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1 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/CONTENTS

Practice Paper CC201 Business Structures

by Kevin Munro and Greg Vale Lawyers, New South Wales Kevin Munro & Associates Revised by Philip Chown LLB (UNSW) BCom (UNSW) Lawyer, New South Wales and Lecturer, The College of Law August 2011

CONTENTS

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Abbreviations Acknowledgments INTRODUCTION................[CC201.10] What are the different business structures available?................[CC201.15] What should a lawyer consider when advising on a business structure?................[CC201.20] What are the characteristics of a good structure?................[CC201.25] SOLE PROPRIETOR................[CC201.35] What are the characteristics of a sole proprietor?................[CC201.40] How do you become a sole proprietor?................[CC201.45] What are the establishment and ongoing costs of being a sole proprietor?................[CC201.50]

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What are the ongoing compliance requirements of being a sole proprietor?................[CC201.55] PARTNERSHIP................[CC201.60] What are the characteristics of a partnership?................[CC201.65] How do you establish a partnership?................[CC201.70] What are the establishment and ongoing costs of a partnership?................[CC201.75] What are the ongoing compliance requirements of a partnership?................[CC201.80] COMPANY................[CC201.85] What are the characteristics of a company?................[CC201.90] How do you establish a company and what are its establishment costs?................[CC201.95] Who should be the directors/shareholders?................[CC201.100] What are the ongoing costs of a company?................[CC201.105] What are the ongoing compliance requirements of a company?................[CC201.110] TRUSTS................[CC201.115] What are the characteristics of a unit trust?................[CC201.120] What are the characteristics of a discretionary trust?................[CC201.125] Unit trust versus discretionary trust................[CC201.127] Hybrid trusts................[CC201.128] How do you establish a trust?................[CC201.130] Who should be the settlor/trustee/appointor/beneficiaries?................[CC201.135] What are the establishment and ongoing costs of a trust?................[CC201.140] What are the ongoing compliance requirements of a trust?................[CC201.145] WHAT PRECAUTIONS SHOULD A PRINCIPAL TAKE TO PROTECT ASSETS?................[CC201.150] STRUCTURES WITH MULTIPLE ENTITIES................[CC201.160] CONCLUSION................[CC201.170]

APPENDIXES
APPENDIX 1 -- INSTRUCTION SHEET TO ESTABLISH A COMPANY................[CC201.200] APPENDIX 2 -- INSTRUCTION SHEET TO ESTABLISH A DISCRETIONARY TRUST................[CC201.205] APPENDIX 3 -- INSTRUCTION SHEET TO ESTABLISH A UNIT TRUST................[CC201.210]

2 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/Abbreviations Abbreviations

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ABN ASIC ATO CGT FBT GST ITAA PAYE PAYG

Australian Business Number Australian Securities and Investments Commission Australian Taxation Office capital gains tax fringe benefits tax goods and services tax Income Tax Assessment Act 1997 (Cth) Pay As You Earn Pay As You Go

3 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/Acknowledgments Acknowledgments

This paper was originally prepared by Kevin Munro and Greg Vale. The paper is regularly reviewed and updated (as necessary). The last of previous reviews was by Philip Chown in July 2010. Current revision by Philip Chown, August 2011.

4 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/INTRODUCTION INTRODUCTION [CC201.10] This paper discusses the most commonly available entities used in structuring a business, and looks at some of the advantages and disadvantages of each of those entities. In very general terms, a business is basically any activity engaged in for the purpose of making a profit. There are many different components that go into making a business. They include the assets, the employees and the intangible qualities of the business. These intangible qualities which add value to the business are known as goodwill. When advising on business structures, a lawyer needs to remember that any particular structure chosen may have different legal or taxation consequences associated with it. The choice of structure is often informed by the objectives of the client.In advising on business structures, a lawyer needs to carefully consider and advise their client on: o o ownership and protection of assets; management and control of the business;

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o o o o o

distribution of profits and taxation consequences; responsibility for liabilities of the business, including taxation; obligations to individuals working for the business; obligations to clients and customers of the business; and later sale of the business and/or its assets, including the taxation consequences of such sale.

Your advice may be sought in relation to an already existing business or a new business that the client is in the process of establishing.

5 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/INTRODUCTION/What are the different business structures available? What are the different business structures available? [CC201.15] The possible structures available to operate a business include: o No separate legal entity: -sole proprietor; -partnership/joint venture; Separate legal entity: -company; -trust: o discretionary; o unit; or -o superannuation fund;

combination of two or more of the above.

The combination of two or more of these entities may lead to a number of different outcomes or consequences in terms of ownership, taxation, exposure to liabilities, and later sale of the business. In particular, it is now possible for legal partnerships in New South Wales to incorporate. If incorporation is selected, this would remove the need for separate administration companies and partnerships. However, since 1 July 1990, the superannuation rules have been amended (this being but one of many amendments made on a regularly continuing basis) which, in part, removes the disadvantage of the self-employed (as compared to employees) in respect of superannuation. This change in the superannuation rules removed the desire to incorporate legal practices and also removed the need for administrative companies.

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[CC201.20] The various issues that must be considered in selecting the appropriate structure include: o o o o o o o o o is the client's business a new enterprise or an existing enterprise; if an existing enterprise, what is its current structure; the nature of the enterprise or primary activity of the business; the nature and type of existing or expected income -- for example, dividends or capital appreciation; the nature and type of existing or expected expenses; the number of persons (individuals) currently participating in the business and their capacity and future expectations; the relationship between participants -- for example, is it solely a family business; current financial commitments and the need to obtain finance now and in the future; and the client's objectives in terms of ownership, taxation, exposure to liabilities, and later potential sale of the business.

In selecting the appropriate structure, the response to the above questions will generally be considered in light of the following factors: o o o o o o o o o o o o control of the business; distinguishing between the assets and liabilities of the business and the personal assets and liabilities of the individuals behind the business; family law issues; stamp duty issues; income tax issues, including capital gains tax (CGT); goods and services tax (GST); land tax/payroll tax/superannuation guarantee charge; estate planning issues; superannuation; limited liability (exposure to third party liabilities); professional/industry requirements; and commercial knowledge/complexity/administrative costs and compliance.

