The Politics of Trusts
The Politics of Trusts:
Taking the Fear Out of Policy and Legislation Changes
Often, people choose to invest in a franchise in the belief that it will simplify the experience of becoming a business owner. since a franchise usually provides support for back office functions, this assumption isn’t necessarily wrong.
But it’s important to remember that a franchisee is, in fact, a small business owner, with all the important responsibilities and decisions that go with it.
One of the first decisions you’ll need to make as a potential franchisee is how to structure your business. There are a few different options, which include setting up as a proprietary limited company, a two-tiered company, or a trust.
The model you choose depends on your goals. For example, if you’re looking for a straightforward structure that’s simple to operate and will protect your personal assets, then a single company model is ideal. It can own its own assets and liabilities, and can enter into contracts on behalf of the franchise, so it keeps your personal assets separate. However, if the business falls into difficulty and needs to be wound up, you’ll potentially lose all the business’s assets. This is only a problem if you were planning to use those assets in the future. As a franchisee, your business wouldn’t own the intellectual property of the franchise, so the franchisor is protected if your business fails.
A more complicated approach is to have a holding company and an operating company in a two-tiered company structure. This separates the assets of the company from its operation, but the structure is complex and can be expensive to set up. You will need to seek professional accounting advice to manage this structure effectively.
A trust is a third and highly effective business structure. In this model, the trustee owns the business assets and operates the business. Legally, the trustee owns the business. Trusts can be restrictive, but they can also help reduce your personal income tax and protect your assets.
Family trusts are the most-often used instrument for franchisees. But, while companies pay tax on their profits at 30 per cent or 27.5 per cent (depending on turnover), trusts only pay tax on profits that aren’t distributed to beneficiaries. Therefore, trusts usually distribute all of the profits, which are then taxed as income for each of the beneficiaries. The trust can be set up with enough family members as beneficiaries to minimise the income tax burden for each person, while maximising the family’s income. Furthermore, subject to the Trust Deed, trusts can change beneficiaries yearly if it chooses as long as they are within the family group. This is a flexibility not offered by a corporate structure.
This is an attractive option compared with a sole trader or simple company model, in which one or a couple of people must pay tax on all the profits.
“It’s important to remember that a franchisee is, in fact, a small business owner, with all the important responsibilities and decisions that go with it.”
However, the Opposition has suggested that family trusts could be in the firing line in the future, proposing a 30 per cent tax on earnings from family trusts. A report from the Australia Institute suggests family trusts have assets of more than $3 trillion and a revenue of $350 billion last year alone. The increase in the tax rate could net the government billions in tax revenue given the prevalence and value of family trusts in Australia.
Furthermore, 21 per cent of Australia’s national income is funnelled through trusts. This contradicts the myth that trusts are tax havens for the wealthy. Of course, trusts can help preserve wealth for already-rich families. But the more typical portrait of a family trust is one where one adult partner is the main breadwinner. The trust structure helps lower that person’s tax burden, preserving more of their income to support the rest of the family.
When small businesses operate through a family trust, the family takes on risk, putting in their own assets as equity or collateral to operate the business. Being able to spread the profits among family members is, arguably, a just reward in exchange for that risk.
Furthermore, running a business through a company or trust structure can provide some liability protection in case there is an issue.
In an economic environment where wage growth isn’t strong and prices keep rising, it makes sense for small businesses to run through family trusts. But if trusts are slugged with a 30 per cent tax rate, small businesses may have to consider restructuring.
A small business may be better becoming a corporate entity with a tax rate of 30 or 27.5 per cent (which will potentially drop to 25 per cent) if the theoretical 30 per cent family trust tax came into effect. Or, depending on the type of business, a 50-50 partnership may make sense. This spreads out the income and potentially lowers tax but there is no corporate veil protection, so family assets would be open to action if something went wrong.
Historically, governments have been wary of trusts and it could be possible that the Opposition hopes to stamp out trusts altogether with the proposed 30 per cent tax rate. This negative view of trusts traditionally trusts stems from the false belief that only the mega-wealthy have trusts.
The number of trusts in Australia has increased over time but more people are using for commercial reasons as opposed to wealth preservation. For example, a small business or tradesperson with a $200,000 income would normally pay a high personal income tax rate. But, if they have a non- working spouse, they can spread out the income using a trust and pay slightly less tax, giving the family more money to spend in the economy.
By discouraging small businesses from using trusts, governments provide no incentive for people to work hard and do well. A better system could be a family tax return, where the husband and wife are seen as a unit and given the benefit of better tax rates. This is already done in many European countries with some success.
While it’s unlikely that the higher tax on trusts will eventuate, for now, Australian small business owners should keep a watching brief. If the tax comes into effect, small business owners should immediately seek professional advice on how to restructure their business to minimise tax, protect the family assets, and ensure smooth succession planning.
Joanne Wynne joined RSM in 1999 and provides taxation consulting and compliance services. Joanne has also facilitated the Chartered Accountants Australia and New Zealand taxation module and has also lectured undergraduate and post graduate taxation units at Curtin University.
Having grown into one of Australia’s leading professional services firms over the last ninety-five years, RSM Australia is committed to enabling clients through a greater understanding of what matters most to their business.
In addition to local knowledge provided by their advisers in 30 offices across Australia, RSM Australia draws on their international reach and scale to ensure clients stay at the forefront of the world’s best practices, technology and innovation within a rapidly changing global economy.
08 9261 9453