Business Structures & Asset Protection
The correct business Structure is essential for business improvement, tax minimisation, wealth creation and asset protection!
So what is asset protection? Broadly, it is about minimising your exposure to risks in such a way that you may be able to protect or quarantine assets to reduce the damage if someone were to make a claim of some sort against you and/or your business.
By structuring, we are talking about the entity (or entities) through which you operate your business. At a relatively basic level, common structures include:
- Individual (i.e. sole trader)
- Trust - discretionary, unit, hybrid
At the simpler end of the scale are the sole trader and partnership structures. As a general rule, you can setup as either of these structures simply by registering an ABN and commencing operations. Under a partnership structure, you should then also consider whether you need to have a formal partnership agreement drawn up by a solicitor.
However, if you are an established business or growing business, or you have significant assets outside of the business to protect, and are currently under a sole proprietor or partnership business structure, then you realistically should be considering other options. More complex entity structures can provide a valuable and effective way to protect the assets you have accumulated.
A discretionary trust is more commonly known as a family trust. It can be an excellent structure for a single family business to operate through. Its main benefit is the ability to distribute the income earned from the trust in any way the trustee sees fit, provided it complies with the trust deed. A discretionary trust also offers asset protection both for the family members and the business. If a family member is sued personally, the assets of the business are protected, and vice versa.
It should be noted that the asset protection is enhanced significantly in most cases where the trustee of the trust is a Pty Ltd company rather than individuals. If running a business through a trust then using a corporate trustee is essential.
There are also opportunities to pass the business down to a younger generation without capital gains tax and the ability to access capital gains concessions on the sale of your business, or its assets, that are not always available to other entity structures.
A discretionary trust can also be a great structure through which to hold investment assets though it is strongly recommended that you don't hold business and investment assets within the same structure.
Partnership of Discretionary Trusts
For a business that involves more than one family, a partnership of discretionary trusts is a relatively sophisticated structure that may provide a potential solution. In this structure, multiple discretionary trusts are used as partners in a partnership structure. The business operates through the partnership (often with a management company included) and the discretionary trusts receive their share of partnership profits.
It’s important to have brand new trusts and companies for this structure for asset protection purposes. Being a partnership structure, it will be administered under Partnership Law, meaning there is joint and several liability for the trusts acting as partners in the business. If the business fails, for whatever reason, and interested parties start chasing monies or claims outstanding to them, they generally have access to the business assets within the partnership and the assets withinin each trust to recover their claim. For this reason, we recommend these trusts hold their partnership interests only and no other assets should be acquired in these trusts.
A unit trust is also a popular structure for partners in business together, particularly where unrelated parties are involved. It is easier to understand and has fewer adjustments required, in comparison to a partnership or partnership of family trusts, when partners exit or new partners are added to the business.
With a unit trust, the partners hold a fixed number of units and so they therefore receive a fixed proportion of income and/or capital per year as set out in the trust deed. Once again the unit trust should have a corporate trustee for asset protection purposes.
Units held are an asset of each unitholder therefore you also need to carefully consider how the ownership of these units is to be structured. In many instances, it can make sense to have a discretionary trust (or trusts) own the units to further enhance asset protection benefits and allow for flexibility of income distributions.
These structures are a relatively boutique form of trust that effectively blend the benefits of discretionary and unit trusts into a single trust structure.
There are a range of special issues associated with running a hybrid trust that require careful consideration so make sure you research all the pros and cons thoroughly before making a decision to operate through such a trust. For instance, the tax office has taken a keen interest in reviewing hybrid trust structures and deductibility of interest on borrowings.
A private company is another structure that you may choose to run your business from. Companies are generally better understood than trust structures because the operation is more straightforward in most instances. A company is taxed at a flat rate on its annual profit before there are distributions to the partners or owners. Any distributions made are then commonly paid out in the form of dividends, often franked, which are assessable to the shareholders.
Business owners operating through a company structure must still be cautious though. There are a range of requirements under the Corporations Act and various Tax Acts, amongst others, that directly affect the operation of a company. For instance, fringe benefits tax, Division 7A shareholders loans, and employer obligations including payments made to owners can all create added complexity to deal with and plan for.
As with a unit trust, shares held are an asset of each shareholder and you may want to include a discretionary trust (or trusts) to act as shareholders.