In selecting the appropriate structure, it is also necessary to consider existing arrangements. As lawyers we do not have the luxury of, say, the economist who can apply economic theories based on the assumption that all other factors remain constant. It is rare that as legal advisors we have the opportunity to establish a structure without the necessity to consider existing structures or arrangements. For example, the choice of what entity to use where a client already has companies as entities owning assets will, in part, be governed by the existing structure. In this situation it is more than likely that the appropriate entity is either an existing company or a new company. This is despite the fact that, for tax purposes, a company is not a structure that should be used to acquire appreciating assets. While a trust is a more appropriate entity to hold appreciating assets, it is more important to maintain consistency in a structure of entities. In the case of a group of companies, this allows profits and losses to be distributed with reasonable ease amongst the group. However, a more significant advantage is that the client is probably more knowledgeable of companies than, say, trusts if the client already uses companies. This will provide significant commercial advantages. Another aspect in selecting an appropriate entity is the question of whether the choice is to be made in the context of a new enterprise or an existing ongoing activity. In the latter case, an alteration to a more appropriate entity may

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have significant change-over costs, for example, stamp duty on the transfer of assets, the possible impact of CGT and the possible loss of income taxation benefits (tax losses).

7 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/INTRODUCTION/What are the characteristics of a good structure? What are the characteristics of a good structure? [CC201.25] The characteristics of a good business structure are: o o o o flexibility so that the structure can accommodate changing circumstances with minimum consequences; the structure provides adequate asset protection to the principals of the business; the structure minimises costs, particularly tax; and the structure allows for the efficient distribution of profits.

This paper looks at each of the entities that may be used to structure a business and, from a consideration of the basic characteristics of each entity, gives an appreciation of how the entities may be combined.

8 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/SOLE PROPRIETOR SOLE PROPRIETOR [CC201.35] A sole proprietor is a natural legal person (an individual). There is no separate legal entity other than the individual. Registration of a trading name does not create a separate legal entity. The business is run by the individual as an individual.

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o o o o

Simple to establish and terminate. Simple to control with the individual in control. There are minimal reporting requirements. Income from the business is taxed at the personal rates of the sole proprietor. This offers the tax

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advantage that tax losses may be offset against other income of the taxpayer (for example, "negative gearing"). For CGT purposes, the sole proprietor is advantaged in a way unsurpassed by any other type of entity. This is because the sole proprietor is eligible to claim the 50% CGT discount for individuals. Under the concession, provided that the sole proprietor has held an asset for at least 12 months, the sole proprietor will only be liable to pay tax on half of any capital gain that they may make on the asset. This compares with the tax situation for assets held within a company or a non-fixed trust, where tax will have to be paid on the whole amount of capital gain. The advantage of the CGT discount is illustrated by the following numerical example. Suppose a sole proprietor buys plant and equipment in the year 2005 for$100,000. In the year 2009, the proprietor sells the plant and equipment for $120,000. Since the sole proprietor is an individual and has held the plant and equipment for at least 12 months, they are eligible to claim the CGT discount. The sole proprietor thus only pays tax on $10,000 (that is, half the capital gain of $20,000). Note that where the asset that the sole proprietor holds is an equity interest in a small private company or trust, the CGT discount can only be claimed if various anti-avoidance provisions are passed. These anti-avoidance provisions are aimed at preventing taxpayers from circumventing the 12 month holding rule and relate to the number of assets held by the company or trust for less than 12 months. Sole proprietors are not employees of their business. This avoids the need to take the sole proprietor's drawings (ie, amounts drawn down by the proprietor from the business on account of profits) into account in respect of "compulsory employee" superannuation contributions (superannuation guarantee charge). A sole proprietor also does not have payroll tax and workers compensation liabilities in respect of his or her drawings.

Disadvantages

o o

o o

The sole proprietor has unlimited liability for debts incurred in the course of the business and for negligence committed in the course of the business. The sole proprietor may not simply allocate or split the income. Salaries paid to family members are limited by the application of the Income Tax Assessment Act 1997 (Cth) (ITAA) and, in particular, s 26-35 of that Act. The sole proprietor is required to substantiate business deductions for "fringe benefits". In the case of sole proprietors the substantiation provisions will clearly restrict the level of deductions that can be claimed in respect of motor vehicle expenses and travel expenses. Even if such expenses are predominantly business related, many people will be unable or unwilling to comply with the rigours of collecting the necessary documentation required. Unless the sole proprietor employs or engages family members, he or she has no ability to vary income between family members from year to year. That is, there is no flexibility in tax planning. Under the Pay As You Go (PAYG) instalment system, a sole proprietor is liable to pay tax in quarterly instalments according to the income earned during each quarterly period. This may cause "cash flow" difficulties. The business ends when the sole proprietor ceases working on retirement or death. Unless the sole proprietor is able to identify assets of value which are transferable to a third party, the business of the sole proprietor ceases without being able to derive any benefit from "goodwill", for example.

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10 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/SOLE PROPRIETOR/How do you become a sole proprietor? How do you become a sole proprietor? [CC201.45] It is generally fast and simple to set up a business as a sole proprietor. A sole proprietor running a business would usually register for an Australian Business Number (ABN) -- a tax file number (TFN) is needed to register for an ABN. Whilst registration for an ABN is not compulsory if a business does not have an ABN, other businesses may withhold 46.5% from any payment to the business. An ABN is needed to register for the GST. A business name would also usually be registered. If the sole proprietor intends to use a business name then that name will need to be registered in accordance with the Business Names Act 2002 (NSW). Note that a proposal to create a new national system of business registration is currently being considered. It is proposed that the new system is to start in the first half of 2012. The Australian Securities and Investments Commission (ASIC) is to be responsible for managing and administering the National Business Names Register. If that register is established, businesses will no longer be required to register a business name separately in each state or territory -- registration on the proposed national register will give recognition in all states and territories. Business names currently registered under the state and territory business names systems would automatically be rolled into the new national system. Further information about this proposal (part of the Australian Business Number (ABN) Business Names Registration Project) is available from the website of the Department of Innovation, Industry, Science and Research: www.innovation.gov.au/.

11 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/SOLE PROPRIETOR/What are the establishment and ongoing costs of being a sole proprietor? What are the establishment and ongoing costs of being a sole proprietor? [CC201.50] To determine the cost of registering a business name and the cost of any business licence, contact the NSW Office of Fair Trading, or visit their website: www.fairtrading.nsw.gov.au, under Businesses. A sole proprietor will have to be able to manage their cash flow so as to meet their quarterly PAYG tax instalments as well as their quarterly GST payments. Other costs incurred will be the accounting costs generated in preparing the sole proprietor's tax return and, if required to be registered for GST, the periodic GST returns.

