When choosing the most appropriate legal structure (i.e., sole trader, partnership, discretionary trust, unit trust or company) for a start-up business, there are numerous issues to consider. The difficulty is that there is no single formula or method that will determine the best structure for a particular business. In every case, the business will have different facts and circumstances that need to be taken into consideration and may affect the choice of structure.
Further, business owners will have needs, goals, and outcomes that they will want to maximise over the lifetime of the business. Many of the desired goals and outcomes may be mutually exclusive. Therefore, some form of compromise will likely be necessary. For example, some structures may provide a good capital gains tax (‘CGT’) result but are a poor way to minimise income tax or may not be optimal from an asset protection perspective.
It is also worth noting that the structure established today may not be appropriate for what happens tomorrow. The right structure will take into account the future needs of the business and will be able to grow with the business owners and afford a considered exit strategy.
While the legal concepts of structuring are generally well understood (the science), it is combining these concepts with the day-to-day practical matters that is most difficult (the art). The appropriate structure will take into consideration several issues including (but not limited to) the following:
- access to the CGT 50% discount;
- access to the small business CGT concessions;
- flexibility to distribute income and capital;
- marginal tax rates of participants;
- ability to recoup losses;
- access to research and development (“R&D”) concessions;
- asset protection;
- potential employee participation;
- future funding requirements;
- compliance costs; and
- exiting and succession planning
- estate planning
Below, we have put together a high-level summary of the how the objectives above work with the legal structures available and is a useful guide for business start-up structuring.
|
Issue |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
|
Access to the CGT |
Yes |
Yes |
Yes |
Yes |
No |
|
Small Business CGT |
Yes |
Yes |
Yes – subject to the significant individual test in some circumstances |
Yes – subject to the significant individual test in some circumstances |
Yes – subject to the significant individual test in some circumstances |
|
Flexibility to distribute |
None |
Some depending on partnership agreement |
Good |
Limited but will depend on the classes of units on issue |
Limited but will depend on the classes of shares on issue |
|
Tax rate |
Marginal tax rate of the individual |
Tax rate of the partners |
Tax rate of the beneficiaries. Trustee may also be taxed in some circumstances |
Tax rate of the |
25% or 30% depending on if the company is a ‘Base Rate Entity’ |
|
Ability to recoup losses |
Yes - straightforward |
Yes – losses will be available to the partners |
Yes – subject to complex tests |
Yes – subject to complex tests |
Yes – subject to complex tests |
|
Access to R&D |
No |
No |
No |
No |
Yes |
|
Asset protection |
Poor – sole trader personal assets at risk |
Poor – partners are joint and severally liable for debts of the partnership |
Good – increased with use of a corporate trustee |
Good |
Good – corporate |
|
Potential employee |
Difficult |
Difficult |
Difficult |
Yes |
Yes |
|
Future funding |
Can only be |
Can only be |
Can only be achieved with debt |
Yes |
Yes |
|
Compliance costs |
Low |
Low |
Medium-high |
Medium-high |
Medium-high |
|
Exiting and succession |
Requires sale of business assets |
Requires sale of partnership assets |
Requires the sale of business assets unless family succession |
Can be achieved through the sale of units – may be complicated if there is a Family Trust Election is in place |
Can be achieved through the sale of shares |
If you are thinking of starting a business, the team at Cutcher & Neale can help you understand the pros and cons of different business structures, provide professional advice on the tax implications of each and what structure will suit your needs now and into the future.
