Martin: Welcome to the business owners’ podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory team.
Hello everybody welcome to the show. I can’t believe we are already at episode 4, our final episode of season 5 with tax guru John Storey. Welcome John.
John: Thank you Martin.
Martin: It’s been a fascinating season John, I do thank you for your contribution and we’ve certainly had lots of positive calls and emails on the previous episodes, so well done.
John: Thanks Martin. Yeah hopefully people are getting a lot out of it.
Martin: I have no doubt about that. And again I thank you for the clear and simple way in which you have been able to talk about some really quite complex and technical issues.
John: That’s the challenge.
Martin: That’s it. Well hey John for this last episode I really wanted to do a good overview of business structures – what’s good, what isn’t so good and what kind of structures suit what kind of situations, because I’ve got no doubt you would have heard this, you know, you’re chatting with somebody at a barbecue or what have you and they say, you know, what structures should I use for my business and they expect that you should give an answer off the cuff and one size will fit all, but it’s not quite like that is it? (Martin laughs)
John: No not at all. It really is horses for courses in choosing business structure, there isn’t one size suits all at all.
Martin: Ok. What we might do because I know that many people listening might be already in a certain structure, I don’t want to talk about restructuring out of your current situation that’s a whole other big discussion, I’m talking about setting things up, so you might be looking to set up a business, you might be in business but you want to buy some land or buy another business set up a new venture. So I’d like to talk about if you’ve got a clean slate what are some of the factors you look at and what are some of the ups and downs of the various structures. So over to you Mr Storey.
John: Yeah well when choosing a structure it’s best to start with some questions. That’s the best way to start. From a tax perspective I suppose some of the key questions are could this business at any stage either in start-up phase or at a later stage make tax losses. Is this business capital intensive, so profits need to be re-invested or is it intended for profits to be extracted each year. And third question is, will there ever be a capital gain arising from this business, could there be a sale? The answers to those questions can lead you to different, down different paths. Of course sitting over the tax questions are also very important asset protection and succession planning. So you know, the key issues there are you generally want to separate valuable assets from risk and from a succession planning view point, if estate claims or that sort of thing are an issue, having appropriate structures to deal with that is a good thing.
Martin: And sorry John if I can interrupt you there because I just want to make one point which is really important and again it goes to one of my pet themes, which is multi-disciplinary advice. We see this all of the time you go to a tax person and you ask what the best structure, you’ll get a tax related response. You go to a wills lawyer and say what’s the best structure, they’ll give you a response that best protects the assets against wills claims. You go to a corporate lawyer and they’ll give you a best structure for exit. You actually need to hear from all of them and of course from your accountant and your financial planner because this is a multi-faceted beast.
John: Yeah and another really important aspect is that things change over time, so advice you had five or ten years ago isn’t necessarily going to be the best advice today. So I’ll give a really good example. A very common structure for business owners is a family trust and they’re still very good today in many respects, they offer asset protection because the beneficiaries and owners are not personally exposed to the activities of the trust, they have flexibility, you can distribute income to multiple beneficiaries that has tax and other benefits. They’re good for succession planning because you can sort of pass the wealth of the trust to your chosen beneficiary so and from a tax perspective they get the 50% discount. So they can see on the surface to tick all the boxes and go why would anyone not want a family trust? But if the answer to one of your questions earlier was I want to re-invest my profits, well after 2009 when the ATO changed the rules around Division 7A and we had another podcast on Division 7A I won’t go into all the issues but they changed the rules and they made it a lot harder for trusts to use bucket companies and cap tax at 30% and so I’ve found a trend since that ATO ruling in 2009 towards using companies as the primary vehicle to conduct businesses from because it’s easier to cap tax at 30%. So you really have to look at specific requirements of the business and that will often require the input of your accountant to access those things.
Martin: That’s a great comment John and of course the other issue that you can see with a family trust is that’s not a divisible structure, you know, if you want to bring on a senior manager who is not a family member they’re not in the broad class of discretionary beneficiaries, you actually can’t do that ‘cos you can’t cut off 20% of the trust and give it to them like you could by , selling them 20% of the shares in a company.