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[CC201.55] There is no specific legislation regulating sole proprietors but they may be liable to comply with legislation which is specific to their business. Sole proprietors may be required to pay a business name renewal fee, to comply with specific business licences or with rules adopted by professional associations.

13 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/PARTNERSHIP PARTNERSHIP [CC201.60] At common law, a partnership is an association of individuals or entities for the purpose of carrying on a business venture or business activity in common with a view to profit. The definition of a partnership under the tax law is much wider, being an association of individuals or entities carrying on business as partners or in the receipt of income jointly. Each partner is entitled to take part in the management of the partnership. Partnerships are regulated by the Partnership Act 1892 (NSW). Unless specifically mentioned, this paper does not consider limited liability partnerships. The maximum number of partners in a partnership is limited by the Corporations Act 2001 (Cth). The maximum number of partners is usually 20, however, there are exceptions. Fifty partners are allowed in partnerships of actuaries, medical practitioners, sharebrokers, stockbrokers, patent attorneys, trademark attorneys and certain collaborative scientific research partnerships. One hundred partners are allowed in partnerships of architects, pharmaceutical chemists and veterinarian surgeons. Four hundred partners are allowed in partnerships of legal practitioners and 1000 partners are allowed for partnerships of accountants. A partnership is not a separate legal entity and, as such, all the assets of the partnership are owned by the partners jointly or in such proportion set out in a partnership agreement. Any contract or agreement to be entered into by a partnership is to be executed by all the partners of that partnership unless the partnership agreement allows for a duly authorised representative of the partnership to execute agreements on behalf of the partnership.

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o o

The legal and administrative procedures and cost of formation are relatively inexpensive. A partnership provides for the combined labour, expertise, management skills and financial resources

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of the partners. The advantages of a partnership are the same as for a sole proprietor where the partners are themselves individuals. The one major difference between a sole proprietor and a partnership is that income may be more easily "split" between partners being, for example, adult members of the family. For ordinary income tax purposes, a partnership is notionally treated as a separate entity (although it is not legally a separate entity nor does a partnership itself pay tax). The partnership must complete and file a tax return each financial year. This return is used to determine the income of the partners. A partner's share of the partnership income is taxed at the personal rates of the partner. This is the same tax treatment as for sole proprietors. As with sole proprietors, any losses from the partnership business will be available to the partner to reduce other income. Accordingly, profits and losses of the partnership are "brought back" into the individual partners' tax returns. Where an activity anticipates losses to occur either initially or occasionally during the venture, then the partnership structure has significant advantages over companies or trusts. As the income of a partnership is taxed in the hands of individual partners on the basis of their share of the partnership's profits or losses, any loss attributed to a partner can be used immediately by that partner against their income from other sources. The loss is not "trapped" in the partnership entity. This is the main reason for selecting partnerships in tax driven investments. For example, tax deferral primary production investments and leveraged lease structures are all based on this ability to distribute losses. The partnership structure may also prove useful where it is necessary to establish that the participants are themselves carrying on a business. Namely, as a sole proprietor the activity may not be sufficiently significant to stamp the transaction with a business venture. With appropriate drafting it is possible to structure a partnership with the flexibility to vary profits/losses between the partners on an annual basis. The share of profits and losses can be varied so that, for example, partner A receives 99% of the profits and 1% of the losses. Alternatively, 99% of the profits in one year can be distributed to partner A and 1% of the profits in the next year distributed to partner A. However, such arrangements should be clearly documented and established prior to the commencement of the particular activity. Otherwise, the Commissioner of Taxation may be entitled to apply the various anti-avoidance provisions. Even where the drafting is clear, a lawyer should be careful to advise a client about the potential application of the anti-avoidance provisions, as changing distributions of profit from year to year may bring into question the nature of the structure -- whether it is in fact truly a partnership or a tax scheme. A lawyer should be careful of any accessorial liability which may arise as a result of the advice they give their client and their facilitation of the partnership transaction on the client's behalf. The partnership structure also allows tax preferred amounts (such as tax incentives and tax free capital gains) to be passed through the partners. This flow through treatment contrasts with the tax treatment of tax preferred amounts for companies and non-fixed trusts. Tax preferred amounts, though tax free at the company/trustee level, become taxable in the hands of the shareholder or beneficiary due to the operation of the imputation system. Partners are able to access the 50% CGT discount as they hold an interest in each partnership asset as an individual. Subject to any partnership agreement, the capital of each of the partners can be increased or withdrawn from the partnership without restriction.

o o

Disadvantages

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The unlimited liability of each partner for debts and the conduct of the business, including for the activities of all other partners in the business. To some extent, this problem may have been addressed by the opportunity to use limited partnerships.A limited partnership is a partnership consisting of at least one limited partner and one general partner. The limited partner's liability to contribute to the debts or obligations of the partnership is limited to the amount of capital contributed by the limited partner. However, the Federal Government amended the tax law to treat limited partnerships as companies for tax purposes. Accordingly, the advantage of accessing losses in a partnership is again often outweighed by the disadvantage of joint and several liability. The use of, say, companies as a partner in a partnership, can minimise the exposure to unlimited liability. Partnerships have certain CGT treatment disadvantages. In particular, the tax laws operate to treat an individual partner's share in the partnership as representing a direct fractional interest in each and every asset of the partnership. Accordingly, if a partnership asset is sold then each partner is treated as having disposed of an asset for CGT purposes represented by that partner's percentage interest. For example, if a partner holds a 331/3% interest in the partnership and real estate owned by the partnership is sold, then for CGT purposes the partner is disposing a one third interest as tenant in common (all joint tenancies are treated as tenants in common) in the real estate. Any gain from the disposal is not included in the partnership income but, rather, directly in the individual partner's income. The implication of this treatment is that some partners may hold an interest in the partnership property as a pre-CGT asset whereas others may hold it as a post-CGT asset. This treatment is, of course, similar to the approach under stamp duty laws. Accordingly, the admission or retirement of a new partner will give rise to both CGT and stamp duty implications. This makes partnerships an inflexible entity for the purposes of holding appreciating assets. For example, A and B are in a 50:50 partnership owning an asset worth $90,000. If C is introduced and pays $30,000 for his or her one third interest then: -A and B will be held to have each disposed of a 16.5% interest in the property for $15,000 respectively; and -C will be held to have acquired a 331/3% interest in the property for $30,000. Whether A and B are subject to CGT will depend on whether the property was acquired after 19 September 1985 and, if so, what was the original acquisition cost. It should be noted that even if C does not pay any consideration for his one third share on admission, the tax laws operate to deem an arm's length consideration. Accordingly, A and B will be deemed to have received $15,000 each. The inability to pay wages to an individual being one of the partners -- any amount paid to a partner is not therefore a deduction (for tax purposes) in the same way as payments to employees. Potential problems relating to the retirement and admission of partners. A change in the membership of partners will constitute a new partnership for the purposes of the Income Tax Assessment Act 1936 (Cth). Accordingly, there is no continuity of business where there is a change in the partners. The potential for disputes and breakdown in the mutual trust of the partners.

