GALLEON INSIGHTS

What Business Structure Suits You The Best

What Business Structure Suits You The Best

Choosing the right business structure to carry out a business should be done carefully and thoughtfully. Although not irrevocable, it is costly to switch between different types of business structures as the business changes. Setting up an inappropriate structure from the beginning can end up costing the business significant amounts in tax each year and if the business runs into financial trouble they may end up losing a lot more.

When choosing the most appropriate structure for a business there are a number of considerations which are often taken into account. Every business is different so there is no one choice that fits every business.

There are four fundamental objectives required to achieve the optimal trading structure for any business owner:
1. limited liability protection — the ability to ‘walk away’ from unsecured creditors in the event of insolvency
2. asset protection — protection of all private equity including the family home, from trading risk
3. tax minimisation — ensure the structure qualifies for all CGT concessions and deductions claimed and maximum flexibility in distributing net profit to low income beneficiaries
4. succession flexibility — maximum options and minimal tax outcomes when selling, listing or transitioning to next generation.

Sole Trader
A sole trader is run by an individual with assets or investments owned personally. There is no legal separation between the individual and the business. This means that the individual is liable for any debts incurred by the business and income generated by the business is treated as personal income.

A sole trader is the simplest, cheapest and most easily administered form of business structure. It is simply a person who carries on a business directly as an individual without the use of formal legal structures. From a legal point of view there is no difference between the person and the business.

The advantages of operating as a sole trader include:
1. It’s inexpensive, simple to set up and easy to maintain
2. The trader has complete control over the management and direction of their business
3. The trader owns all their business’s profits and assets
4. There is less paperwork than other business structures
5. Minimal statutory provisions and government regulations govern how the trader operates their business
6. Unlike a corporate structure, the trader does not need to disclose their profits to the public which offers greater privacy
7. They are easy to wind up and they keep any after-tax gains if they sell the business
8. Capital gains tax (CGT) small business concession and 50% CGT discount for sale of assets held by a sole trader are available.

The disadvantages of operating as a sole trader include:
1. Personal liability — business debts may need to be paid from the personal assets
2. Sole traders are fully liable for their business debts, so they risk losing personal assets (e.g. home, vehicles) if they cannot repay their debts.
3. Sole traders may be limited in how long they can stay away from the business (i.e. fewer holidays). Similarly, if they become sick, disabled or have an accident, their business may stop operating
4. Sole traders pay tax on profits at their individual income tax rate, which may be higher than the company tax rate
5. Sole traders are unable to expand the business as they have very limited capital raising ability.
Given the sole trader is by their very nature, there is no pooling of assets and the sole trader has only their own personal assets to draw on for fundraising purposes
Sole traders are unable to minimise tax by income splitting.

Partnership

A partnership involves two or more partners that jointly own the business’s assets and liabilities and make joint decisions over how the business is run. In its simplest form, a partnership is where two or more individuals, companies or trusts agree to carry on business together with a view to profit.
All the partners in a partnership are treated equally from a legal point of view. If there is no written agreement, all partners will share in the profits equally, are liable to cover losses equally and are equally responsible for the activities and trading of the business.

From a legal point of view, partners should prepare a partnership agreement to formalise their relationship. As far as third parties are concerned, the liability of the partners for all business debts and obligations is joint, several and unlimited.

The advantages of partnerships include the following:
• Partnerships are easier and less expensive than companies to set up
• Partners in a partnership may carry on business under a trading name.
• Partnerships combine the resources and expertise of a number of people.
• Partnerships are simple to administer. Profits and losses are shared between partners according to their share (as specified in the ‘partnership agreement’).
• Unlike the sole trader structure, partnerships allow for greater flexibility in holidays and sick leave.
• Changing the legal structure of a partnership is relatively simple (e.g. changing from a partnership into a company at a later stage).
• The CGT small business concession and 50% CGT discount for sale of assets held by a partnership are available.

The disadvantages of partnerships include the following:
• All partners together are personally responsible for business debts. Each partner is individually liable for debts incurred by the other partners. This is known as being ‘jointly and severally’ liable or ‘unlimited liability’. The profits of the partnership have to be shared with the other partners, so it may seem disproportionate to have the burden of unlimited liability.
• All partners have a right to participate in the management of the partnership (unless otherwise agreed).
• Tax is charged at the personal tax rate for a partnership. As business earnings increase, so does the tax rate.
• Partners cannot transfer their ownership to someone outside the partnership unless the other partners agree.
• Personal differences may interfere with business in a partnership.

Trusts

A trust involves the trustee (either an individual or company) holding trust assets in their or its own name, but for the benefit of a group of persons or entities (beneficiaries). The trustee is required to use any property belonging to the trust for the benefit of the beneficiaries.

Trusts are often created because of the flexibility they allow in tax planning, asset protection and estate planning. They are also a popular form of business structure because they allow a flexible means of distributing income and assets and because they can provide certain income tax savings by distributing income among tax-advantaged beneficiaries.

