Companies have been considered the structure of choice for listed and large operating businesses where there is a clear distinction between the owners (shareholders) and the management (directors) of a business. For small business owners and investment purposes trusts have often been favoured over companies as the structure of choice. This is due the flexibility and ability to achieve better tax outcomes for the family group.
In this article we will look at why companies will increase as the structure of choice particularly for small business owners which is being driven by both tax and economic trends.
Lowering Company Tax Rate
We note that at present the company tax rate is 27.5% for businesses with a turnover of less than $50 million (provided the income derived by the company is not passive (investment) income). We also note that by 2021-2022 the headline company tax rate is scheduled to be 25%. When comparing these rates with personal marginal tax rates at 47% the argument for building and retaining wealth in the family business (company) makes sense.
Remuneration for Owners
It is important to remember that in small businesses the owners and managers of the business are the same and that at a personal level the owners will need to be remunerated by the company for their efforts either in the form of wages or dividends.
Where possible we tend to favour dividends as the best form of remuneration for the shareholders for the following reasons:
- The dividends are paid out of after-tax profits and will normally have attached to them imputation credits which can reduce the tax otherwise payable by the shareholder on the dividend;
- Dividends are not assessable for payroll tax purposes; and
- History of dividends shows potential suitors of the business a history of returns for a potential investor.
The shareholders of a company are also able to control the amount of tax they are required to pay by having the company declare and pay dividends each year.
For people that own and run their business through a company structure that want to sell either all or part of their business this can be done through a sale of the company’s share. In these circumstances there is no need for the business to change its registrations, contracts, lease agreements or transfer its intellectual property the new owners simply acquire all or the requisite number of shares agreed to be sold. Importantly now in most Australian states, transfer (stamp) duty will not apply on the transfer of shares in a private company.
It is much simpler in a company structure to raise capital simply by issuing shares in the company to new investors. In most circumstances this will also not give rise to any capital gains tax implications for the shareholders as they have not sold any of their interest in the company.
Unlike trusts which have a limited lifespan companies have no defined end period and can continue to operate. This means assets held in the company structure do not need to be transferred to a different structure for that wealth to pass to future generations. Instead that wealth would be transferred by the transfer of the shares of the company which if passed by will is unlikely to have any immediate capital gains tax implication.
What about Loan accounts & Division 7a
Many of the issues surrounding the deemed dividend rules (commonly known as Division 7a) arise from distributions of profits made by trusts to companies. The purpose of these distributions was to limit the tax on the profits of the business (which was operated by a trust) to the corporate tax rate.
Given the continued tightening of these rules the opportunity to continue to use this as an effective tax planning strategy is limited.
The continued trend of these rules is to ensure that the profits made through a trust are taxed to the people that benefit from those profits. This means that successful businesses will be forced to pay marginal tax rates on their profits unless those profits physically pass in the form of cash or value to the company.
We believe that companies in most circumstances will be the structure of choice for business owners (large or small) for the following reasons:
- Lower corporate tax rate;
- Easy to effect transfer of business from a legal, tax and stamp duty perspective;
- Easily understood within the business and broader community; and
- Simple to set up effective remuneration structures for the owners.
Should you be considering establishing a new business or investment structure please feel free to speak with us.