o o

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[CC201.70] A written partnership agreement is not required for the establishment of a partnership, although it is highly recommended. The partnership agreement defines the rights and obligations of the partners between themselves subject to the Partnership Act 1892 (NSW). A partnership bank account should be opened with all income and expenditure passing through that bank account. All the partners, unless they all use their proper names, should register a business name in accordance with the Business Names Act 2002 (NSW). Ownership of all assets of the partnership and all obligations of the partnership should be in the name of all partners. The partnership should also maintain a proper set of financial accounts detailing the income and expenditure of the partnership and the capital contributions and drawings of all the partners. The partnership should obtain a TFN and an ABN for the tax office, and consider registration for GST.

16 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/PARTNERSHIP/What are the establishment and ongoing costs of a partnership? What are the establishment and ongoing costs of a partnership? [CC201.75] The cost of a partnership agreement will depend greatly on the complexity of the arrangements. A standard partnership agreement would cost between $500 to $1,500 in legal fees. Other costs incurred will be the accounting costs generated in preparing the partnership tax return and, if required to be registered for GST, the periodic GST returns.

17 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/PARTNERSHIP/What are the ongoing compliance requirements of a partnership? What are the ongoing compliance requirements of a partnership? [CC201.80] The partnership must comply with the Partnership Act 1892 (NSW). Partnerships may also be liable to comply with specific business legislation, licences or with rules adopted by professional associations. All businesses must comply with certain legislation regulating businesses. This regulation covers such things as industrial relations, retail leases, factory and shop laws, workers compensation, holiday and long service leave, superannuation, income tax, FBT, payroll tax and local government laws.

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Business Structures/[Commentary]/COMPANY/[Commentary] COMPANY

[CC201.85] A company is a separate legal entity capable of holding assets in its own name. The two main participants in a company are the shareholders and the directors. The shareholders are the owners of the business and the ones who put the capital into the business. A shareholder has an interest in the company but no direct link to the particular assets of the company. The shareholders also have no say in the day to day management of the company except that they have the right to elect the directors at a general meeting of the company. The directors are the individuals who have the day to day control of the company. As the directors are managing the company for the benefit of the shareholders, a number of obligations and duties are imposed on directors. This paper does not intend to cover these duties but a client must be made aware of them before using a company in his or her business structure. Companies are commercially well understood and accepted, and this often results in the recommendation to conduct an activity through a company.

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o o o

A separate legal entity with perpetual succession and limited liability. May be established by incorporation quite quickly and efficiently. As a borrower, a company may be a commercially advantageous entity to use because of "commercial familiarity" and the capacity of a company to grant a floating charge, a fixed charge or a combined fixed and floating charge. Note that once the Personal Property Securities Act 2009 (Cth) is in operation (now expected to be in October 2011), then what is currently referred to as: -a "floating charge" will be known as "a security interest in a circulating asset"; -a "fixed charge" will be known as "a security interest in a non-circulating asset"; and -a "fixed and floating charge" will be known as "a security interest in non-circulating and circulating assets". In broad terms the company tax imputation system has made companies more competitive as a choice of an appropriate entity, the reason being that company profits are no longer subject to the traditional double layer of tax (namely, tax at the company level and then further tax at the shareholder level). The imputation system ensures that if the company has paid tax, then the shareholders will get a credit for that tax paid.

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Contributions made by the company to a superannuation fund on behalf of employees may be claimed by the company as a tax deduction. The amount of the deduction is limited by the "age based" limit. Interest on borrowings entered into by the company to pay superannuation contributions may be claimed as a deduction for tax purposes. Companies are entitled to make tax deductible retirement payments to all employed family members. However, the amount concerned is subject to superannuation benefit limits and the possible application of s 109 of the Income Tax Assessment Act 1936 (Cth). Losses may be transferred from one company in the group to another provided that there is 100% common ownership. Note that the losses may only be transferred where a parent-subsidiary situation occurs. For example, if A and B own company X and company Y -- the losses in, say, company X can not be grouped with (or transferred to) company Y. Such grouping could only occur if, for example, A and B owned company X which, in turn, owned company Y or company T owned both company X and company Y. The company structure provides an opportunity to employ the principals. This allows you to use the FBT rather than having to substantiate fringe benefit expenses as a sole proprietor has to -- this may be of particular benefit in the case of motor vehicles. Where the principals are employed by the company, their wages will be subject to the PAYG withholding system. Companies offer some ability to "split" income among family members. This may be achieved through either: -the employment of family members; or -the issue of different classes of shares. A shareholder will be liable to pay tax on their dividends under the PAYG instalment system. Where the dividends that they receive are franked (that is the company has paid tax on the dividend amount), the shareholder's tax liability will be reduced as the shareholder is given credit for the amount of tax paid by the company. Companies offer the ability to obtain CGT deferral where a company is formed to replace existing family entity structures. A CGT "roll-over" election can be exercised where assets are transferred to a company in consideration for the issue of shares or securities in the company, such that after the transfer the transferor owns all the shares in that company. A CGT roll-over election cannot be utilised where assets are transferred to an entity other than a company. The company tax rate was 34% for the 2000/2001 income year. This tax rate fell to 30% for the income years after the 2001/2002 income year (this tax rate is called the entity tax rate and will cover companies and non-fixed trusts). This company tax rate is much lower than the highest marginal tax rate for individuals which is 45% (excluding the Medicare levy). Further, there is no requirement to distribute profits. The profits can be accumulated in the company. This, in effect, enables a taxpayer to structure his or her affairs so that tax is paid at a maximum rate of 30% and any further liability to be deferred indefinitely (after tax profits are retained in the company). The benefit of accumulating income in a company at this lower tax rate is, however, qualified in two respects. First, it will be difficult to distribute this accumulated income later on without triggering further taxation. Deemed dividend problems may arise where a shareholder attempts to use a company's retained profits for personal purposes: see s 108 and Div 7A of the Income Tax Assessment Act 1936 (Cth). Second, legislative provisions prevent independent contractors who supply their services through an interposed entity from being able to accumulate income at the lower entity tax rate. These personal

