Family businesses can provide financial security for generations to come. However, if your business lacks direction, or is not structured in a manner which helps ensure success and risk protection, you could be setting yourself up for a less than ideal financial outcome. Consequently, deciding how to structure your business and family organization is some of the most important strategic decisions you will ever make.
Since your business structure impacts business success and family harmony, including the significant priorities of optimal taxation and asset protection, making the right structural choices will help you to both meet your current business goals and continue to provide financial support for your family in the longer term.
What are the Most Common Business Structures?
In operating a business in Australia, you basically have four business entity choices:
- Sole trader: This is the simplest entity and allows you to maintain full control of the business, yet may expose your personal assets should your business become insolvent.
- Company: A company can limit your personal liability as a company is a separate legal entity.
- Partnership: This requires two or more people to form the partnership who share the distribution of income or losses. This however may also leave partners vulnerable to becoming personally liable for business debts.
- Trust: Trusts require a trustee who becomes responsible for all business operations. When set up properly, they too can help protect your assets and effect sound taxation planning strategies.
When choosing an entity to operate your business, you must consider things such as tax planning, asset protection, management control and administrative costs. In many instances it is beneficial to adopt more than one entity as part of a broader Family Group Structure approach which we explain in further detail below.
Family Group Structure
An example group structure that we have set up for a number of our clients is as follows:
Click the image above to enlarge.
Benefits of the above group structure include:
- Operating the business through a company (i.e. Trading Company Pty Ltd) provides the opportunity for asset and director protection.
- Company profits are taxed at a lower rate than the top marginal individual rate. For example, a high income producing sole trader would pay 47 cents in income tax for every dollar in profit generated. By contrast, profits achieved through a small business company are taxed at the rate of 27.5 cents for every dollar in profit generated.
- Profits of a Family Trust, whether from trading, dividends streamed from company or income from investments, can be discretionarily distributed to those in the family group with lower marginal tax rates (e.g. a non-working spouse), thereby reducing the overall amount of tax paid by those in the group.
- By utilising discretionary distributions and franking credits from the company, it is possible that no or little personal tax is paid by Mum and Dad, despite a healthy level of “income” being available and at their disposal.
- Making concessional contributions to a Self-Managed Superannuation Fund (SMSF) may further decrease taxable income and funds are invested entirely in line with members’ preferences.
- Income earned in the SMSF is taxed at a lower rate than investments held personally, building a larger nest egg for retirement or family succession.
Considering All Factors
Here are some of the most important factors to consider when choosing a structure:
- Tax Planning: As mentioned, if you choose a discretionary trust, you can distribute income and capital gains to your beneficiaries with lower marginal tax rates and distribute different types of income to each beneficiary. As a result, the overall tax paid by your family is reduced. Using this structure allows each beneficiary to pay tax at their individual marginal rate on income distributions received from the trust in each financial year. Care needs to be applied in such planning to ensure that structuring is not mainly for the purpose of tax evasion. Your taxation advisor will be mindful of these requirements.
- Asset Protection: Business structure dictates if owners or directors can be held personally responsible for debt. Choosing a company or trust provides the most protection for your personal assets. For example, if you choose a discretionary trust to own shares, you may have asset protection even if a beneficiary is sued or becomes bankrupt or insolvent.
- Costs: There are costs associated with different setups. For example a corporate trustee set up will cost more money as you must incorporate another company, which makes your setup and maintenance costs higher.
Considering all of these points can help ensure you have the best protection and financial security.
Directors and Business Debt
Directors have important duties to the common law and the Corporations Act 2001 (Cth). When a director breaches these duties it can leave them liable for debts of the company. This would include:
- Failing to adhere to their fiduciary duties;
- Negligent actions;
- Failing to exercise their power and discharge their duties with care and diligence, in good faith and for a proper purpose; and
- Improperly using their position and/or company information.
Since the director’s job is to always work in the best interest of the company, when they fail to do so, or worse, act in their own best interests at the company’s expense, it can lead to the Courts finding them personally responsible for company debt. It’s important to remember that this means the director can have a duty to creditors in cases of insolvency or near insolvency.
In fact, when a company is at a real risk of insolvency, there have been cases where the Courts determine the directors owe a duty to their creditors. When this happens, it is not uncommon for liquidators to expect directors to pay debts from their own funds.
How Can a Director Protect Personal Assets?
It starts with choosing the right business structure. In general, a sole trader or partnership is the riskiest as they offer limited protection options, leaving your personal assets vulnerable to business liabilities. You can protect your personal assets by:
- Selecting the most appropriate risk structure such as a company that acts as a separate legal entity;
- Avoiding actions that interfere with your protective “corporate veil”, which allows the courts to hold directors personally responsible;
- Ensuring you purchase adequate insurance;
- Making superannuation contributions;
- Insulating assets from risk;
- Moving assets to family members;
- Protecting your IP; and
- Having solid contracts.
To better understand the ideal business and asset protection structure for your family and unique circumstances, schedule a complimentary no-obligation consultation with us today.