Business owners choose different types of structures for a broad range of reasons and it is safe to say that the particular mix of issues that drive this decision is rarely the same from business to business. Will the business one day be sold by the current owners or will it stay in the family? Are there arm’s-length parties in business together or plans to bring in outside investors/owners? Is my business experiencing significant growth in scale and profitability? Does my competitor’s structure give them an advantage over mine?
Although these issues are quite different, the answer can often lead us to the same question. Does my business structure have a use-by date? If you answered yes to any of the above questions, then perhaps it’s time to consider the useful life of your current structure.
One issue that often drives change in the structuring space is the impact of income tax rules on trust structures. Unlike a company, it is the beneficiaries of the trust that pay tax at their own rate, on trust net income that is distributed to them. If there is income that is not distributed, the trustee pays the tax on that income at the highest individual income tax rate, basically forcing trustees to distribute all income to its beneficiaries every year.
Where income is distributed but not paid (an unpaid entitlement), the beneficiary still pays tax on that unpaid entitlement, and is able to call on payment of it at any time. In this way, it was common for trusts in business to drive income back into the business (i.e. to retain the income in the business) by distributing but not paying that income to a corporate beneficiary. This put trusts on a similar footing to companies, effectively allowing them to retain profits at company tax rates for their working capital and business investment. This all changed in late 2009.
The Commissioner of Taxation released a draft ruling (finalised in 2010) which effectively overturned this longstanding practice of trustee’s distributing but retaining profits using corporate beneficiaries. The outcome is that for many trust businesses that are deriving significant profits, they are being forced to pay individual (higher) rates of tax on their retained income than their company competitors. The answer for many is to restructure to a company.
There are many compelling reasons to choose a company over a trust structure that did not exist or just weren’t on the radar in 2009. The lowering of the corporate tax rate from 30% to 25% for businesses with a turnover of less than $50million, is a particular highlight. In addition to the lower income tax on profits, the traditional advantage of using a trust over a company (i.e. trust access to a 50% capital gains tax discount when distributing capital gains to individuals) has been significantly eroded.
The compared difference on capital gains tax will often be 23.5% or half of the highest personal rate of tax for a trust vs 25% for a company. The margin is now much smaller and nowhere near the drawcard that it once was.
Perhaps most alarming for trust clients is the ATO recent release of a draft taxation ruling, guidance and taxpayer alert on reimbursement agreements (TR2022/D1, PCG2022/D1 and TA2022/1).
The new releases see the ATO taking a much more restricted approach when it comes to distributions by trusts to family members (such as adult children), as well as tightening up the ATO’s views on the appropriate treatment of trust distributions made to related companies (TD2022/D1).
The ATO is particularly concerned with common situations where trust distributions (mainly to adult children on lower tax rates) are not paid to or applied for the relevant beneficiary in that year, but instead the monies are used by others (usually the parents) to fund their own lifestyles. In this situation, the ATO is more likely to consider applying a specific anti avoidance provision for what are called ‘reimbursement agreements’, unless there are compelling “non-tax reasons” for making these distributions. If this anti-avoidance provision is applied, trust distributions can be ignored so that the trustee pays income tax on them of 47% instead.
A further issue and perhaps not as well known is that where land is involved in NSW, companies have a further advantage over the commonly used discretionary or family trust, for land tax purposes. Land tax is payable when the Valuer General’s valuation of land in NSW exceeds a certain threshold. For discretionary trusts, there is no threshold, meaning that land tax is paid on all subject land from the first dollar. Companies have a threshold in NSW of $822,000 in the 2022 land tax year.
Lastly, the ability to offer equity to investors or separate ownership amongst multiple owners (family or arm’s- length) is also much more straight forward and acceptable to investors in a company structure that a discretionary trust, that by its nature, cannot offer ownership interests.
So what can you taxpayers do if they have a trust structure and it’s reached its use-by date?
The good news is it’s often not as hard to restructure as you think. In many States such as NSW and Victoria, there is no stamp duty on business assets except for land. Combined with the availability of CGT rollovers for appropriate internal restructures, the tax cost of moving to a company, can be negligible. A CGT rollover in this context is generally designed to shelter internal restructures from capital gains tax where there is no change in ultimate ownership. In this way you can move from a trust structure to a company owned by that trust, without triggering a liability for CGT by choosing a rollover.
Where it is crucial to maintain the identity of the current business owner (e.g. because of licenses or operating authorities that are difficult to obtain or current arrangements that cannot be upset), there are other solutions that may be more suitable, such as having a trust operate in a newly formed corporate group, so that it is treated as a company for income tax purposes but otherwise maintains its legal status as a trust to the outside world.
In jurisdictions where stamp duty is still payable on businesses there may be concessions that a particular business is eligible for, such as the recently announced “exemption for small business restructures” in Queensland. As mentioned in the previous paragraph, it may otherwise be possible to corporatise the business, without moving it out of the trust, so that the restructure does not trigger duty on the business.
Although this article is mainly about trusts, the principles of maintaining the appropriateness of your structure to your business applies equally to all, including current company structures. When meeting with your advisors it’s always good to spend some time examining how your current structure is performing for your business and whether a different or modified structure, might give you more.
This information is provided solely for general information purposes and is not intended as professional advice. Readers should not act on the information contained therein without proper advice from a suitably qualified professional.
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