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services provisions operate to treat personal services income (that is, income which is derived through the personal effort or skills of the individual but which is received through an entity) as being assessable income of the individual whether the income is passed through to the individual as salary or wages, dividends or trust distributions. Such personal services income will be taxed at the individual's marginal tax rate rather than the entity's tax rate. An individual who has the personal services income of an entity attributed to them, will also be generally limited to work-related deductions available to employees. These personal services provisions are also applicable to partnerships and trusts. A sole proprietor is not affected by these provisions as they are already paying tax on income that they derive at their marginal rate of tax. Ownership in assets may be transferred in certain circumstances, through a company structure without significant stamp duty costs. That is, subject to the provisions of Ch 4 of the Duties Act 1997 (NSW) (landholder provisions) it is possible to transfer ownership by transferring shares with minimal duty. Not only is the rate of duty less (0.6% for transfer of shares as compared to a maximum marginal rate for transfers of assets of 5.5%) but also the value of the transfer can take account of liabilities, and so reduce the potential exposure to duty even further. Note that duty on the transfer of "business assets" (goodwill, certain intellectual property and statutory licences) is to be abolished from 1 July 2012: Duties Act 1997 s 35. The share buy-back and reduction of capital provisions in the Corporations Act 2001 (Cth) provide greater flexibility in cancelling shares or reducing the paid-up capital of companies, and so make companies a less "rigid" form as a choice of entity.

Disadvantages

Tax losses are trapped within the company. This often means that negative gearing should be structured outside the company. Namely, the shareholders should enter into the borrowings and invest the funds as capital (equity) into the company.This allows the tax deduction to be used by the shareholders leaving the company with profits. This structure also has some advantage for CGT purposes. However, commercially such a structure may prove difficult to implement. In particular, if it is necessary to use the investment (the property acquired by the company) as security for the borrowings (by the shareholders) then a problem under s 260A of the Corporations Act arises. That section provides that the company may only give financial assistance to a shareholder to purchase shares in the company in very limited circumstances. Tax preferred amounts (that is, tax free capital gains and tax incentives) received by a company will be subject to tax on distribution to shareholders. This inability to pass through tax preferred amounts to shareholders without causing further taxation stems from the way that the imputation system operates. Under the imputation system a shareholder is required to gross up a dividend to its original amount prior to the company paying tax on it before working out their tax liability. No imputation credits are available with respect to the distribution of a tax preferred amount as the company did not pay any tax on the amount. This causes the recipient shareholder to be liable to pay tax on the whole tax preferred amount and effectively the benefit of the tax free capital gain or tax incentive is lost. Prior to 1 July 2000, the benefit of imputation credits could be lost through the inappropriate structuring of entities within an entity group. For example, in the case of a privately owned company, consideration must be given to the mix of dividend and non-dividend income derived by family member shareholders. However, since 1 July 2000, imputation credits received in excess of income can give rise to a tax refund. The commercial costs in maintaining a corporate entity can be significant. Annual filing fees,

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o o

accounting fees and greater accountability have added complexity and costs. In particular, the Corporations Act now requires that directors of companies must now take a positive role in the affairs of the company. The incorporation of an enterprise means that the principals become employees of that company. This gives rise to certain disadvantages including exposure to payroll tax and "compulsory" superannuation. A company is not entitled to claim the CGT discount concession which is available to individuals and superannuation funds. Shareholders -- particularly minority interests -- may not have very effective involvement or control over decision making or management.

20 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/COMPANY/How do you establish a company and what are its establishment costs? How do you establish a company and what are its establishment costs? [CC201.95] A person wanting to incorporate a company can lodge an application for its registration with the Australian Securities and Investments Commission (ASIC) using the appropriate form. The application must contain specific information. A fee is payable. The ASIC may register a company upon receiving the application for registration, together with the requisite fee. The registration process involves ASIC: o o o providing an Australian Company Number (ACN); registering the company; and issuing a certificate of registration.

The company comes into existence as a body corporate at the beginning of the day of registration and remains in existence until deregistered under the Corporations Act 2001 (Cth). Presently, a new company may be registered fairly quickly. Having registered the company, it will be necessary for the company to obtain a TFN, and it may be appropriate for it to register for the purposes of other taxes such as GST. An alternative to a person actually registering a company is for the person to purchase a "shelf company". There are a number of businesses that specialise in company incorporation, and provide online services that allow all documentation necessary to set up and register a company to be completed very quickly. Another form of "shelf company" is a company that has been pre-incorporated (often by lawyers, accountants or shelf company providers) and then left "sitting on the shelf" ready for purchase. When a client bought a shelf company, the shares in that company were transferred to the client (or client's nominee) and the original directors of the shelf company resigned and new directors (nominated by the client) were appointed. The name of the shelf company was also often changed to that chosen by the client/purchaser. The information required to establish a company is in Appendix 1.

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21 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/COMPANY/Who should be the directors/shareholders? Who should be the directors/shareholders? [CC201.100] Proprietary companies now only require at least one shareholder and one director. Single director companies are often used in family business arrangements. In the case of a partnership between family members, formation of a single director company means only one family member is subject to the obligations imposed on directors by the Corporations Act 2001. For asset protection planning purposes, in a married couple situation, one spouse could be the director of the company and the other spouse could own such assets as the principal residence. The selection of the shareholders of the company is important, as shares are a CGT asset. In particular, from a tax point of view, it is difficult to later change the shareholder without giving rise to CGT consequences. Further, as the shareholder has the "value" of the company then, from an asset protection point of view, it may be undesirable for individuals to own the shares. A flexible structure is to have a family trust established (see [CC201.115] and following) and for the trustee of that family trust to be the legal owner of the shares in the company that conducts the business. It is often recommended that the trustee itself is a company with either or both of the spouses as the shareholders of that trustee company. This facilitates asset protection and allows for flexibility in distributing income from the company amongst family members.

22 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/COMPANY/What are the ongoing costs of a company? What are the ongoing costs of a company? [CC201.105] A company's annual review fee must also be paid to ASIC. Where more than one company is used in a structure, annual review fees can quickly add up. Other costs incurred will be the accounting costs incurred in preparing the company tax return and if required to be registered for GST, then the periodic GST returns.

