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Choosing the Correct Business Structure

By Tyler J. Wise|March 16th, 2021|Blog|

Once of the most important factors to consider when you are establishing a business is ensuring the structure to choose is one that not only allows you to achieve your short term goals in a tax efficient manner, but one that also considers the long game, such as business succession and sales. Most clients when they are commencing a business have little head space for such concerns, however, we stress that this needs to be considered. If your business follows your expectations, assuming your goals are aspirational and achievable, then you will either need additional capital / equity / partners, or may wish to sell the business.

Some clients, accountants, and business owners will much prefer to have these conversations further down the line, which we understand and appreciate. In certain instances budget constraints may dictate the structure you have to choose, but often the cost outlay at the beginning is saved in spades at the other end.

If you commence a business in any structure now, and look to change it later on you may trigger a capital gain event; whilst their exist concessions in place, pending your business position, the costs incurred with investigating and executing this can more than exceed the initial set up costs that may occur in the beginning.

In addition to exit strategies it is imperative to consider external business, investment and personal interests and assets you may hold that could potentially be exposed if something unexpected occurs in your business, and the structure is not one that affords you security.
The most common trading set ups are:

1.    Sole trader – you trade in your own name, with all profits being attributed to you. This structure is suitable when public risks are minimized, you have a low capital requirement, and all profits may ultimately be attributed to you under personal services income provisions.

2.    Partnership – these are certainly less common recently, due to the lack of protection offered to partners. These are adequate if you are using an interposed entity (such as a trust with a corporate trustee) however, ultimately one partner bears the risk of the other partner, without limitation. It is important to note that this is typically the mechanics of a tax partnership, and a legally binding partnership established under legal agreements may provide certain exclusions. These are most common for ‘mum and dad’ businesses where public risk is minimised, or the personal asset pool is not material.

3.    Trust (with individual trustee) – ultimately this structure is use din place of a sole trader, when the personal service income / personal services business provisions do not impact this entity. This structure provides some tax flexibility with a discretionary trust allowing profits to be distributed at the trustee’s wishes. This structure provides tax flexibility but not asset protection. This is typically seen in place of sole traders, where the personal asset pool is insignificant, low capital expenditure is required and the personal services provisions are not involved.

4.    Trust (with corporate trustee) – arguably the accountants preferred structure as it provides both tax flexibility and asset protection. If the trust is a discretionary trust it can provide issues with a partial business exit, however, a substitute that is seen is a unit trust used as the trading entity, and the units being owned by a discretionary trust. This will provide tax flexibility and asset protection, but ultimately is superfluous with excess entities being established. This structure may be used, as opposed to a company to avoid any potential Division 7A loans that are anticipated to be a potential issue.

5.    Company – with the lowering of the corporate tax rate, and the intimations from the Treasury that they continue to consider taxing trusts in their own right, these are again becoming popular trading entity choices. Companies provide the ultimate in asset protection, so long as directors are not trading whilst insolvent or undertaking illegal activities. As shares are owned within the company it is very easy to dilute or increase your ownership percentages (triggering capital gain events) as needed by selling or re-acquiring shares in this entity – much like you would with a listed entity. The issue with this trading entity, from an accounting perspective is that companies are not afforded a tax free threshold, and as a result the tax efficiency may not be present immediately. Although any good accountant will help develop a tax strategy to ensure you are still maximizing tax concessions that exist in other structure. As with the unit trust, a discretionary trust can own the shares in this entity, and so tax flexibility may exist with the dividend income (when received).

We are aware clients generally have a short term and long term plan in place for their business; without the structure being considered too intently until such time that we raise it. It is imperative that the tax advisor have a handle on these matters, the benefits and pitfalls of each structure. It is very much a case of ‘horses for courses’ and any one of the above structures may suit your business interests, just be certain you have considered all outcomes, business growth, potential exit(s) and tax efficiency.

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