David French | 18/02/2009 4:18:38 PM

This article was originally published in The Morning Bulletin in November 2004

Investment decisions not only involve choosing assets that perform well, but also housing them in the correct structure. Each structure has different legal and taxation characteristics, and associated costs. Using the correct structure can increase flexibility in management and funding choices, protect assets and assist in making your income more tax efficient.

Many businesses in regional Queensland are formed as simple sole traders or partnerships. These are very simple structures that amount to running your business in the individuals’ own names. Once business expenses are deducted, income is distributed to the partners and taxed at their marginal rates. In years gone by, partners simply gave all their income and expense information to their accountant, and the accountant sorted the wheat from the chaff. Many times it seems the wheat and the chaff got mixed together, resulting in tax deductions being claimed on general living expenses. With much tighter tax laws, such accounting is risky and messy.

Partnerships offer limited protection in the event of legal action. It is often very difficult to distinguish between the assets of the partnership and the partners, and such weak distinction puts assets, which may have had nothing to do with the matter at hand, at risk.

Trusts are controlled by trustees who must look after the interests of the beneficiaries who receive benefits from the trust. In many family trusts, the trustees and beneficiaries are the same. Trusts put a formal barrier between the assets of the trust and the assets of other parties, including the trustees and beneficiaries. Therefore, if a trust was operating a business and the business was successfully sued, recovery in the first instance would be against the trust’s assets. There are very strong tax incentives to distribute all of a trusts income by the end of the financial year – failure to do so means that the income left in the trust will be taxed at the highest marginal rate. The beauty of trusts is that the income distribution can be determined at the end of the financial year, and the income distributed retains the characteristics it had when it was earned. For instance, a capital gain can be distributed as a capital gain and franking credits retain their nature. Moreover, different beneficiaries can receive different proportions of income. That can be useful for making the best use of each individual’s scaled tax rates.

Companies are very formal structure controlled by a board of directors who decide if and when to distribute money from the company (usually by way of dividends). Unlike trusts and partnerships, companies are taxed in their own right and once tax is paid, the directors can decide whether to distribute residual cash or not. At present company profits are taxed at 30 per cent. Once tax is paid, the company earns a franking credit, which allows the company to pass dividends onto shareholders as if they were tax paid at the rate of 30 cents in the dollar. Effectively this means the shareholder is receiving pre-tax income on which tax must be paid at the shareholders marginal rate.

While many people criticize the use of companies to protect assets, and sometimes their use is abused, such protection is fundamental to the efficient operation of business. Business has to be able to take risks with shareholder funds, without rendering the shareholders themselves, or other associated parties bankrupt. That is the nature of incorporation. Increasingly however, directors of companies are not immune to legal action on account of perceived wrongdoing by directors brought about by clients, staff or shareholders. It is therefore trite to say that a company will afford complete protection of assets in any situation. The courts can and have lifted the veil of incorporation to expose others associated with the company.

Obviously the choice of entity is very important. Talking to a good financial planner, accountant or lawyer is essential.

The Investment Collective (AFSL 471728) is a non-aligned financial planning and investment firm specialising in providing tailored financial and investment advice for individuals and small business. Capricorn Investment Partners Limited's services include financial planning, share trading, portfolio management, insurance broking and self managed super fund administration. Additional information on services provided by The Investment Collective Limited can be found by following this link. Readers are reminded that this document has been prepared for general information purposes only, and any advice contained herein has been prepared without taking into account your financial objectives, situation or needs. Readers are advised to see their financial advisor prior to acting on any general advice.

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