Unfortunately, these objectives sometimes conflict. For example, the structure that is most simple and easy to operate is not necessarily the structure that will provide the best tax benefits. So let us consider each of the objectives and how likely they are to be achieved using the different business structures.
Simplicity and Ease of Operation Almost everybody understands the concept of running a business in their own right. All that is required to set up as a sole trader is the registration of a business name in the state of which you are operating – and even this is not necessary if you are operating under your own name. The cost of registering a business name is about $100. This contrasts with the cost of setting up a company and a trust which, depending on the type of trust, could be in excess of $2,000. Many people struggle with the concept of a company and the fact that although it is their company, it is a separate legal entity from the individuals. Similarly, many people struggle with the concept of a trust and trustee and the fact that with this structure there is one operating entity although there are two entities (the trustee is the legal owner of the business whilst the trust is the beneficial owner). A sole trader is undoubtedly the simplest structure and the easiest to operate. It is also the least costly to establish and maintain.
Flexibility By flexibility I am referring to the ability to get taxable income to those persons most suited to receive that income. Sole traders and partnerships offer little or no flexibility. With a sole trader, all income must go to the sole proprietor, and in a partnership the income must be distributed in accordance with the partnership agreement. A company also does not provide much flexibility. Salaries can be paid to people who work in the company, but the remaining profits must be distributed to shareholders in proportion to their shareholdings. A discretionary trust on the other hand provides the maximum flexibility.
Each year the trustee of the trust can determine how much money, if any, each beneficiary (as named in the trust deed) is to receive. Distributions can be made to a wide range of beneficiaries, even to children below the age of 18, but the amount of income that can be distributed to those children without paying maximum marginal rates of tax is limited.
Protection of assets I have already pointed out that when operating as a sole trader, or when individuals are in partnership together, it is your – the individual’s - assets that are at risk. Everything that is in your name is potentially at risk. The same applies when you personally are the trustee of a trust. However, when the business is operated by a company in its own right or by a company acting as trustee of a trust, then it is effectively the company operating the business and it is the company’s assets (not the individual’s assets) that are at risk. When using a company your risk - the individual’s risk - is limited in theory to the amount you have contributed to the company. I say ‘in theory’ because in practice that limitation does not exist if you as an individual give personal guarantees on behalf of a company. Usually when you are entering into a franchise the franchisor will insist on getting personal guarantees from you if you use a company. Further, the landlord of premises will seek your personal guarantee if your company enters into a lease and the bank will seek a personal guarantee for any loan that is made to your company. This reduces the practical benefit of the limited liability of a company. Notwithstanding this, the use of a company (with or without a trust) usually provides the best asset protection, albeit limited when personal guarantees are given. Irrespective of the structure that is going to be used to operate the franchise business, there are often steps that can be taken to protect assets. For example, in a case of a husband and wife, it is possible for one spouse to take the risk and for the other spouse to hold the assets. Thus, if a company is to be
formed, one spouse can be the director (and therefore probably the guarantor) and at risk, and the other can perhaps hold assets. If the family home is in the names of both spouses, it may be possible to transfer ownership of half of the home from the spouse who is at risk to the spouse who is not at risk. In some states in Australia this will require the payment of stamp duty, and in some states it will not. Generally, there will be no capital gains tax on this transfer because principal residences are exempt from capital gains tax. It may also be possible to transfer other assets from the spouse who is at risk to the spouse who is not at risk, but there may be capital gains tax and other costs.
Minimisation of Income Tax We all aim to pay as little tax as is legally possible. Further we all wish to defer the payment of that tax as long as possible. I am sure we could all think of better uses for our money than having it sitting with the tax office earning zero per cent interest. With partnerships and sole traders, the individuals receiving the profit must pay tax on that profit. The rate of tax on that profit will vary between 0 per cent and 49 per cent, depending on the level of income each individual has in their tax return. As the income level increases so does the marginal rate of tax. Companies, on the other hand, pay tax on their profits at a flat rate. The current company (non-small business) rate is 30 per cent. Small business companies have a rate of 28.5 per cent. A small business is broadly one which has aggregate turnover of less than $2 million. The Federal Government in the 2016 Budget proposed that the small business aggregate turnover threshold be increased to $10 million and the tax rate for small business companies reduce to 27.5 per cent. This proposal was due to apply from 1 July 2016, however at the time of writing these measures have not been enacted. Any dividends paid to shareholders are taxed in the hands of the individual shareholders receiving that income, but they get a credit (imputation credit) for the tax paid by the company on that income.
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