This is part two of a three part post covering business structures. Part one covers individuals and partnerships, this part considers companies and trusts and part three will consider combinations of these structures.
While the usual requirements when carrying on a business are constant, each of these structure have different characteristics and taxation treatment. It can be costly to change business structures, so it is worth getting the structure right from the start.
A company is a separate legal entity that has the power to enter contracts, sue and be sued. Companies are governed by the Corporations Act 2001.
The key parties in a company are:
Shareholders: Shareholders are the owners of the company. This can be one or more individuals, companies or trusts or a combination. A shareholders’ liability for the debts of the company is limited to the amount of capital they have agreed to contribute to the company. Subject to the terms of the Company’s constitution, shareholders can vote to determine the Directors of the Company. In some companies, shareholders are also referred to as members.
Directors: Directors are elected by shareholders (in accordance with the constitution) and are responsible for the actions of the company, whether performed by them or under their direction (for example by management or staff). Directors have a fiduciary duty to act in the best interests of the Company. In certain circumstances, directors of a company may personally be responsible for the liabilities of the Company.
Constitution: This is a document that contains the rules that govern the company. These include procedures and eligibility criteria for the holding of meetings, and voting for the directors of the Company.
Shareholders agreement: Where there is more than one shareholder, they may agree on how decisions concerning the company are to be made and document these in a shareholders agreement. These may include how the company is to be run and a process for resolving disagreements.
Taxation of Companies
Until 30 June 2015, every company paid tax at the flat rate of 30%. From 1 July 2015, companies that qualify as a small business entity will pay tax at a rate of 28.5%, while all other companies will continue to pay 30%.
When a company pays dividends to distribute profits, the dividends can be ‘franked.’ A franked dividend gives the shareholder a tax credit for tax paid by the company. This is to avoid income earned by the company being taxed twice (at the company then at the shareholder level).
A trust is not a legal entity in its own right, but is best described as a relationship between someone who holds an asset (the trustee holding trust property) on behalf of sometime else (the beneficiaries) under an agreement (usually documented in a trust deed).
A trust can be a discretionary trust, where the beneficiaries have no fixed entitlements to the assets of the trust, or a unit trust, where beneficiaries own units in the trust (although they do not own the underlying assets). A hybrid trust is a combination of a unit trust and discretionary trust.
Deceased estates and Self-Managed Superannuation Funds are special types of trusts.
Key parties in respect of a trust are:
Settlor: The settlor is someone who gives money to the trustee to hold on behalf of the beneficiary or beneficiaries. The settlor can generally not be a beneficiary under the terms of the trust deed.
Beneficiaries: Are individuals or entities that are entitled to benefit from the trust under the deed. Beneficiaries can be specifically named, or be grouped into classes (for example children, grandchildren and their descendants of a particular person). Modern deeds generally cast the list potential beneficiaries quite widely, and can include people not yet born and entities not yet established.
Trustee: Trustee(s) legally own and are responsible for the assets of the trust. Subject to the terms of the deed, they are also responsible for making decisions on how the income of the trust is to be distributed each year, and how the assets of the trust are distributed when the trust is vested (wound up).
Trust Deed: The trust deed contains the rules of the trust, including what the trust may do, the details of the settlor, trustee and beneficiaries. It also contains the rules on how the income and capital of the trust is to be distributed.
Family Trust Election: A trustee may make an election that the trust becomes a family trust. This election restricts the eligible beneficiaries to family members of a nominated person (and certain funds and tax exempt bodies). By making a family trust election, the trustee is able to make use of prior year losses, and satisfies the holding requirements to distribute franking credits received to the trust’s beneficiaries. Once a family trust election is made, it generally cannot be revoked.
Taxation of Trusts
Generally a trust pays tax on their assessable income to the extent that it has not been distributed to the beneficiaries of the trust.
The characteristics of income received by the trust remain the same when they are distributed to the beneficiaries (for example, capital gains earned by a trust are distributed as capital gains to the beneficiaries). Beneficiaries of the trust then pay tax (or deal with the income) at their relevant tax rate.
Information provided above is a summary only and should not be considered advice. For professional advice, tailored to your needs, please contact us on 1300 884 797.