23 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/COMPANY/What are the ongoing compliance requirements of a company? What are the ongoing compliance requirements of a company? [CC201.110] A company and its officers must comply with the Corporations Act 2001 (Cth) which in part: o o places many duties on directors; requires certain formal meetings to take place; and

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requires certain documents to be lodged with ASIC.

It is beyond the scope of this paper to deal with the specific requirements of the Corporations Act relating to companies. A company may also be liable to comply with specific business legislation, licences or with rules adopted by professional associations. The business of a company must comply with certain legislation regulating businesses. This regulation covers such things as industrial relations, retail leases, factory and shop laws, workers compensation, holiday and long service leave, superannuation, income tax, FBT, payroll tax and local government laws.

24 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS TRUSTS [CC201.115] A trust exists when the holder (the trustee) of a legal or equitable interest in certain property (trust property) is bound by an equitable obligation to hold that interest for the benefit of another person or persons or (beneficiary or beneficiaries) for some other object or purpose permitted by law. A trustee may hold separate interests in the trust property for separate beneficiaries. Commonly, a trustee may hold the corpus of an estate for one or more beneficiaries and the income of an estate for one or more other beneficiaries. All transactions in respect of the trust are undertaken by the trustee. Accordingly, a transaction entered into by the trustee is a personal obligation. The trustee could, for example, be personally sued. A trustee sued in the capacity of trustee will often have a right of indemnity as against the assets of the trust. The trustee is given the power to enter into transactions on behalf of the trust under a deed outlining the terms of the trust. If there is no deed, then the powers of the trustee in administering the trust are defined pursuant to the relevant state Trustee Acts. These statutory provisions are limited in their powers and, accordingly, it is desirable to have a written deed of trust. The nature of the interest of a beneficiary under a trust depends upon the type of trust involved. The two main types of trust are the unit trust and the discretionary trust. The interest of the beneficiaries in a unit trust is that the units held by the unitholders confer a proprietary interest in all the property of the trust estate. Of course, it is possible to vary the interests of the unitholders by varying the rights attaching to the units, in much the same way as issuing different class of shares. Accordingly, it is possible to issue units which have rights only to the income or different classes of income of the trust, or to capital of the trust, or to capital gains of the trust or any combination of the above. Under a discretionary trust, the trustee has a discretion as to who to distribute or apply the income and capital of the trust. The beneficiaries of the discretionary trust merely have a right to be considered by the trustee. They have no right to demand a share of the income or capital of the trust. Accordingly, the discretionary beneficiaries have no equitable interest in the property of the trust estate.

25 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201

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Business Structures/[Commentary]/TRUSTS/What are the characteristics of a unit trust? What are the characteristics of a unit trust? [CC201.120] Advantages

o o

Unit trusts are in many ways similar to companies in that the trust is separate from the unitholders; the unitholders subscribe equity on units and the principals may be employed by the trust. The major tax difference between a unit trust and a company is that a unit trust need not pay tax. Rather, the unitholders incur the tax on taxable profits derived by the unit trust. This is a significant advantage in "joint venture" type arrangements. For example, A and B wish to invest in a property. If A and B subscribed for shares in a company which undertook the investment then any profits derived would be subject to tax at the company level. This will be the case even if, say, A has tax losses from another activity. If instead A and B had subscribed for units in a unit trust which in turn undertook the investment then the trust itself would not pay tax. Rather, the profits would be distributed to A and B and if, say, A had tax losses then the profit from the trust could be off-set against A's losses. The use of a unit trust in this type of situation allows, in effect, A and B to do their own tax planning, whereas with a company structure, any tax planning has to be undertaken at the company level. This requires both A and B agreeing on the appropriate arrangements. The benefit of tax free capital gains (the indexation portion) and tax incentives may be passed through to the unitholders provided that appropriate structuring is undertaken. Tax free capital gains and tax incentives received by the unit trust are distributed to unitholders prima facie as non-taxable income not forming part of the "net income" of the trust as defined in s 95(1) of the Income Tax Assessment Act 1936 (Cth). They are, however, regarded as capital distributions for CGT purposes. These provisions operate so that in calculating a capital gain or capital loss on the eventual sale by a taxpayer of the units in a trust, the cost base of the units will be deemed to have been reduced each time a tax free distribution is received: ITAA s 104-70. If this tax free distribution is greater than the indexed cost base of the units at that time, the excess is treated as an immediate taxable capital gain of the unitholder. To avoid this consequence it is desirable that a unitholder's cost base on units in the trust is maximised. This is generally achieved by the unitholder subscribing equity in the trust sufficient to meet the capital requirements of the trust.Namely, the trust itself should not borrow (negatively gear) but rather the unitholders should borrow and invest the moneys as equity on units. This ensures that the "cost base" on the units is at least equivalent to the "cost base" on the property acquired by the trust. Unit trusts offer the opportunity to "stream" different forms of income to different unitholders. This is achieved under modern forms of unit trust deeds by providing for different classes of units. This, of course, can be structured in various ways. A simple form is to distinguish, under the trust deed, between revenue income and taxable capital gains. One class of units can then be defined as entitled to the revenue income and another class to the taxable capital gains. A good example of such an arrangement is a unit trust established to invest in stocks and shares. A

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private superannuation fund holds 50% of the units, whilst the other 50% is held by individuals not associated with the private superannuation fund. The units held by the superannuation fund are the "revenue income" units, whilst the units held by the individual are "taxable capital gains units". The reason for this structure is that taxable capital gains derived by the trust are distributed to the individual. The individual then can take advantage of the 50% CGT discount thus minimising the exposure to tax. The superannuation fund is only required to pay tax at the rate of 15% on the revenue income. Further, as the trust is investing in shares, a significant portion of the income derived will be in the form of franked dividends. The franking credits received by the superannuation fund virtually eliminate the tax otherwise payable by the superannuation fund on other investments and contributions. The use of various classes of units can be important in stamp duty planning arrangements. For example, where a unit trust is a so-called "landholder" under Ch 4 of the Duties Act 1997 (NSW) any change in the underlying ownership of the trust could give rise to significant exposure to stamp duty. Accordingly, if a new unitholder is being introduced (for example, a personal superannuation fund) it may be beneficial to issue "income access" type units to that new unitholder. The 50% CGT discount is available to all trusts (this includes unit trusts and discretionary trusts) in relation to disposals of assets. This is a significant tax concession in the short term because the 50% CGT discount can be claimed at both trustee and beneficiary level. That is, the trustee can choose to either claim the 50% CGT discount at trustee level and accumulate the capital gain, or to distribute the capital gain to a beneficiary who can also claim the 50% CGT discount (provided that if the trustee has claimed the discount the beneficiary must gross up the discounted distribution. See Practice Paper T102 Capital Gains Tax at [T102.70]). This results in a maximum tax rate of 23.25% being paid on the capital gain. It is common practice when drafting unit trust deeds to include "discretionary powers". A hybrid form of trust has developed from a crossing of a unit trust with a discretionary trust. Under the hybrid trust deed, the trustee has the power to exercise a discretion to apply the income (or a particular form of income) on a class of units to the exclusion of other classes of units. In the event that the discretion is not exercised, the income is applied to the various classes on a pro rata basis. By using a hybrid trust it is possible to obtain the advantage of flexibility as available with a discretionary trust. That is, income can be applied to one unitholder in one year and to another unitholder in the next depending on the individual circumstances of the particular unitholders. This is of particular relevance in family type arrangements. It is unlikely to be applicable in an arm's length joint venture type arrangement.

