCE REQUIREMENTS
- ABN Registration compulsory
- GST registration - depends on turnover over $50,000.
- BAS - monthly or quarterly.
- Tax Return - Yearly.
- Financial Records - Income and expenditure statements.
ADVANTAGES
- The structure is simple. The business is really just you.
- You are not subject to any tax avoidance rules that apply to the other three structures, regarding the distribution of income.
- You can claim the whole 75% Capital Gains Tax discount on the sale of your business goodwill.
- Any losses are offset against any other income of yours, subject to the non-commercial loss rules.
- Basically, there must be $20,000 turnover per year,
before losses can be counted.
DISADVANTAGES
- You cannot divert income to family members, or others who are in lower tax brackets, so as to minimise tax.
- You can only claim a full tax deduction for the first $5,000 of contributions to a super fund. There is a further claim for 75% of contributions up to age-based limits.
- You cannot provide yourself with fringe benefits, and obtain some advantages enjoyed by companies, and trusts.
- If travel is a fundamental part of your business, you
must substantiate all travel claims.
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Superannuation Fund
PARTNERSHIP
This is a structure where you, and one or a number of other people jointly carry on a business. It can also be 2 trusts, or 2 companies, or a combination of a person, and a trust or company, or any combination at all. The partnership may be formed as a result of a written or verbal agreement. All of the business assets must be owned by the partnership. Each partner is then held to own his or her own separate partnership interest. A Partnership interest can be any amount. Eg. partner A may own 1%, and partner B may own 99%. If no percentage is specified, then the interest is taken to be equal shares. The ATO will allow one partner, or partners to be paid a salary, which increases their share, even though they have an equal share. There must be a reason for this. Generally, it is that the partner receiving a salary does most of the work.
Partnerships must be genuine. ie
the business being operated must be a genuine business. I realise that is a
vague statement. However, whether a business is a genuine business or not is a
grey matter. There have been many cases over the years, but each case must be
decided on its merits. I like to say that it is common sense. If it looks, and
smells like a business, then it is a business. Even if you pass the test for a personal services business, you can't divert income to family members if your income is derived from your personal skills and effort. As well, there must either be
substantial goodwill (not merely a franchise payment), and perhaps substantial
plant and equipment. The goodwill does not have to be purchased. It may have
been built up. There is a lot to this, and you really have to seek my advice.
Partners are also jointly and severally liable for any debts and litigations of
the partnership.
SET UP PROCEDURE
- Register for separate TFN
- Register for ABN
- Register for GST (if applicable).
- Register trading name with state authority (if applicable).
- Partnership agreement (if applicable).
- Register for PAYG-W (if applicable).
- Public Liability Insurance and Professional Indemnity
insurance recommended.
COMPLIANCE REQUIREMENTS
- ABN registration
- Tax File Number application.
- GST registration - depends on turnover
- BAS - monthly or quarterly
- Tax Return - Yearly
- Financial records - Balance sheet and profit and loss.
ADVANTAGES
- You can split your income with your wife, and or other family members. The split is inflexible, and must be consistent with each partner's share. This can result in savings in Tax.
- The structure is still simple. If a husband and wife partnership, then there is not a lot of difference to a sole trader.
- When you sell your business goodwill, you can receive a 75% discount on Capital Gains tax.
- Any losses can be offset against any other income that
you earn. This is subject to the non-commercial loss rules. Basically, there
must be at least $20,000 in turnover before any losses can be distributed.
DISADVANTAGES
- You cannot just set up a partnership, and start distributing your income among your family members to avoid tax. It must be a genuine business.
- The interaction of Social Security may make such a strategy a bad one. If your wife receives income from your partnership, and if she previously had a small income, or none at all, she may no longer receive FTB part B, and other payments for children. If there are no children, then her spouse rebate will be affected.
- Tax scales have been raised recently, and this new layer of complexity may not give any advantage.
- If there is a marriage breakdown, then Capital Gains Tax may have to be paid if you wish to reacquire the other half of the business.
- You cannot receive any Fringe Benefits, and derive any of the advantages enjoyed by companies and trusts.
