For my blog this month, I thought I would do a refresher on S100A and then discuss the options of potentially restructuring your partnership to a company.
It’s been a few months since the furore of S100A changed our view of Discretionary Trusts. In this time, the appeal by the ATO on the Guardian AIT case was heard in the Full Federal Court at the end of August and we are currently waiting for a decision to be handed down.
For those who are unaware of S100A, in a nutshell is an anti-avoidance provision in the Income Tax Assessment Act of 1936. It was designed to counter tax avoidance arrangements within a discretionary trust.
Specifically, it focused on trust distributions, that came about as a result of a reimbursement agreement entered into with the purpose of reducing tax liabilities. The agreement was not entered into in the course of ordinary family or commercial dealings.
The reimbursement agreement is when someone who becomes presently entitled to a distribution and someone else actually benefits from the distribution but the purpose of the parties being involved in the agreement is to obtain a tax benefit. Interestingly the ATO intimated that S100A would not apply if an arrangement was considered to be “ordinary family or commercial”.
So, this blog discusses whether a company would be a better structure for these new partners as compared to the traditional partnership set up.
Going back to basics: How a Discretionary Trust works
The trust has income that is earned or generated in the trust by investments such as shares, rent, pharmacy income or distributions from a pharmacy partnership. At the end of each year, the net profit (income less any expenses) is determined and the trustee is tasked with determining the beneficiary to whom the net profit can be distributed. So, when a beneficiary receives the distribution, they become presently entitled.
Having a present entitlement is not defined in the legislation and over the years the courts have determined that a present entitlement is when a beneficiary has a legal claim to funds distributed to them. That is, they can demand immediate payment of their share of the trust income.
However, what has become common practice across all manner of industries over many years, is that whilst the distributions are determined by the trustee, the funds are usually directed to another person. For example, we have a trust which receives a partnership distribution from a pharmacy. At the end of the year the net profit of $400,000. The beneficiaries of the trust are 3 adult children and their parents. Each child receives $100,000 each and the balance split between the parents - $50,000 each. By making the distributions in this manner, the overall family group tax is reduced as compared to if the distributions were made to the parents who generate the income. A point to note here - The funds however are not passed onto the children but rather retained by the parents to run the home and business.
In light of the uncertainty of S100A and given our recent focus on partnerships we reviewed our client base and determined that perhaps this was the time to review the structuring of our partnerships which may or may not always include a trust.
Over recent weeks, we have talked about all things partnership related. Primarily, this has always been about the broader concept of entering a partnership for the first time and ownership structures. During this time we have also been reviewing our structures to ensure they are tax effective. This blog discusses whether a company would be a better structure for these new partners as compared to the traditional partnership set up.
As an advisor I need to understand your strategic plan - why you are in business and your long term goals to ensure you have a structure that gives you the best opportunity for asset protection, risk limitation or for tax purposes – noting here that we have put tax last as whilst an important consideration, it shouldn’t be the primary reason a particular structure or transaction is entered into.
In my view, the strategic plan for your business, will be the most important document you have to consider when determining your ideal business structure. For example, your strategy may be to build and grow a business to sell one day, or your strategy could be to take on investors to grow your business. Strategic planning is all about developing a roadmap to guide your future decision making.
We are all familiar with the partnership structure, so we have focused on companies – it has not always been a recommended structure but I feel now is the time for companies to shine.
Restructuring to a Company
The company is its own entity for tax and legal purposes. This means that the directors and the shareholders of the company are not liable for the debts of the entity. Note however, that under certain circumstances directors can be held personally liable for some debts by the Australian Taxation Office, creditors, and finance lenders.
Companies also pay a fixed tax rate compared to the marginal tax rates paid by individuals. So, there can be tax efficiencies to be had in trading as a company. However, the importance of seeking advice specific to your circumstances and not being influenced by the lower tax rate is critical.
Another benefit if you are considering restructuring from a partnership to a company is that, because the company is a separate entity, you would become an employee of the company. As an employee, you would be covered by workers compensation insurance (a policy must be held) and be entitled to compulsory superannuation.
In the current legislative environment, provided you meet certain criteria, it is possible to transfer the business to a company structure without capital gains tax being incurred.
On the flipside, a company structure may not be ideal due to the cost of maintaining a company, for example accountancy and ASIC fees. Please note that companies are also more regulated than other structures by the Australian Taxation Office and ASIC. Director or shareholder loan accounts can also cause issues and increase taxes.
A company structure may also be appropriate if you are considering expansion and looking for capital or partners.
If you have any questions about restructuring or pharmacy partnership, book a meeting with Priya below.