Business Structuring In Australia For 2020 Onwards

Business structuring is one of those areas that people going into business know is important.

They hear it from their accountant (if they have one) or someone has mentioned it to them in passing.

But let’s be honest.

It’s generally not top-of-the-list when setting up a business in Australia with everything else that has to be done.

So people may be tempted to simply operate in their own name and save some costs.

It’s simple … you already have to lodge a tax return … and already have a bank account.

But there’s a reason there are different business structures in Australia and these can provide far more benefit for you than you might have ever expected.

If you know what to look for.

So let’s take a crash course in business structures so you have more insight into what to consider for your situation.

The you can talk to your accountant and solicitor about it, if ever the need arises.

Sound good?

Then let’s start.

1. What is business structuring and how it affects your business operations

When accountants and solicitors talk about business structuring, they’re really talking about one simple question:

What is the legal entity through which you will operate your business?

For some people, this may be the first time they have ever considered the question.

And people may not even be aware that different legal entities exist and can affect how their business is operated.

Here in Australia, most privately-owned businesses operate through one of the following:

• Company
• Trust (discretionary or unit)
• Partnership
• Sole Trader

So what’s the difference between each one and what’s best for you?

Well, we’ll get to that in a bit but for the moment, there’s something far more important that will help us move closer to that answer.

2. The 5 major areas that provide the overall foundation for structuring

It’s very easy, when a new business owner understands the concept of business structuring, to want to jump right in and compare the different business types in Australia.

But that’s a bit like buying the latest luxury car model because of the features advertised, without understanding where you’ll even drive it.

The good thing with business structuring is that it forces a business owner to think about what’s most important to them with the “behind-the-scenes” running and growth of the business.

And those behind-the-scenes focuses usually fall into the following 5 areas:

• Minimising taxation
• Maintaining accumulated assets
• Considering retirement objectives
• Considering estate planning objectives
• Keeping administration as simple as possible

2.1 Minimising taxation

Everybody wants to pay the least amount of tax as legally possible.

But some people place a higher priority on that goal than anything else.

Even if that means setting up complicated structures and paying more for the maintenance of those structures.

This could occur when retaining the maximum amount of after-tax profits is required to fund the business operations through its honeymoon period.

That doesn’t mean they don’t give consideration to any of the other 5 foundational areas we’ll discuss.

They just place a higher priority on minimising taxation.

2.2 Maintaining accumulated assets

Some people commence business already having accumulated assets from other sources.

These could include assets from external investments, the family home or even a previous business.

Whatever the source, those assets may have been accumulated over a number of years.

And the owner’s main focus may be not to lose what’s already been acquired through years of hard work.

So he/she may not want the business operations to potentially jeopardise them.

Any other foundational areas become a secondary consideration.

2.3 Considering retirement objectives

This may sound like an issue that’s for the distant future but sometimes the future is nearby.

There are many people in their 40’s and sometimes even in their 50’s who commence a business or undertake a project.

In these cases, their main focus may be to build the business to a stage where they can sell it and use the proceeds of the sale to fund their retirement.

For these people, their structuring needs may revolve around the most attractive structure for a potential sale.

Sometimes, maintaining part ownership or incorporating superannuation implications also need to be considered.

2.4 Considering estate planning objectives

For someone undertaking business for the first time in their 30’s, this may not be the top priority.

But for someone in their 40’s or 50’s, this goes hand-in-hand with retirement objectives.

What do you want to happen when you’re no longer here?

Do you want your business to continue or do you want everything cashed-in and paid-out to beneficiaries?

Whatever your desires, your business (or the proceeds from its sale) may form a big part of your estate.

Your your main focus may be to maximise this, so you leave a legacy.

2.5 Keeping administration as simple as possible

Some people are good at running the day-to-day operations of their business but struggle with the paperwork (or should I say “digital” work).

Having to deal with income tax, GST, employment obligations, BAS’, etc is hard enough when operating in your own name.

So imagine what it’s like having to deal with all of that, as well as director obligations, Corporations law and additional bank funding requirements when operating through a separate business structure.

At times it can seem very overwhelming and so a business owner may prioritise keeping the administration as simple as possible.

This doesn’t necessarily mean they don’t operate through a separate business structure.

They may very well do so but focus on ensuring the administration is simplified by having systems in place to keep everything up-to-date at all times and provide real time data, as needed.

It’s generally the case that most business owners have one or two focus areas that are the most important to them.

Meeting these focus areas allows the owner to satisfy the “sleep at night” test.

Once you have some idea of which of the 5 foundational focus areas is/are important to you, you’re then in a position to start looking at which legal entity type may be best for you.

3. The Case Study

Sometimes, a table providing a comparison of the pros and cons of the different business structures in Australia can provide benefit.

But of even more potential benefit and value is seeing how they’re considered in real life.

So let’s take a look at the hypothetical example of Max & Jenny, who have decided they want to start a business.

They’ve heard about the different business types in Australia and want to talk it through with someone to see what structure may be best in their circumstances.

