The Big Step
Starting a business is a big step. There is a lot to think about – a business plan, leases, finance, staff, marketing, and so on. People often think about tax when they are setting out, in the sense that they know they may need to register for an ABN, GST, PAYG withholding (if employees will be engaged) and obtain a tax file number for the new trading entity. Some people think about putting money aside for income tax at the end of the year.
The Trap
The biggest trap a new business owner with a solid business plan can fall into is failing to think about how to structure their business. How a business is structured has significant tax implications. If structuring is ignored, or or done without considering the commercial and tax consequences, then:
- the business may lose access to the 50% discount on capital gains;
- a business conducted through a trust structure might end up with a trustee assessment, which means paying tax at the highest marginal rate;
- shareholders may have deemed dividends included in their income meaning that they lose the advantage of the corporate tax rate they thought they had gained;
- partners may find themselves liable for the actions of their partners;
- sole traders might find they are at a competitive disadvantage because their incorporated competitors are paying less tax.
The above is not an exhaustive list and are just some of the potential consequences.
Cost/Benefit Analysis
A key reason that people do not give proper attention to structuring at the beginning is the upfront costs; people figure they can restructure down the track, and they need their money in the short term for other more pressing reasons. But structural changes after a business has commenced can be considered tax avoidance and are likely to have a capital gains tax (CGT) consequence. The costs of arranging the business structure correctly from the beginning can be significantly less than the costs of having a restrictive or inappropriate business structure.
And once you are in business, many of the set-up costs will return to you in the form of GST input tax credits and tax deductions (possibly written off over five years). For example, if the costs of establishing your business structure are $10,000, then the actual cost may really only be around $6,000 after the benefit of tax deductions. That $6,000 should be regarded an investment; that is, you will receive a return on that $6,000 in the form of better tax outcomes and less risk exposure.
Question Your Plan
Another reason some people have difficulty with structuring is because structuring forces them to think about and question their plan – not only their business plan, but their life plan including their current life circumstances. The questions are broad-ranging. They can include a consideration of whether you have children, how old they are (relevant to how effectively income may be distributed through a trust), through to how long you plan on operating the business and whether you would want to maintain a share in the business after stepping down (relevant to setting up a company); fundamentally, no-one has a crystal ball but plans must be made to avoid later uncertainty and unnecessary tax bills. You will also need to think about retirement plans, superannuation and estate planning.
Boring… but important
A further reason people neglect structuring is because structuring seems like a boring detail. There are so many exciting things to do when setting out such as choosing the décor, writing the menu for your café, buying a new Hilux and setting up a web presence. However, each of those activities fall behind the importance of ensuring the optimum business structure is established.
Establishing the optimum business structure at the outset means that you will spend more time focused on growing the business, writing the most appetising menu, purchasing the best coffee beans, engaging enthusiastic staff, and receiving good reviews on Trip Advisor.