John: Yeah that’s another really important question into the future. Will investors come in whether they be sort of employee shareholders or, you know, a business partner in the future, family trusts are not suitable for that structure.
Martin: One thing that I think would be really useful John would be if you could articulate some of the key differences between running a business through a company and running it through a trust because I don’t think those differences are well understood.
John: Yeah well the key difference is that a trust has to distribute its profits, its income every year out to the beneficiaries. If it doesn’t, it pays tax at the top tax rate, that cannot be ideal in the situation where the business needs to retain profits as working capital because you either get into the situation where well you distributed out to individuals and they lend the money back and they’ve paid a higher tax rate than a company would of, or you use a corporate beneficiary and with the current rules that will require a Division 7A loan to manage that. So that’s probably the main reason, it becomes really problematic when you’ve got multiple owners because for example, one structure that’s often used for multiple owner businesses is a unit trust, so it’s a trust it gets the 50% discount, some of the other benefits of the trust and you’ve got one, two or three owners with a precise 50%, 25%, whatever of the units in the trust. Basically the profits will need to be distributed each year, now there could be a dispute between the unitholders one unitholder might want to say, I want to grow the business, I want to reinvest the profits, the others say no I want to extract it and it can become really problematic where as a company for example, all the profits are retained each year and you just pay out what you want to payout as a dividend. So in that scenario a company can be better.
Martin: Thank you John. And what about corporate groups because often it kind of doesn’t stop at one company, does it, there might be a holding company and some subsidiaries and the like, what are some of the I guess the benefits or downsides of having a corporate group?
John: Yeah what you would normally find is that factoring in what I said before about a business wanting to reinvest its profits, you might have the business owned by the company but the shares owned by a family trust. So you get the ability to you know, flexibly distribute the profits and other benefits of the trust, so from that point of view it’s often multiple layers. A corporate group has the advantage that you can separate assets into separate subsidiaries, say for example, you might have a land owning company and an intellectual property owning company and a company that owns plant and equipment, a company that might employ the staff and then you’re operating entity, the advantage of that is that if something happens to say the operating entity other valuable assets are shielded from it and because it’s in a corporate group, there isn’t the usual complexity of having so many things separated. You could use the intellectual property without having to pay, being taxable on the royalties for example, you can move assets within the corporate group without being subject to capital gains tax, and there is often stamp duty exemptions for movement within corporate groups as well.
Martin: That’s great John. So, say if I might be a mum and dad business owner, I might be looking to start up a business and I know, I was going to say what structure is best but I know (Martin and John laugh) I clearly can’t ask that based on the previous discussion and of course we only provide general advice not specific advice on this podcast, but you know, what I see in this situation is also that people don’t want to spend a lot of money, it might be a speculative venture and frankly they just want a quick, cheap solution because they don’t know if this is going to work, what would your advice be to people like that?
John: Probably the worst example of that is when people set up a company and have the shares in their own name because they don’t want the cost of a separate family trust and they just want to keep it simple, you know, if it’s a start up that fails or if it’s a start up that doesn’t, you know, generate big profits it might be ok. But if it’s successful it can be completely inappropriate to have the shares in your own personal name, whether it be for tax purposes, it minimises your tax flexibility, asset protection and fixing that up later yet can cause a headache.
Martin: Yeah and it’s such a common one, I mean the large amounts of private businesses we see where they are in that situation it’s huge, and it means that they can’t distribute profits tax effectively as they could if they held the equity through a family trust, it’s appalling for asset protection because business people get sued all the time because their directors or what have you, and yet they hold this valuable equity and their company in their own name, that’s a disaster, so I mean wholeheartedly agree John for, you know, a few hundred bucks may be a grand extra and start up casts to set that up right and to lock that in, I think that’s money very well spent.
John: Absolutely yeah.
Martin: What about superannuation, because sometimes people have ideas about holding the equity in their business through their DIY super funds and I know there’s complex rules about that, can you give us a quick over view?