Disadvantages

Tax losses in a unit trust cannot be distributed to the unitholders. Accordingly, unit trusts should be structured so that losses are incurred at the unitholder level rather than the unit trust level. To achieve this, see the comments above in relation to tax free capital gains and tax incentives. Note also that, unlike companies, the problems associated with s 260A of the Corporations Act do not apply to unit trusts. There is no opportunity to defer a capital gain through the CGT roll-over relief provisions when assets are transferred into a trust.

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26 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/What are the characteristics of a discretionary trust? What are the characteristics of a discretionary trust? [CC201.125] Advantages

o o

A settlor may settle property on a trustee, and the trustee then, in effect, directs the flow of income and capital to beneficiaries in accordance with the terms of the trust deed. Limited liability can be achieved with discretionary trusts provided that the trustee does not own assets in its own right. Accordingly, it is desirable to use a corporate entity as a trustee and this corporate entity should not undertake any activity other than acting as trustee. Discretionary trusts were once virtually the automatic choice of entity for family run businesses because of the flexibility they offered in income splitting and their ability to pass tax preferred amounts to beneficiaries. Discretionary trusts provided income splitting opportunities in two ways. First, income could be applied on a varying basis from year to year. Further, provided that the trust deed was correctly drafted, the trustee could be empowered to apply different forms of income (franked dividends as compared to unfranked dividends, foreign source of income as compared to Australian source income, interest income as compared to capital gains, and so on) on a varying basis from year to year. This flexibility in income splitting allowed family groups to achieve an optimum tax position each year as income could be distributed to family members on lower marginal tax rates. The ability to pass through tax preferred amounts contrasted with companies and unit trusts where CGT arose when such tax preferred amounts were distributed (for unit trusts this occurs when the distributions exceeded the unitholder's cost base).

Disadvantages

o o

As with companies and unit trusts, tax losses are "trapped" in discretionary trusts. Further, since it is not possible to "gear" an investment into the trust by a beneficiary, discretionary trusts are an inappropriate vehicle for negative gearing purposes. However, a trust will not be able to deduct prior year and current year losses and relevant debt deductions if it fails certain tests relating to the control or ownership of the trust. Discretionary trusts suffer a commercial disadvantage in that they are not well understood. This is particularly so with financiers. Accordingly, difficulties can arise from a commercial aspect. Care needs to be exercised in changing the provisions of a trust deed. The risk faced is that the amendment could cause the imposition of ad valorem stamp duty and expose the trust to CGT. The risk is most likely to arise where the beneficiaries are changed. For example, an amendment which provides a new beneficiary with a fixed entitlement to the corpus of a trust is likely to trigger stamp duty and CGT, whereas the appointment of a mere discretionary object will not cause a problem from a stamp duty and CGT perspective. Discretionary trusts are not entitled to the tax exempt threshold for land tax purposes. Accordingly, the advantages offered by discretionary trusts in holding real estate investments must be countered by the additional costs in land tax.

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Discretionary trusts are generally not an appropriate vehicle for joint venture type investments. The reason being that the "interests" of the joint venturers are not defined and therefore commercial risks can arise. Care should be exercised in appointing a trust as a beneficiary of another trust. You should ensure that, in this situation, the vesting dates of the respective trusts do not infringe the perpetuity rules thus voiding the original trust.

27 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/Unit trust versus discretionary trust Unit trust versus discretionary trust [CC201.127] A unit trust is often preferred (as a business vehicle) over a discretionary trust, and that preference is usually attributed to the following characteristics of a unit trust: o o o negotiability of units; fixed annual entitlements to income; and fixed entitlements to "capital".

28 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/Hybrid trusts Hybrid trusts [CC201.128] In recent years a new form of trust has been created which is commonly referred to as a "hybrid trust". It combines some of the features of both a discretionary and unit trust so that there are both discretionary beneficiaries and fixed (unitholder) beneficiaries. Hybrid trusts are complex trusts and it is beyond the scope of this paper to outline how they are intended to work. It is sufficient to say that the discretionary beneficiary component is intended to allow flexibility in streaming income to a discretionary beneficiary as allocated from time to time by the trustee. On the other hand, a unitholder may hold an income unit or a capital unit or both so that either income or capital gains or both appear to be automatic entitlements because they are a fixed unitholder, which requires no allocation by the trustee. Sometimes, the apparently fixed distribution entitlements of unitholders may only be notional if the trustee first allocates available income or capital gains to discretionary beneficiaries under a power in the hybrid trust deed. There are some variations on this theme. The Australian Taxation Office (ATO) issued Taxpayer Alert TA 2008/3 cautioning that the use of hybrid trusts raises a number of tax law non-compliance issues and may also trigger the general anti-avoidance provisions in Pt IVA of the Income Tax Assessment Act 1936 (Cth). Taxpayer Alert TA 2008/3 is available on the ATO's website (under Compliance issues/Tax planning & schemes/Alerts & warnings): www.ato.gov.au/.In advising on any of these complex arrangements, as an Australian legal practitioner you also would need to consider your professional ethical

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obligations in relation to your practising certificate.

