When starting a new business one of the most important decisions that should be made is choosing the most appropriate business structure to operate the business through.
Getting the structure right at the start is important because failing to get it right can have costly or even disastrous consequences later on.
Unfortunately this important consideration is often overlooked. Spending the time and money to consider the issue should be viewed as an essential part of the planning in setting up a new business and should be part of the business plan. Spending the time and money to consider these issues when commencing a new business is essential.
If you get the structure right it can save the business and its proprietors a significant amount of money and stress in the future. The choice of structure is important for protection planning and ensuring that only the minimum amount of tax that needs to be paid is paid.
Some structures provide more as a protection and some are more tax effective.
The most common structures are listed below:
Sole Trader, Partnership, Family Trust, Unit Trust and Company
A Sole Trader is basically an individual conducting a business either in their own name or in a business name. This structure is very cheap to set up and run but has no benefit in terms of asset protection. The assets of the business and the owner of the business are not separated and all are available to creditors should the business fail. It is also limited as far as ability to stream income in a tax effective manner.
This structure is best suited to small operators who don’t have a large turn over and have little associated business risk.
A Partnership is basically a collection of individuals who have decided to trade together. In a Partnership all the Partners are jointly and severally liable for the debts of the Partnership. That means that they are each individually and collectively liable to creditors. A creditor could pursue the partner with the most assets to the exclusion of the other Partners. As with Sole Traders there is little asset protection in benefits in operating through a Partnership.
There is also limited ability to stream income in a tax effective manner. These days partnerships are most commonly seen in small family businesses operated by a couple.
Family Trust which are also known as Discretionary Trust are commonly used by many small business operators in Australia. A trust is not a legal entity as such but rather a relationship. In a trust an individual or company or a group of individuals or companies will hold property or assets on behalf of a specified group. The party holding the assets is regarded as the legal owner of the assets to the outside world. This person is called a Trustee. The people that the assets are held for are referred to as beneficiaries. These are the people that are entitled to the benefit of the assets. This gives some asset protection benefits.
In a Family Trust or a Discretionary Trust the beneficiaries are usually a range of different classes of people associated with a specified individual. The class of beneficiaries can be quite wide. The trustee makes a decision each year as to who is to receive the income from the Trust. The income of the Trust can be divided in a tax effective manner.
Family Trusts are a good structure for operating a small business in which one family is involved.
A Unit Trust is similar to a Family Trust or Discretionary Trust except that beneficiaries of the Trust are called Unit Holders. Each Unit Holder purchases units in the Trust. Each Unit Holder also has a fixed interest in the Trust Assets according to their proportion of units in the Trust. If there was a Trust created for 100 units and two people held 50 units each, they would each have a 50% entitlement to the assets and income of the Trust. The Trustee has no discretion as to how to divide the assets or income.
There is little ability to stream income through a Unit Trust, however it does have the same asset protection as a Family Trust.
Where you would commonly see a Unit Trust is where you have two or more family groups or individuals wanting to invest in a venture together. In a typical structure sitting underneath the Unit Trust would be the Family Trust of the respective individuals.
This means that the units in the Unit Trust are owned by the respective Family Trusts. In the above example if there were 50 units to each individual these units would be held by the Family Trust, the result being that the income of the Trust is split equally between the two individuals however each individual Family Trust would effectively split that income in a tax effective manner relative to the personal circumstances of each individual.
A Company is a separate legal entity. A Company is taxed at Company Tax Rates which is currently 27.5 cents in a dollar for a small business. A Company is a good structure for asset protection. They are also good entities where the business has to retain significant earnings as working capital. There are limitations however on getting money out of the company. Income needs to be paid as either wages or as a dividend. With changes in tax laws companies are becoming a more popular option for running a small to medium sized business.
There are advantages and disadvantages of any structure. The individual circumstances of each situation have to be considered. It is also a decision that needs careful discussion with accountants for each party.
If you are considering commencing a new business please feel free to contact Ben Carroll to discuss any aspect of Business Structuring.