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NEWS - PLANNING
Finding the right structure
4/22/2003
Whether you are considering starting a business, or buying an established one, it is essential to do some early planning to avoid unnecessary tax liabilities, stamp duty costs and exposure to other liabilities.
From a taxation perspective, there is a number of issues to weigh up, including:
• The different income tax rate applying to various business structures - companies pay 30 per cent tax, individuals pay up to 48.5 per cent.
• The ability of the owners to use start-up or recurring losses that the business may incur.
• The ability of the owners to access the 50 per cent discount in tax rates applying to capital gains upon the sale of the business or the capital gains tax small business concessions.
While tax is important, it should not drive the business structure decision solely. There are usually three main issues to consider when deciding upon a business structure - commercial acceptance, asset protection and income tax.
Commercial factors will often influence the type of business structure. The factors to be considered include the ability to raise finance, whether other businesses will deal with that structure and whether professional or industry regulations allow you to operate through that type of structure.
Asset protection concerns limiting the ability of creditors to access the assets of the business and the business owner if a claim against the business arose.
The imposition of tax on business profits and on capital gains upon sale of the business varies depending on the structure. Planning from the outset may help to manage and even reduce these. Typically, the structures available vary from sole trader to partnership, trust, company or a combination of these.
A sole-trader structure would generally be used only for small trading businesses or for consultants who have few, if any, employees. Sole traders are taxed at the individual's marginal tax rate (top rate is 48.5 per cent), but business losses can be offset against other income where the business meets certain eligibility requirements.
Individuals will pay tax on only 50 per cent of capital gains where assets have been held for more than 12 months. This means that the maximum tax rate on capital gains is 24.25 per cent.
The ability to combine the "discount capital gain" with other small business CGT concessions can significantly reduce any CGT. This is available where the net value of business assets and certain assets owned by related parties connected with the business is below $5 million.
The sole-trader structure provides no asset protection, as there is no separation between the ownership of business assets and private assets. And customers of some businesses will prefer to deal with a company rather than an individual to avoid being caught up in employment obligations.
A partnership structure consists of at least two different entities carrying on business with a view to profit. The level of risk will depend on the structure of the underlying partners, which could be individuals, trusts or companies.
A risk in using a partnership structure is that each partner is jointly and severally liable for actions of the other partners. The partnership does not pay tax, but the underlying partners are taxed on their share of the income at their marginal tax rate. Partnership losses may be offset against other income of the partners and this can be advantageous where the business anticipates initial or continuing losses. CGT will be paid according to the rules that affect the underlying partner's structure.
Trusts controlled by a corporate trustee are a popular business structure for privately owned businesses due to the flexibility they provide and the limitation of liability they offer.
Unit trusts must distribute income and capital in accordance with who holds the units, while the trustee of a discretionary trust has discretion for distributions among a range of nominated beneficiaries.
A trustee does not usually pay tax on behalf of the trust; rather, the beneficiaries pay tax at their marginal rate on their trust distributions. Trusts cannot distribute losses, but can carry them forward to offset against future income. A trust has access to discount capital gains and these are passed on to beneficiaries who can utilise the discount.
A company is the most commonly used form of business structure because of its commercial acceptance and the limitation of liability that it offers. The company tax rate is at present 30 per cent. Companies can carry forward tax losses and offset them against future income if certain ownership and same-business tests are met. Unfortunately, discount capital gains do not apply to companies.
Therefore, any capital gains are taxed at 30 per cent, rather than the 24.25 per cent maximum rate that applies to individuals. While a company may be able to utilise the small business concessions and reduce its tax on capital gains, any untaxed income that is to be distributed to shareholders will be unfranked dividends, which are taxed at the shareholder's marginal tax rate. This effectively negates the benefit of the concession.
This overview highlights that there is a range of commercial and taxation decisions that need to be considered to determine the structure appropriate to your business. Proper planning will help to manage both tax on business income and CGT on sale of the business as well as provide asset protection to various degrees.
Seeking professional advice to assist you to determine the correct structure for your circumstances is a sensible first step.
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