Getting some structure in your life… (Part Two)

Posted 22 May '19

The Problem with only one entity

Now the problem with only having one entity in your business group is that you may be missing out on hitting one or more of the key considerations in my last article (see here if you missed it).

Tax Minimisation

With sole company in the business structure, yes it does provide the corporate tax rate shelter so there is cap on tax. So it doesn’t matter if you are earning $1 or $1 billion, tax will be, you guessed it, 30%. But the issue isn’t now but in the future. With proper planning and opportunities, your business will begin to retain earnings and build some cash over time. But to actually reap the rewards of company profits, the company needs to pay dividends. This is where the major issue lies as it is only the shareholders who will be entitled to these dividend. Now assuming it was a sole director & shareholder company, who do you think is going to be taxed on that dividend? I’ll give you a hit “sole” means it can be only one person; YOU. And what is the highest marginal tax rate again, let’s see, a spectacular 47%. But if you did have a discretionary (family) trust as the shareholder, then you have the discretion, to distribute the dividend from that company to whoever you want at whatever proportion you decide. See how fun it gets when we combine structures.

On the flipside to this, let review this from a sole discretionary trading trust’s perspective. If you simply had a discretionary trust, yes you would have the ability to nominate whoever and to what proportion you may want to distribute profits from the business to, but what happens again when you don’t have anyone else to distribute to. For example if all your family members were under 18, were in the top marginal tax bracket or you didn’t want the income to affect their government entitlements. You are almost faced with the similar situation with the sole company above ~ 47% tax. And trust me, you don’t want to retain income in trusts, you also pay 47% as a penalty tax for not distributing income before the end of the financial year. However, if you also had a company in place, you could distribute the net business profit from the trust to that company to cap the tax at 30%. So flexibility is the key.

Asset Protection / Limited Liability

From an asset protection perspective, a company isn’t always fool proof. Directors can be personally liable for the debts of the company in the event negligence and breach of directors’ duties. Further the superannuation and withholding tax is also subject to a director’s penalty notice. Now in a situation where you are a director of a company and you are also a shareholder. Because you personally own the shares, and following a lawsuit or claim being place on yourself personally, well the shares (the business) will also be at risk. This can simply be eliminated by interposing a trust to hold the shares in the company.

With a sole discretionary trading trust, it is important to note that the trustee, whilst being the legal owners of trust assets, can be sued personally for the conduct of the trust. This means that they can be indemnified from their personal assets in the event of litigation. This is an easy fix; set up a private limited company and have that act as the corporate trustee of the trading trust.

Succession Planning

Last but not last we consider succession planning in the context of only having one entity. With only one company, is makes the transfer of the business to the next generation potentially more costly; at least tax wise. To pass on ownership of the company to your children, you would have to physically transfer the shares to them. Unfortunately as there is a change in beneficial ownership, capital gain tax in triggered and you need to pay tax on the deemed sale of shares (again up to 47% tax). If you’ve built up a solid business at the time, this could potentially be hundreds of thousands of dollars in tax. How do you fix this? Again, by interposing a family trust. Now how does this avoid a direct transfer in this case? Well, he who controls the trust controls the company. So all you would need to do is simply resign as trustee of the trust (being the controller) and appoint your son or daughter to be the succession trustee of the trust. In addition to this, as trust are not estate objects, they do not fall in the realm of your will. And thus you can hire wire succession clauses in your trust deed and it will be very difficult to challenge this in court.

With regards to trusts, it succession planning to pass on your business to the next generation in your family member is not the main consideration. The issue here is with transferring the business to key employees and staff in the business. As discretionary (family) trusts do not have fixed entitlements, it is almost impossible to incentivise them into the business by giving them equity interests in the business. A company give issue employee shares over time linked to their performance and upon retirement, have them purchase the remaining shares to complete the succession plan. You retire with a pot of money from the share sale and the employee gets to continue on your legacy. Win/Win.

So can you start to see a pattern emerging from this? That it is almost impossible to achieve maximum tax effectiveness and optimal asset protection without the other entity being in place.

Only have one entity?

Now if you are reading this and you only have one entity at the moment, don’t worry! It just maybe the case that your business and personal situation doesn’t suit either another company or trust being added to your business structure. Remember, it is about you! So whether you are looking to start/buy into a business or have been in business for a long time, call us today on (07) 3124 0244 to secure your complimentary review session (normally worth $300 + GST). If your accountants are doing everything they can for you to ensure your business structure is kicking goals, then I’ll tell you and you can walk away with the peace of mind that ‘hey, my accountants not half bad’. But if there’s anything wrong, trust me, you’d definitely want to know. That second opinion never hurts!

Leonard Jiang | CA, CTA, DFP
Senior Accountant
Tax Specialist

T 07 3124 0244 | E leonard@empireaccountants.com.au