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Tax & Commercial issues in Family Business Restructures
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If a business was not established correctly at the outset or has outgrown the existing structure, the owners should consider a restructure.

The considerations for a restructure include but are not limited to the basic legal entity. There can be enormous benefits of a restructure that include better management of business risk, protecting intellectual property and personal assets, reducing income tax, capitalising on business growth or planning a succession from the business or sale.

What underpins such advantages though is the basic legal entity, so in considering a restructure of the trading entity, a first step is identifying the owners current and future needs and aligning those with the most appropriate structure.

We focus on the two common structures used by family businesses (a company and family trust) and highlight some of the advantages and disadvantages of each:

1.   Tax minimisation 

Family trust

Flexibility is often associated with a family trust (also known as a discretionary trust) as it offers the ability to split business income between family members (i.e. beneficiaries) on a discretionary basis which can manage and reduce the overall tax payable. Provided that a family trust distributes all income (if they do not they are taxed at 47%), a family trust does not pay income tax and are eligible not only for a number of concessions relevant to the sale of assets but also allows those tax sheltered amounts to be paid out efficiently and simply.

That flexibility however comes at the cost of it being difficult for a family trust to utilise a corporate rate of tax and an inability for individuals to have an identifiable interest in the assets owned by the family trust.

Company

Unlike a family trust, a company is not required to distribute its income and can instead accumulate it where it is subject to either 30% or 27.5% tax (dependent on both turnover and how it earns it’s income).  A company can subsequently choose to pay dividends to its shareholders who can benefit from the tax already paid by the Company in the form of franking credits that accompany dividends. 

Historically, there has been a dislike of companies given their inability to claim the 50% General Discount (unlike individuals and family trusts) and the difficulty in extracting some of the concessions that apply to gains made from small businesses.  This dislike is however being diluted as a consequence of the difficulty for a family trust to attain the corporate rate of tax as well as the lowering of the corporate tax rate.

2.   Asset protection

Asset protection, at its simplest, is the protection of assets from liabilities that befall their owners.  Assets of value should not be owned by a person or entity that is exposed to risk. 

Family trust 

Family trusts can provide ideal asset protection when one is used to own and operate the business and a second is used to hold investments.  The advantage of a family trust is that the beneficiaries don’t own or have an interest in the property held by the family trust.

The trustee of the family trust which manages the business is liable for all the debts and obligations it incurs. As a consequence, the trustee of a family trust that operates a business should not be individuals or a company that has value in its own right or (ideally) that acts as trustee of a SMSF.  Having a so-called shelf company act as trustee is crucial in assisting with asset protection by limiting the liabilities associated with trusteeship to what is in the family trust and not extending to assets otherwise owned outside of the family trust by a trustee. 

Company

If appropriately established, companies too provide ideal asset protection given that debts and liabilities of the company are not attributed to the shareholders.  The shareholders of a company are therefore protected in that sense as are other assets that they own., however this is not the case if a shareholder is also a director.  In order to avoid this circumstance an individual who is a director of a company should ideally have a family trust own their shares as opposed to them personally.

This way the only risk for shareholders is the decline of value of their shares if the business fails or suffers a severe downturn as well as for any unpaid share capital. This is important particularly in the rare circumstances where company directors can be held personally responsible for the debts of the company in the event of tax obligations or financial distress of a business that remain unaddressed by those directors.

3.   Business succession/estate planning 

Family trust

Under a family trust, control of the business can usually be transferred relatively easily without triggering capital gains tax, stamp duty or disturbing third party dealings. This makes the family trust a good option for succession for family owned businesses though it can become complicated where you want different assets in the family trust to benefit different individuals.

Company

Similarly control of the business owned in a company can be straight forward and be done without disturbing third partly dealings.  If however shares are being transferred or issued, there are likely to be capital gains tax issues to consider and stamp duty.

Self-managed superannuation fund

A SMSF can be considered in addition to a family trust or company (as opposed to an outright alternative) in developing an estate and succession plan.  SMSF’s are often used to acquire business premises that can be leased to the family trust or company that owns and operates the business where market value rent would be paid.

Such a strategy can provide superior asset protection for the assets owned by the SMSF as well as an environment that offers a maximum rate of tax of 15% (where the SMSF is not in pension phase).

4.   Small Business Restructure Rollover  & Other tools

Often, the hard part in changing legal entities (other than new bank accounts, TFNs, ABNs, renegotiating leases, employment contracts etc) is dealing with tax. The Small Business Restructure Rollover allows small businesses to transfer active assets (those used in the business) between common entities such as companies and family trusts (but not a SMSF) without incurring any income tax liability.

There are still the traditional rollovers that can be accessed but they do not favour family trusts (or more precisely moving into them) and only deal with gains on capital and depreciating assets (not trading stock).  Similarly the concessions that shelter gains for small businesses only shelter gains on capital assets and not depreciating assets or trading stock.

There are a number of matters to consider and it is never the case of one size fits all.  For most, there will always be a bit of mixing and matching in trying to get the best of all worlds but trying to keep it simple at the same time.


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This information is provided as a guide only and is not intended to constitute professional advice. You should obtain appropriate advice concerning your particular circumstances.

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