- You can only get a tax deduction for the first $5,000 of your super contributions, and 75% of the remainder.
- If travel is a fundamental part of your business, you must substantiate all travel claims.
- Each partner is responsible for the debts of the business, even if they are run up without your knowledge.
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Partnership -
Discretionary Trust -
Unit Trust -
Company -
Superannuation Fund
DISCRETIONARY TRUST
A trust is a fiduciary relationship in which a person or company is the holder of an interest
in property but is subject to an equitable obligation to use or keep the property for
the benefit of another person or for some commitment object or purpose.
In a discretionary trust, the trustee is able to exercise discretion as to who is or are the Beneficiaries, and what proportions of the trust fund or trust income they are to receive.
In this structure you (and generally your wife) act as trustees for a family trust. The Trust owns a business, or simply an investment. The business is operated through the trust, which owns all the assets of the business. These assets are held in the name of the Trustee(s) on behalf of the Trust. A trustee can also be a Company. The Company acts as trustee only. The business is still owned and operated in the Trust. Again, the business must be a genuine business. Many people protest that they have a genuine business, when they don’t in the eyes of the ATO. Even if you pass the test for a personal services business, you can't divert income to family members if your income is derived from your personal skills and effort. You must seek my advice on this matter.
Most businesses use a Discretionary Trust for asset protection and the flexibility of
distributing to various different entities to minimise their income and capital gains tax.
Typically when the threshold of all beneficiaries are utilised fully the larger businesses
typically run through a Company structure to take advantage of the Company's flat rate of tax.
We usually accumulate assets in a Discretionary Trust and we keep the assets separate
from the Trading Company that deals with the clients or customers.
When a trust has a company as a trustee, then the trustee has limited liability for debts incurred
by the trust. However, this advantage is usually negated in practice for large amounts, as the
debtor, or bank require personal guarantees from the directors of the company. In
addition, any personal negligence of the trustees or directors is sheeted home to them.
SET UP PROCEDURE
- Create by a settlor with a Trust deed. (See me to set up)
- Establish a trustee.
- Register ABN.
- Register for GST (if applicable).
- Register for PAYG (if applicable).
- Register for WorkCover (if applicable).
COMPLIANCE REQUIREMENTS
- ABN registration.
- Tax File Number registration.
- GST registration (if applicable).
- BAS - monthly or quarterly.
- Tax Return - Yearly
- Financial records - Financial accounts balance sheet
and profit and loss statement.
ADVANTAGES
- You have the ability to be flexible in the amount of income that you distribute to each beneficiary.
- The trust can employ the Trustee(s).
- Because the effective owners of the business can be employees, then they can receive Fringe Benefits. The basic advantage is that the provision of Laptops, mobile phones, and calculators are FBT free. The employee can also depreciate these items in their own Tax returns, subject to substantiation requirements for them personally (ie. a diary of personal and business use for 4 weeks per year). The Trust can also provide them with a car on a novated lease. The saving is approximately $2,000 per year.
- Capital Gains can be distributed as the Trustee(s) see fit. This is probably the main advantage. If you have a Son or Daughter over 18, who is not earning an income, and say going to university, then you may be able to divert Capital Gains, or income to them. You can also divert approx $750 per year to each child under 18 tax free.
- The Trust can make super contributions on behalf of employees, and receive a full tax deduction up to age-based limits.
- The cost to set up, and maintain is not as expensive
as a company.
DISADVANTAGES
- If the trust makes losses, they cannot be distributed to the beneficiaries' Tax returns. They are quarantined in the trust, and cannot be used until a profit is made within the trust. This may be restrictive, if your business is a start-up, and expected to make losses in the early years, or if it is a rental property, where there is negative gearing.
- There is a large increase in complexity. There are many complex rules regarding treatment of Tax losses, and treatment of sale of business assets. There could be a definite increase in accountant’s fees.
- Again, the Social Security interplay may make the whole exercise a bad strategy.
- Super guarantee contributions of 9% of wages paid to the owners of the Trust, must be paid.
