Business and investments may be conducted through a number of different legal structures. The choice of structure can significantly affect a taxing of various transactions. The correct choice of a structure can result in significant tax savings each year, as well as optimize legal and economic risks to the owner.
The most common types of trading structures are:
- Sole traders;
- Companies; and
There is no single, superior operating structure. Rather, the most appropriate structure depends on individual circumstances and needs. When making a choice, consideration should be given to the following factors:
- Asset protection;
- Minimization of tax; and
- Compliance costs.
There is a risk attached to every business venture. One of the goals of most business owners is to limit their personal expenditure to creditors. At one end of the spectrum are sole traders, who assume personal risk as they are personally liable for all of the debts of their business. This expenditure can put at risk their personal assets if the business goes bad. By contrast, at the other end of the spectrum, are companies. Company directors are largely protected from creditors except where the director offers a personal guarantee or where a Director Penalty Notice is issued by the Australian Taxation Office, demanding payment of outstanding superannuation guarantee amounts or PAYG withholding amounts.
Minimisation of Tax
Arguably, the most important consideration is to pay as less tax as possible on your business profits. To this end, you can limit your maximum rate of tax to 30% of your business profits or be liable for as much as 46.5% tax depending on which structure you choose. Furthermore, if you have non-working family members, then by choosing the correct structure, some of your business profits can be tax-free.
Along with income tax, the minimisation of CGT is a prominent consideration for most business owners. When it comes to the time to sell your business, or when you are just disposing of certain business assets, CGT will likely arise. Choosing this structure will give you access to the 50% CGT discount and the following small business CGT concessions is crucial:
- The 15-year ownership exemption (if your business qualifies, you can entirely disregard the capital gain from the sale of the business);
- The 50% active asset reduction (if your business qualifies, you can reduce your capital gain by 50%);
- The retirement exemption (if you qualify, you can disregard a capital gain up to a certain limit); and
- The rollover concession (this allows you to defer either all or part of the capital gain).
Not all business structures allow you to access the above concessions. This can put you at a significant disadvantage when a capital gain arises.
There is a wide variance in terms of the establishment costs and the ongoing compliance requirements of the various structures. On the one hand, while offering advantages such as asset protection, companies can be expensive to establish and are strictly regulated, which can mean significant ongoing reporting requirements and administrative costs. On the other hand, a sole trader structure is inexpensive to establish, is easy to understand and has few, if any, ongoing reporting requirements.
When choosing your structure, a range of additional factors should also be considered, including:
- The ability to admit other business partners;
- The ability of a business owner to leave/retire from the business;
- Minimization of other taxes such as FBT, GST and Payroll Tax; and
- Your understanding of the structure and your ability to comply.
Unlimited Partnerships may be used, provided there are no more than 20 partners.
Limited Partnerships can also be formed in certain cases. Limited partnerships are typically taxed as companies.
Joint Ventures are common in the mining industry. They are also common between companies desiring to operate a new venture.
Bodies Corporate are treated as public companies and taxed at a flat rate of 30% on all of their taxable income. Blocks of homes, strata and titled units are examples of a body corporate.
Clubs, Societies and Associations may be exempt in certain situations. Many clubs and other non-profit organizations do not pay any tax on income from members, but may pay tax on income from non-members and investment income.
Pooled Development Funds are specially registered companies providing equity capital for resident, small and medium sized Australian companies.
Contact us to find out more or to arrange a consultation with an experienced lawyer in Sydney CBD.