John: Yeah well super funds aren’t prohibited from carrying on a business but generally it would not be a suitable investment to have a business itself in a super fund because businesses might need to borrow and super funds aren’t allowed to borrow and other things. You can, a super fund can own the shares of the equity in a company or unit trust that carries on a business and this is where the ownership structure is really important. So if that super fund owns, it’s a super fund and its associates are the members and what not, own more than 50% of that company it’ll be a controlled company and its pretty much subject to the same restrictions as a super fund has, so it’s not allowed to borrow for example, which will, you know, be a big problem for carrying on a business. However for businesses that are more widely held its, yeah its certainly feasible for a super fund to take a stake in that business as the owner and the clear advantages of that are the ability to pay out profits and they’re taxed at the very concessional super fund rates.
Martin: And it might be one of the few ways that you can actually get some good money into super these days. (Martin laughs)
John: Yeah that’s right. I mean with the government proposals to cap how much money you can put into super, yeah if you can, you know, use the money that’s already in super you can borrow to buy an investment subject to very strict rules, you could buy your interest in a business, as long as you don’t control the company, 50% is ok, but no more than 50%, yeah that’s a way to grow some wealth in your super.
Martin: Yeah the other dynamic is the kind of the trustee dynamic isn’t it, because as the trustee of the fund you need to be comfortable that the risk profile is appropriate etc, etc.
John: Yeah that’s right. There are rules to you know, make sure that super funds are effectively used conservatively for future retirement purposes rather than highly speculative. So it has to be, the investment in the business has to be part of an overall financial and retirement plan, but if it’s a business it’s likely to generate solid revenue, you know, and it ticks all the other boxes and you may have diversified you might have other investments in your super fund, yeah holding some equity in your super fund is, to be honest, it’s probably an overlooked structure in the private space people assume it’s a private business I can’t own it in my super fund. Well that’s certainly true for wholly owned but you know, if you’ve got a business partner it is a possibility.
Martin: Yeah alright. That’s great John. Well look there’s so many take outs from today I think firstly holding different assets and different entities that can be very, very powerful for us at protection, separating the valuable assets from the business risk. There’s a really key message I think about you’ve got to ask the right questions, or you’ve got to engage in an adviser who will ask the right questions before you leap into these structures because if you get it wrong you know, the ramifications can be disastrous.
Just one structure that we haven’t mentioned today and it’s not commonly used but it might be worth just a quick mention John, because certainly some business owners talk about these structures and think about them, is the partnership. And in particular the partnership of trusts which yeah is sometimes favoured for tax reasons. Could you just talk to us about that?
John: Yeah there are two reasons why you might look at going down the path of a partnership of family trusts. So the reason you would have a family trust as the partner is that, as you know partners don’t have limited liability, partnerships don’t have limited liability. So you don’t want to be an individual owner of an interest in a partnership because you are exposed as a business risk, so you have your family trust as the partner. So why would you use a partnership of a family trust. One of them is if your business could make losses maybe in the start-up phase or maybe it’s a business that could have down years, it’s a fluctuating revenue. If you’ve got say two or three business owners and it makes a loss for a year, if you had a company or a trust or a unit trust or something like that, that loss gets sort of trapped in that entity and it’s really only going to be able to be used if the business makes profit in the future, if at all. Whereas a partnership, that loss flows through to the partners so they may have their own individual family trust which they can utilise those losses within their own individual family group, so flowing through losses, if losses are a possibility either in the start-up phase or it’s some other stage are a real advantage of partnerships. The other advantage is the CGT small business concessions, to claim those concessions you have to meet the $6 million net asset value test. Now if you own a business in a company with say four owners 25% each if the value of that company, if the value of that business is more than $6 million well there will be no small business relief for those owners, but if you own it in a trust each partner gets to claim up to $6 million. So the business can grow, you know, nearly to $24 million before they are necessarily going to miss out on the $6 million test. So they can be a better structure to maximise the CGT small business concessions.
Martin: That’s brilliant. Thank you so much John.
Look it’s been a great season. I’ve certainly learnt so much over the last four episodes John so thank you very much for that. If anybody listening has got any queries of a tax related nature how should they contact you?
John: Yep give me a call 03 9605 0825 or my email firstname.lastname@example.org and yeah I love to get queries it tells me what’s happening out in the market place and sometimes I can come up with solutions and but if not I’d love to hear what’s going on.
Martin: That’s wonderful. John Storey thank you very much.
John: Thanks Martin.