- Although the Trustee(s) have vicarious liability for any negligence committed by the employees, the employees can still be liable in their own right. This means that if the Trustee is a $2 company, the plaintiff's solicitors can still sue the employee (that is you). What I am trying to say is that neither a company nor a trust can save your house from your own negligence.
- All profits must be distributed at year end. Any profits undistributed attract tax at the highest marginal Tax rate.
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Superannuation Fund
UNIT TRUST
This structure is very similar to a partnership. The difference is that you can divorce yourself personally from the business, by having a company as trustee. Again, you will not be able to get out of your personal liability for negligence.
There are a certain number of units issued in the trust. Each unit is usually equal. If there are 2 units, then each unit is worth 50% of the business. All profits must be distributed at year end, and are distributed according to the value of the units. If there are 2 units, then they must get 50% of all capital and income each.
This structure is often used where there are 2 or more families involved in a business venture, and they want to be able to own their shares in the business in their own right, and be able to dispose of their shares. This cannot be done with a discretionary trust, because there is no ownership, except that of the Trustee(s).
ADVANTAGES
- Individual shares (units) can be disposed of without selling the whole business.
- Fixed share of income and Capital Gains may be distributed to a Family trust that owns the unit(s). The income and capital gains can then be further distributed in a discretionary manner.
- The same advantages of a discretionary trust except the ability to distribute income as the Trustee(s) see fit. However, having discretionary trusts own the units alleviates this problem.
DISADVANTAGES
- Same as a Discretionary trust, except that another
layer of complexity has been added depending on who owns the units, and
whether there is a company as trustee.
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Sole Trader -
Partnership -
Discretionary Trust -
Unit Trust -
Company -
Superannuation Fund
COMPANY
A company is a separate, legal entity and is administrated by its directors. It is formed by
people who own its shares and whose liability is linked to the amount (if any) unpaid on
the shares respectively held by them.
The Company must operate completely separately to you. If you mix your money, and the company's money, the ATO will penalise you. There are onerous rules in regard to Director's responsibilities. Changes of Address must be notified within 28 days of the change, or there are fines and penalties. There are numerous restrictions on what you can do. You cannot borrow money from the company, unless it is an arms-length transaction evidenced by a mortgage document, and appropriate security, or if unsecured, the loan must be paid back in 7 years, and appropriate interest must be paid. The loan must be evidenced by a deed.
There are only 3 ways to legally get money out of a company –
Wages on which you will pay tax at your marginal tax rate
As a dividend, on which the company has paid tax (called a franked dividend)
You will still have to pay tax at your marginal tax rate, and get a credit for the tax paid by the company (Franking credit)
As an unfranked dividend, on which you pay tax at your marginal rate without receipt of a franking credit.
As a loan from the company outlined above.
If you take money out of the company, without it being wages, a franked dividend, or a properly documented loan, then it is deemed an unfranked dividend.
SET UP PROCEDURES
- Purchase a shelf company or establish a new company.
- Register for ABN.
- Register for GST (if applicable).
- Register for PAYG (if applicable).
- Register for WorkCover (if applicable).
COMPLIANCE REQUIREMENTS
- ABN registration
- Tax File Number application.
- GST registration (if applicable).
- BAS – monthly or quarterly
- Tax Return – Yearly
- Financial records – financial accounts balance sheet and profit and loss in required format.
- ASIC annual return yearly
ADVANTAGES
- You can pay tax on profits of 30%, and retain those profits in the company for later distribution as a franked dividend. You will then have to pay tax at your marginal tax rate. As long as you don’t need these profits to spend, then you can time the dividends to coincide with a period when your income is low. You may then be able to reduce the tax rate to 18.5%, and get the balance of 11.5% originally paid as a refund.
- Because you are an employee, you can enjoy all the Fringe Benefit advantages outlined in Trust.
- You can make super contributions just like the trust.
- A Proprietary Limited Company can give your business a higher profile for advertising purposes.
- Limited Liability. However large debtors, and bank
usually insist on personal guarantees from directors. You still have liability
for your own personal negligence.
DISADVANTAGES
- A company is expensive to setup and maintain (currently $1,400). Accountancy fees are higher. There is company administration that has to be attended to.
