Author: Tanya Titman, Managing Director Date Posted: 8 September 2016
Running a business is tough. No one wants to do all that hard work just to find themselves in the wrong business structure at tax time or when something goes wrong. The structure of your business has an impact on how much tax you pay. It also impacts on t Running a business is tough. No one wants to do all that hard work just to find themselves in the wrong business structure at tax time or when something goes wrong. The structure of your business has an impact on how much tax you pay. It also impacts on t
Running a business is tough. No one wants to do all that hard work just to find themselves in the wrong business structure at tax time or when something goes wrong. The structure of your business has an impact on how much tax you pay. It also impacts on the amount of paperwork your business has to do, your personal liability, the risk to your assets and your ability to raise money.
Many business owners start as a Sole Trader, often because it’s the cheapest and simplest structure. This is a great strategy for initial startup and micro businesses. However, as your business grows changing to another type of structure can be beneficial. Deciding which structure is best for your business can be quite complex. However, as this example highlights, there are two reasons you need to get it right.
Firstly, the most important thing to consider is risk. Every business carries a level of risk. Some can be insured against but insurance doesn’t cover every possibility. Let me give you an (extreme) example to demonstrate our point
Bob operates a photography business. Low risk, right? While taking a photo of a $300,000 Ferrari he accidentally left the brake off. Although his shots of the car rolling off the cliff went viral, the owner was less than impressed and sued Bob’s business. As a result, Bob’s business had to pay $300,000 in damages.
All Bob’s expensive business equipment is sold and Bob has to sell his house to meet the claim. His family are forced to move into rented accommodation and Bob can no longer run his business.
Bob is forced to pay his $100 in unpaid share capital to his company. The company bank accounts containing $1,000 are closed to pay the business debt. The company has no other assets. The company is liquidated and the matter is at an end.
There are some bonus outcomes for Bob under this structure. He owns his camera gear personally so gets to keep it and can continue trading under a new company. And, as an employee of the company, Bob is not personally liable for his error so his family stays in their lovely family home.
This is a fictitious scenario and simplified for the purposes of illustrating how the right structure can save you a lot of time and grief.
Here is a simplified example to show the different tax outcomes for three common business structures earning $80,000.
|Effective Tax Rate||22%||27.5%||11%|
|Income Streaming Flexibility||None||Some||Complete|
We have made a few assumptions above but the outcome is clear: the right structure can save thousands of dollars in tax.
If used properly, Discretionary Family Trusts, can protect your assets, provide for succession planning and save you thousands in tax.
Essentially a Family Trust is an entity that can trade or invest in its own right. When it distributes profit each year, the trust doesn’t pay any tax itself. Instead the nominated trust beneficiaries are taxed according to their own marginal rates. We recommend all discretionary trusts use a company as the trustee for asset protection. Profit can be distributed to family members at the discretion of the trustee so it’s important that the trustee is owned by someone who you trust to control the income of the trust.
It’s difficult to illustrate the benefits as it depends on your individual circumstances but the example below compares owning a business as a sole trader, as a company and as a trust.
Dave owns an online store. Profit from the business (not including his salary) amounts to $200,000. Dave’s wife Sally is not employed elsewhere and helps out with the bookkeeping each week. They have two daughters aged 13 and 18, Dave’s parents are on a Centrelink pension and Sally’s parents are self funded retirees with a taxable income of $10,000 each.
|Less salary paid to Dave||$0.00||$80,000||$80,000|
|Less salary paid to Sally||$200,000||$80,000||$80,000|
|Tax payable on profit||$66,547||$22,800*||$12,400**|
|Add net salary received by Dave and Sally||$0.00||$97,623||$97,623|
|Actual funds received for the year||$133,453||$154,823||$165,223|
* Company tax paid of 28.5c
** Trust profit distributed as follows:
|Family Member||Profit Distributed||Tax Payable|
|Sally (Dave's Wife)||$40,000||$12,400|
With the scenario above, there is a significant saving to be gained from using a discretionary trust. Of course the outcomes of this scenario will vary according to the individual’s circumstances. Before recommending a business structure or a change to your structure we always analysis each business owners’ unique circumstances.
Understanding which structure is right for your business is complex. Our downloadable infographic (at the bottom of this page) is designed to help simplify your options. Before setting up your business, talk to our Real World Accountants. If you’re considering changing your business structure for asset protection or tax purposes, book a chat with our experts to review the pros and cons of all the business entity options.