3.1 The details

• Max is 35 and Jenny is 32 and both currently working full-time.
• Max is looking to start a business of preparing computer-aided design instructions relating to the medical field.
• He will start with some existing customers who know him and will employ a computer engineer who will help with the design and compilation of the products.
• Jenny will continue working for the next two years but then wants to stop so she and Max can start a family.
• Jenny owns the family home, with a small mortgage left to pay-off and they own no other major assets (apart from superannuation).
• The long-term plan is for the business to be operated for the next 20 years, at which stage, they may look at selling it or closing it down.
• The business will be a private family business … no other partners involved.
• The business will also be profitable in the first year, after a salary for Max.
• Both Max & Jenny want to make sure the family home isn’t adversely affected by anything that happens to the business.
• Max also wants to minimise taxation in the first few years to ensure cash is maximised for potential reinvestment back into the business (i.e. more complex computers and specialist equipment and more staff).

So … with these limited facts, how did the discussion unfold?

3.2 The discussion

From the information that Max & Jenny provided, minimising taxation and maintaining accumulated assets were the main focus areas for them.

So these areas had to be kept in mind at all times when making any decisions.

3.2.1 Ensuring the business didn’t affect the family home

As the family home was owned by Jenny, it was important she had no official capacity in the business.

If she did, this could potentially expose her assets if anything went wrong.

With company structures, this would generally mean being a director and for trust structures, this means being a trustee.

This meant acknowledging that Max would bear the risk as he would be running it and have some form of official capacity.

However, as Max did not own any assets, this position was seen as acceptable.

3.2.2 Minimising taxation

Even though Max did not own any assets in his own name, it was decided that the business should not be run as a sole trader.

The business was to be profitable from its first year.

So any profits earned under the sole trader model would be taxed solely to Max and incur a high rate of tax.

If the business was operated under a discretionary trust structure, then profits would be distributed to beneficiaries who bear tax.

In this case, both Max and Jenny would already be earning a salary and have income in their own names.

Any profits distributed from a trust would only increase their taxable income and once again incur a higher rate of tax.

There would also be the question of then having to lend after-tax funds back to the trust for working capital purposes.

A company structure, though, pays a flat rate of tax of 27.5% (currently).

So any after-tax profits can be retained in the company without the obligation of having to pay them out.

3.2.3 Keeping administration as simple as possible

It had already been decided that the business would not be run by Max as a sole trader.

Therefore, it was accepted that another business structure would be utilised.

Because the business would involve employees, suppliers, invoicing and work-in-progress, it was agreed that online accounting software would be used.

This software would automatically reconcile transactions, prepare BAS’, send bills and record invoices from suppliers as soon as received.

This would allow the administration of the business to be streamlined and Max to focus on marketing.

It was also agreed that the business structure would need separate tax returns, financials statements and any other registrations.

3.2.4 Retirement and estate-planning considerations

Even though it seemed like a far-off matter, it was explained that in 20 years, the business may have considerable worth.

Therefore, someone may want to buy it and so any business structure should be able to facilitate the transfer of the business and minimise any taxation associated with this.

A trust structure currently allows for a 50% Capital Gains Tax exemption on the sale of any assets held for more than 12 months.

However, both Max and Jenny felt that this concession  would not be available in 20 years.

Additionally, Max believed he may still want a part ownership in the business to allow some income to continue to be earned in retirement.

Depending on how this part ownership was structured, it could then form part of his estate-plan.

3.3 Decisions reached and why

After discussing the factors above with Max and Jenny, the following structure was decided-upon.

The business would be operated through a company structure.

Max would be the sole director with the shares owned by a discretionary trust.

From a taxation perspective, Max and Jenny felt comfortable in having the ability to pay tax at a flat rate in the early years.

At some point in the near future, Jenny would also be stopping work and not earning any income.

So the after-tax profits of the company could be paid-out to her as dividends, via the trust shareholder.

This may allow the possible refund of company tax paid.

Having the discretionary trust shareholder also meant that Max didn’t own a potentially valuable asset in his own name.

This was an important consideration given he was the risk-bearer (i.e. director).

The company structure also allowed for the possibility of selling shares in future if Max wanted to retire or semi-retire and maintain part-ownership.

Having a company as the operating entity was also beneficial if ever it needed to obtain bank borrowings.

Banks generally better understand and are more comfortable lending to companies than discretionary trusts.

Both Max and Jenny believed the structure chosen was the best one for their circumstances, both now and into the future.

4. Final Thoughts: Business Structuring in Australia Going Forward

The above case study is a purely hypothetical example and doesn’t encompass everything that needs to be considered.

But if you’ve made it this far then you’re smart enough to have noticed something about the factors discussed above.

It doesn’t just apply to those starting a small business.

All factors are equally relevant to those who have been in business for years.

Why so?

Because structuring is based on people’s circumstances and circumstances constantly change.

Unforeseen events do happen, such as divorce, death and financial adversity.

Which means your business structure should be constantly reviewed to keep up-to-date with your circumstances.

And now you’re in a better position to understand some of the issues to discuss with your accountant and solicitor.

These people should ALWAYS be involved in business structuring discussions before any decisions are made.

But at the end of the day … really … no-one will ever know your circumstances better than you.

Anything not discussed in this article that you’d like to talk about?

Then hop over to www.sculptaccountants.com.au/contact/ and let us know. _______________________________________________________________________________________________________________

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Until next time. Please Note: These articles are provided for education purposes only and should not be construed as specific advice. Always seek professional advice in relation to your personal and business circumstances.