- A company is inflexible. All dividends must be equal among shareholders. There are numerous laws against company owners, who are also employees, receiving excessive remuneration. You can’t simply setup a company, and start paying your wife out of profits.
- Director’s potential liability in case of negligence or insolvent trading can be large.
- Compulsory workers compensation, and superannuation contributions are required on wages drawn.
- The interplay of the Social Security system, and spouse rebates, with wives receiving income from the company. In addition, there are numerous rules about payments to associates.
- There is no discount for capital gains tax paid by a company. The only way a shareholder in a company can obtain the 50% discount for capital gains, is to sell their shares. This can be quite difficult if the purchaser only wants to purchase part of the company, or wants all the assets, but not the company. Purchasers are loathe to purchase a used company, since they take over all of its debts, and any future legal actions against the company, whether they know about any problems or not.
- Losses cannot be distributed to shareholders.
- ASIC Company returns need to be lodged annually with a $200 fee.
- A company cost about $440 to wind up. You can’t just
forget about it. ASIC keeps on sending the bills
.
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Sole Trader -
Partnership -
Discretionary Trust -
Unit Trust -
Company -
Superannuation Fund
SUPERANNUATION FUND (Self-Managed)
All Self-Managed Super Funds (SMSF) have less than five members. Each individual trustee of the fund is a fund member, and each member of the fund is a trustee. No member of the fund is an employee of another member of the fund unless those members are related. The requirement that all members be trustees ensures that each member is fully involved in the decision making process.
This is a trust. It is a trust with special rules. The assets of the trust cannot be released to members until they reach the age of 55, if born before 01/07/1960. The age of release is then phased in to 60 if you are born after 30/06/64. There are some exceptions, but they are so rare that I am not going to mention them. So the first thing you must realise is that you can’t touch any of the money in the super fund until you are 55, or the ages stated above. If you want to withdraw a lump sum, then you must retire also.
Any contributions received by the fund are broken up into Undeducted contributions, and Post 30/06/1983 contributions. Undeducted contributions are those for which you have never received a tax deduction. They are not subject to tax in the fund, and they can be withdrawn at release age, without tax being paid. However, any earnings from these undeducted contributions are taxable at the rate of 15%. Other contributions are taxable at 15% as well as their earnings. Any capital gains are taxed at 10% (providing the assets are held for a year and 2 days).
SET UP PROCEDURE
- Trust deed. (See me to set up.)
- Appoint a trustee.
- Elect to become a regulated fund.
- Register for a TFN.
- Register for an ABN.
- Register for GST (if applicable).
COMPLIANCE REQUIREMENTS
- ABN registration.
- Tax File Number application.
- GST registration (rarely applicable).
- BAS monthly or quarterly (rarely applicable).
- Tax Return – yearly.
- Financial statements – Balance Sheet, Investment Strategy, Profit and Loss, and members’ Investment Accounts.
- Yearly audit by an approved Auditor.
ADVANTAGES
- Assets protected in Super fund.
- Lower tax rate of 15% on income and contributions.
- Retirement planning – payment of pensions.
- Capital gains tax discounts.
- Imputation credits offset tax liability.
- Control over investments.
- A better vehicle than the traditional Testamentary Trust in respect to Deceased estates.
- Can purchase Business real estate property from members, or unrelated parties.
- Can purchase Residential real estate property from unrelated parties.
- Can purchase property jointly with related parties.
- Is a particularly good Tax Planning tool, in company with the right business structure.
- In the allocated pension phase, there is no tax payable by the fund.
- Entire superannuation account under RBL (currently $588,056) can be passed to
dependants including wife by deceased member, tax free.
- Employers may be forced to direct any super contributions to the fund of your choice. (Legislation pending)
DISADVANTAGES
- Cost of establishing, maintaining and compliance.
- Recordkeeping must be rigorous
- Trustee responsibilities and duties.
- Audit certificate required.
- Contribution surcharge.
- Funds locked until retirement age.
- Government legislation may change in the future.
- Cannot borrow.
- Restriction on type of investments it can hold.
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