A trustee holds the legal interest in trust property on behalf of another entity or group of entities known as the ‘beneficiaries’

There are many types of trusts, including the following:
• Discretionary trust: The trustee has discretion to distribute the net income of the trust as they choose among the beneficiaries. Most small family trusts are discretionary trusts.
• Unit trust: This is a fixed trust with beneficiaries holding units in the trust. Most public offer managed funds are unit trusts.
• Fixed trust: The beneficiary’s share in the trust estate is fixed by the trust deed
. • Bare trust: This is the most basic form of trust as the trustee simply holds the trust property for the beneficiary with no discretionary powers, and there is no formal trust deed. A common example is that of a parent holding a bank account for a child under age 18
• Hybrid trusts: Where a set allocation of trust assets or income are fixed and the balance discretionary. • Superannuation funds: Operate under a trust structure.

The advantages of trusts include the following:
• A discretionary trust provides asset protection and limits liability in relation to the business.
• A discretionary trust separates the control of an asset from the owner of the asset and so may be useful for protecting the income or assets of a young person or a family unit.
• Trusts are very flexible for tax purposes. A discretionary trust provides flexibility in the distribution of income and capital gains among beneficiaries.
• Beneficiaries of a trust are generally not liable for the trust debts, unlike sole traders or partnerships.
• Beneficiaries of a trust pay tax on income they receive from a trust at their own marginal rates.
• CGT small business concession and 50% CGT discount for sale of assets held by trust are available.

The disadvantages of trusts include the following:
• Establishing a trust costs significantly more than establishing sole traders and partnerships.
• A trust is a complex legal structure which must be set up by a solicitor or accountant.
• The trustee has a strict obligation to hold and manage the property for the exclusive benefit of the beneficiaries.
• Operation of the business is limited to the conditions outlined in the trust deed.
• As with companies, there are extensive regulations that trusts must comply with
• Losses derived in a trust are not distributable and cannot be offset by beneficiaries against other income they may have.
• Unlike a company, a trust cannot retain profits for expansion without being subject to penalty rates of tax

Company

A company is a legal entity that separates its owners (the shareholders) from those who manage the affairs of the company (the directors). It operates as a separate legal entity from the individuals that own the company shares. The assets and liabilities of the business as well as all income and expenses incurred in running the business are accrued to the company, not the individual. As such, the shareholders and directors are generally not liable for the debts of the company, provided that they do not contravene provisions relating to insolvent trading as defined in the Corporations Act 2001.
A company is regulated by the Corporations Act and must comply with the standards the Corporations Act stipulates. It can operate as either a private company or a public company.

The advantages of companies include:
• Generally, shareholders can only lose the value of their shares and are not liable for the company’s debts (i.e. limited liability).
• Legal arrangements are in the company’s name, not in the name of its directors and managers.
• Companies can trade anywhere in Australia.
• The business structure ensures continuity of management and ownership in the event of the death or disability of key people (because company shares may be transferred).
• The tax rate for companies is less than the highest marginal tax rate for individuals.

The disadvantages of companies include:
• Companies are more regulated than other business structures.
• The rules for establishing and running a company are more complex and costly than other business structures.
• Suppliers and lenders are reluctant to lend money or enter into contracts or leases with proprietary limited companies unless directors or shareholders provide personal guarantees.
• If directors trade while a company is insolvent, they may be held personally liable for the company’s debts
• No CGT small business concession or 50% CGT discount for sale of assets held by a company is available.

Complex Business Structuring
Your choice of structure will depend on the size and type of business and how you want to run it. Each structure may have an impact on key areas such as tax you’re liable to pay, asset protection and costs to set up. In real life, business chose combination of business structures when optimising above factors.

Some of the complex structures that are used for businesses are :
1. Partnership of Trusts
2. Corporate Beneficiary ( Bucket Company )
3. Company with Discretionary Trusts
4. Unit Trust with Discretionary Trusts
5. Separation of “At-Risk” asset

At Galleon Capital & Advisory, we work with Specialist Business Advisors / Tax Accountants to provide you business structuring advice as well keeping your business on track

To learn about our company, services, process, fees and contact details please visit our website :
www.galleoncapital.com.au

By : Shan Muthukuda | CERTIFIED FINANCIAL PLANNER®
Galleon Capital & Advisory Pty Ltd (Corporate Authorised Representative No. 001301679) and Shan Muthukuda (Authorised Representative No. 001233173) are authorised representatives of Spark Advisors Australia Pty Ltd ABN 34 122 486 935 | AFSL 380552.
General Advice Warning: “The information in this document has been prepared for general information purposes only and does not take into account your personal objectives, financial situation or needs. It is not intended to provide commercial, financial, investment, accounting, tax or legal advice. You should, before you make any decision regarding any information, strategies, or products mentioned in this document] consult a professional financial advisor to consider whether it is suitable and appropriate for you and your personal needs and circumstances. Before making a decision to acquire a financial product, you should obtain and read the Product Disclosure Statement (PDS) relating to that product, together with the Target Market Determination (TMD)”.

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