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Business Structuring for SMEs – Tax and Practical Aspects
Business and investment structuring is an art, often involving a weighing up of different competing goals. For instance, the goal of asset protection may not always produce the best tax outcome. Ensuring one’s business or investment structure is correct in its initial set up is extremely important since generally there are costs if an inappropriate structure needs to be revised later on.
This paper reviews key factors which need to be addressed when devising a business or investment structure, and the various structures which may be used.
The latter part of this paper explores a number of commonly found business and investment structures to further elucidate the principles discussed.
This paper is confined to NSW state taxes and does not consider the state taxes of other jurisdictions.
PART 1 – ISSUES TO BE CONSIDERED IN STRUCTURING
1.1 What factors should a solicitor consider in devising a business or investment structure?
1.1.1 When considering how to structure a business enterprise or an investment, three high level issues are typically traversed:
(a) ease and costs of setting up and operating the structure during its existence;
(b) ease and costs of exiting the structure; and
(c) asset protection.
1.1.2 The importance that one places on each of these issues differs depending on whether a business or investment structure is desired. Asset protection and exit costs (such as the ability to claim various capital gains tax (“CGT”) concessions) are foremost for an investment structure. In contrast the robustness of a business structure is likely to be judged via the ease of operation, and the ability to minimise running costs and maximise after tax profit for the principals of the business.
1.1.3 The various issues which should be considered in selecting an appropriate structure include:
(a) Is the proposed activity a new enterprise or an existing enterprise?
A change to a more appropriate business structure entity may entail significant change-over costs. For example, stamp duty on the transfer of assets; the possible impact of CGT; and the possible loss of income taxation benefits (tax losses).
(b) What entities, if any, are currently utilised? What are the existing entity structures?
The choice of what entity to use may be influenced in part by what existing entities and group structure a client has. In this situation it is possible that the appropriate entity is either the existing entity or a new entity of the same or a different nature.
If the existing entity is a company, in certain circumstances it may be appropriate to use the existing company or a new company despite the fact that, for tax purposes, a company acting in its own right is not an ideal structure for acquiring appreciating assets. While a trust is a more appropriate entity to hold appreciating assets, it may be more important to maintain consistency in the structure of entities in certain cases. In the case of a tax consolidated group of companies, profits and losses may be distributed with ease amongst the group. Further, a more significant advantage may be that clients are probably more knowledgeable about companies than say trusts if they already use companies. This may provide commercial advantages such as lower transaction costs.
(c) Does the activity involve the acquisition of an appreciating asset? Does it involve the conduct of a trade or business? What is the form of the income to be generated (dividends, interest, business income, foreign source income, capital gains)?
(d) Who are the participants/principals? – Will there be arm’s length participants or is the activity to be pursued within the “family group”? Will new participants be sought in future?
(e) What are the financing requirements, and how is the security to be provided?
1.1.4 In selecting the appropriate entity the response to the above questions will generally be considered in light of the following factors:
(a) control of the business;
(b) asset protection (protecting personal and business assets from third party creditors);
(c) family law issues;
(d) CGT issues;
(e) stamp duty issues;
(f) income tax issues;
(g) goods and services tax issues;
(h) land tax, payroll tax, and other state taxes;
(i) estate planning and succession issues;
(j) professional/industry requirements; and
(k) commercial knowledge/complexity/administrative and compliance costs.
1.2 What are the different business and investment structures available?
1.2.1 The possible structures available include:
(a) No separate legal entity:
(i) sole proprietorship; and
(ii) partnership/joint venture.
(b) Separate legal entity:
(c) Trust relationships:
(i) discretionary trust;
(ii) unit trust;
(iii) hybrid trust; and
(iv) superannuation fund.
(d) Combination of two or more of the above.
1.2.2 Obviously, the choice of a combination of two or more of the entities mentioned above can lead to a spectrum of possibilities. In practice combinations of structures may be used to deal with the short comings that one particular type of structure may have. For instance, a trust may have a corporate trustee so as to obtain limited liability.
1.3 What are the characteristics of a good structure?
1.3.1 The characteristics of a good business or investment structure are:
(a) flexibility so that the structure can accommodate changing circumstances with minimum consequences;
(b) the structure provides adequate asset protection to the principals of the business;
(c) the structure minimises costs, particularly tax; and
(d) the structure allows for the efficient distribution of profits.