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Coping with complexity in business structuring

Selecting the right structure for a business has never been as crucial as it is today. This is due to several factors. They affect business structuring considerations for start-ups, spin-offs and business re-constructions. This article discusses how to cope with the complexity.

With businesses striving to compete in globalising markets and operating under several legal, fiscal and regulatory constraints, selecting a limited liability company structure is no longer the easy choice it used to be.

In Australia, as in other common law countries, the explosion of business law relevant to companies has dramatically increased the burden on company directors, management and the operation of companies. This has been accompanied by increased record keeping and disclosure obligations. Some of this is helpful, some ventures into regulatory overkill. Collectively the changes have dampened enthusiasm for use of company structures, here and abroad.

Not only is more company law compliance required, but at times issues arise when a particular company structure is not appropriate given the impact of other law, such as tax, trade practices and employment law.

There has been some shift away from regulation overkill. We've noted that in the article Regulation overkill comes full circle. Nonetheless, governments and regulators in common law jurisdictions are likely to act cautiously and work slowly towards lessening the compliance burden on companies. To do otherwise could involve them in political risks and could result in even more legal confusion. There is a lack of political will and just too much complexity at work in law to unravel it quickly.

So we are left to cope with what is available. We will turn now to look closer at:

  • popular business structures, their exposure to tax laws,
  • anti-avoidance and associateship considerations
  • grouping considerations under GST law
  • related bodies corporate consideration under company law

What business structures options are there?

Although limited liability companies continue to provide significant advantages, other popular structures include trusts and partnerships and even hybrid entities such as partnerships of trusts. The table below is a non-comprehensive list of business structuring options and considerations. They apply broadly, including for a start-up, spin-off or business re-construction.

 

Sole Trader

Partnership

Private Company

Unit Trust

Discretionary trust

 

Income tax

Personal liability

Personal liability of partners

Company liable

Taxed as companies

Trustee liable on residual income

Maximum tax at 30%

No

No

Yes- except when paid as dividends

No

No

Offset of losses against other income

Not applicable

Yes

No

No

No

Distribution of capital gains

Taxed as capital gains

Taxed as capital gains

Taxed as dividends

Taxed as capital gains

Taxed as capital gains

CGT discounts

Yes

Yes if partners are individuals

No for company assets

Yes

Yes

CGT small business concessions

Yes, subject to asset limit and active asset test

Yes, subject to conditions

Yes if specific control conditions satisfied

Yes, subject to specific conditions

Yes, subject to specific conditions

R & D Concessions

No

No

Yes

No

No

We'll turn now to some special considerations which have arisen due to the flood of business law in recent times and its accompanying conflict of law issues.

Tax law's anti-avoidance and associateship considerations

One of the critical aims in structuring is to fall within anti-avoidance measures in law.

The most common form of anti-avoidance provision used in legislation is the use of an associateship clause in the case of entities. In a typical associateship clause an entity will be taken as having the characteristics of its associated entities. Such treatment of entities has both advantages and disadvantages and a business should select the most optimum structure, balancing its strategic aims.

For example in tax consolidation there are several tax advantages to businesses, notably only the head company is responsible for the income tax liability of the consolidated group, including lodging the tax return for the group and there is no capital gains tax implications in respect of transfer of assets within the group. However consolidation is available only to companies that are wholly owned by the head company and further once the election is made to consolidate, all companies that are wholly owned by the head company are automatically consolidated, which may not be desirable.

Grouping considerations under GST law

Grouping does not involve the same principles when the focus shifts to goods and services tax (GST) structuring considerations. The ownership requirement for GST grouping is not the same as for income tax consolidation. For GST purposes, a company must satisfy only the 90% ownership requirement to become a  member of a GST group. The ownership can be direct or indirect. A 90% ownership is defined as:

  • controlling 90% of the voting power;
  • the right to receive 90% of any dividends that may be paid; and
  • the right to receive 90% of any distribution of capital.

All three above conditions must all be satisfied for GST grouping.

Related bodies corporate consideration under company law

In complete contrast to the above, the "related bodies corporate" concept in the Corporations Act 2001 (Cth) is less rigorous. This can work both ways for companies.

holdingcoUnder the Corporations Act, a holding company, its subsidiaries and subsidiaries of the holding company's subsidiaries are related bodies corporate as defined by the Corporations Act.

In the accompanying diagram the arrows denote that there is a 50% shareholding in the relevant company.

Companies 1, 2, 3 and 4 are related bodies corporate, even though an unrelated person has a 50% shareholding in Company 3 and Company 4.

What must be noted here is that for a company to be a subsidiary under the Corporations Act, the holding company must either:

(a)     control the composition of the board of the  company;

(b)     have at least one half of the votes in the company;

(c)     have at least one half shareholder rights to receive distribution of profits or capital, in the company.

Unlike in the case of tax consolidation and GST grouping where companies are allowed to consolidate or group only if the subsidiaries are wholly owned or where there is a 90% ownership interest, related bodies corporate under the Corporations Act exist when the ownership interest is only 50%.

More importantly, under the Corporations Act there is no requirement that an election be made that the companies wish to be considered as a group or related to each other. The status of related bodies corporate is automatic when the necessary 50% ownership interest arises and therefore may come as a surprise to businesses as it probably did in the 2006 employment law case discussed above.


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