Not only will the right structure help you build wealth it will help you retain wealth. The top three structures we see being used when operating a business are a sole trader, a trust and a company. Each of the structures have their advantages and disadvantages and choosing the right one is critical.
As part of the Federal Governments 2015-16 Budget, changes have been made effective 1 July 2016 that allow small businesses to restructure their affairs without incurring a CGT liability. This is great news for small business owners as generally the business structure they start with is not always the best structure over time.
The top three reasons why business owners might need to restructure are:
1. Tax– Your business structure determines the tax rate you pay. Some structures offer great tax concessions for realising Capital Gains Tax (CGT) and others may allow research and development benefits.
2. Asset protection– companies and trust structures generally offer greater asset protection than operating through a sole trader or partnership. Separating assets from business operating entities can also provide protection of assets.
3. Compliance– Companies and trusts are generally more expensive to maintain but the benefits of doing so usually outweigh the costs.
So what is the best structure for your business? This decision needs to be made by weighing up all the relevant facts in your situation and what the long term plan of your business is.
Some of the advantages and disadvantages of each structure are out lined below:
Sole Trader vs Trust vs Company
Sole Trader:
Pros: a. Cheap and easy to start up;
b. Cheaper ongoing costs as you only need to lodge one tax return;
c. No need for workers compensation insurance if you are the only one working in the business.
Cons: a. Limited options available for tax planning;
b. Limited options available for asset protection. You and your business is a single entity, that is, if the business is sued, you are being sued.
Company:
Pros: a. Personal assets are protected from action against the business;
b. More options available for tax planning;
c. If the company goes into debt, generally the creditors are not able to recover their debts from its shareholders and directors.
Cons: a. More expensive to setup and administer each year (2 tax returnsto lodge each year);
b. More paperwork;
c. Generally, will need to have workers compensation insurance even though you might be the only employee in the business.
Trust:
Pros: a. If you have a corporate trustee (a company), your personal assets are protected from action against the business;
b. Profits from the trust can be distributed to its beneficiaries. In a family trust's case, usually the named beneficiaries, their kids, grandkids, parents, grandparents and any related entity (provided the correct elections have been made).
Cons: a. More expensive to setup, i.e. you need to setup a trust and a company. If the trust is setup in NSW, it also needs to pay $500 stamp duty. More expensive to administer each year. A tax return for the trust and each of its beneficiaries is required.
b. More paperwork;
c. Generally, will need to have workers compensation insurance even though you might be the only employee in the business.
If you are thinking of changing your business structure, there are a few overarching principles that you should consider:
1. Don’t overcomplicate things– A simple structure is often the best structure. The more complex a structure gets, the costlier it gets to administer the structure. If the structure is overly complicated and is done just to reduce your tax, the Tax Office might start to question the reasons the structure is in place.
2. What is the plan of your business– too many business owners setup their businessbased on how it is going to operate today. Always setup your business with the end in mind. The structure should allow for effective and efficient future growth. Consider your exit strategy and how this is going to come about as each structure has a different tax outcome and some buyers want to buy only business assets whereas some buyers want to buy into the business structure.
3. Keep valuable assets away from risky business activities– all business and personal assets should be separated from the business activities to ensure if anything happens with your business your assets are secure.
At risk individuals- Choose one person in the family to be the 'at risk' individual. This is usually the individual who runs the business. This person will be the director in the company and they provide personal guarantees to lenders etc. This person owns no assets.
4. Consider a corporate trustee for a trust– when a business operates through a trust, a corporate trustee is a must have. This will generally separate the debts of the trust from the individual to the corporate trustee.
5. Consider a family trust as a company shareholder– If you choose to run your business through a company, consider owning the shares through a family trust to improve both asset protection tax efficiency.