29 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/How do you establish a trust? How do you establish a trust? [CC201.130] The information required to establish a discretionary trust is in Appendix 2 and the information required to establish a unit trust is in Appendix 3. A trust is funded by the payment of property (settlement sum) by a settlor to the trustee. Such sum is paid and accepted in accordance with the terms and conditions of the deed of settlement executed by the settlor and the trustee. The settlement sum together with any other money paid or property subsequently transferred to the trustee is called the trust fund. The deed provides that the trust is to terminate on a day called the vesting day stipulated in the deed or such earlier date as the trustee may determine. On the vesting day, the beneficiaries appointed by the trustee in accordance with the terms of the deed are entitled to the whole of the trust fund. The trustee may, on that day, divide the whole of the trust fund between such of the general beneficiaries in such proportions as it determines by an instrument in writing. In the absence of the trustee executing such an instrument on the vesting day, the whole of the trust fund is divisible between the persons named as remainder beneficiaries (if any). In the most unlikely event that on the vesting day the trustee has not determined to appoint the trust fund to any general beneficiary and there is no remainder beneficiary surviving, and the trustee has not appointed additional remainder beneficiaries, then the whole of the trust fund is payable to or for such charitable purposes as the trustee nominates. The trustee's powers of investment of the trust fund are specifically set out in the deed or, in the absence of a deed, by the Trustee Act 1925 (NSW). Ordinarily (but not necessarily), a trustee is authorised to do all things which an individual or a company could do in respect of his or her or its own property.

30 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/Who should be the settlor/trustee/appointor/beneficiaries? Who should be the settlor/trustee/appointor/beneficiaries? [CC201.135] Having regard to common law and s 102 of the Income Tax Assessment Act 1936 (Cth), the settlor should not be beneficially entitled under the trust. Usually the settlor is the lawyer or accountant of the clients. The trustee may be either individuals or a corporate entity. Since the trustee may be personally sued in respect of its activities on behalf of the trust, it is generally recommended that the trustee be a special purpose company.

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Accordingly, the considerations in respect of the formation of a company must also be taken into account. It would be desirable that such a company does not own assets in its own right. The selection of the beneficiaries of a unit trust gives rise to the same issues as the selection of shareholders in a company as discussed earlier. In a discretionary trust, the beneficiaries are generally referred to as a "class of beneficiaries" as distinct from the nomination of particular individuals. This has the advantage of complete flexibility in who may benefit under the trust in the future. A trust deed may provide for the role of an appointor who is empowered to appoint or remove the trustee. A beneficiary has no interest in the trust fund, and may have difficulty in enforcing due administration of the trust. The position of appointor under a discretionary trust may therefore become important.

31 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/What are the establishment and ongoing costs of a trust? What are the establishment and ongoing costs of a trust? [CC201.140] The cost of an ordinary discretionary trust deed can vary from $300 to $1,200. More complicated discretionary trust deeds such as the hybrid discretionary trust (with the facility to issue units) or joint venture discretionary trust (with classes of general beneficiaries) cost approximately $1,000-$2,500, or significantly more -- depending on the level of complexity. A standard unit trust with one class of units costs approximately $800, while specialist unit trusts (with different classes of units) cost approximately $1,000-$2,500. In the same way that a shelf company may be purchased from a provider, it is also possible to source standard trust deeds in most of the above categories from providers at less than the above identified amounts. Lawyers need to be aware that such standard trust deeds may require significant drafting work to ensure that they meet the legal needs of a client. The above estimates therefore still represent a reasonable estimate, even though a standard document may be sourced from a provider for less than the above estimated amounts. Every trust deed is subject to stamp duty. This is $500 in New South Wales plus $10 duty for each duplicate copy of the trust deed which is in addition to the above costs. Lawyers should take care to ensure that the trust is established ("declared") before entering into a contract to purchase dutiable property, otherwise the duty on the declaration of trust may in fact be at ad valorem rates on the purchase price of the property, and where the contract for purchase is itself subject to duty this may result in double duty on the transaction. A corporate trustee is often used where a trust operates a business. Accordingly, all the costs associated with a company will also be incurred in addition to the costs of establishing the trust (refer to [CC201.95] above). It is possible for the company to be trustee of more than one trust or superannuation fund. Other costs incurred will be the accounting costs incurred in preparing the trust's tax return and if required to be registered for GST, then the periodic GST returns.

32 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/What are the ongoing compliance requirements of a trust? What are the ongoing compliance requirements of a trust?

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[CC201.145] Trustees must comply with the common law rules dealing with the rights and obligations of the trustee. The most important of these is to ensure that the trust deed provides that the trustee has the power to undertake any dealing which the trustee plans to do. Many of the rights and obligations are replicated in the Trustee Act 1925 (NSW). Trading trusts may also be liable to comply with specific business legislation, licences or with rules adopted by professional associations. All businesses must comply with certain legislation regulating businesses. This regulation covers such things as industrial relations, retail leases, factory and shop laws, workers compensation, holiday and long service leave, superannuation, income tax, FBT, payroll tax and local government laws.

33 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/TRUSTS/What precautions should a principal take to protect assets? What precautions should a principal take to protect assets? [CC201.150] A creditor of a sole proprietor or partner may have recourse to "personal assets" of the proprietor or partner. In certain circumstances, a creditor of a company may be able to access the personal assets of a director. It has been common practice for persons in those roles not to personally hold any significant assets. As a lawyer, you need to be cautious that any advice you give to persons in these roles regarding ownership of assets is not provided to defeat or frustrate existing or anticipated creditors, or in any other circumstance that might be a breach of any duty or statutory provision, or your professional responsibility obligations as a lawyer. The legal title of a trust asset is held by the trustee. The trust is a separate legal identity. In the case of a discretionary trust, a principal who is named as an ordinary beneficiary does not have an interest in any asset of the trust before the exercise of the trustee's discretion. The principal is a mere discretionary object with the right to be considered as a beneficiary, but no more. Accordingly, the creditors of the principal have no rights to these assets in the event of a claim.This may not be the position where the principal is a residual beneficiary having an interest in the residue of the trust or if the principal actually controls the trust. The fact that a sole proprietor, partner or director has no significant assets in his or her own name may cause difficulties in raising finance, as lenders typically look for security from principals. Lenders will usually require guarantees to be given by principals, and where principals own no significant assets, the lenders will usually require the asset holding entities to also provide guarantees. What should be of more concern to the principal is to protect his or her assets from unidentifiable claims such as public liability and professional negligence.

34 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/STRUCTURES WITH MULTIPLE ENTITIES STRUCTURES WITH MULTIPLE ENTITIES [CC201.160]

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In operating a business through the use of multi-entities, companies clearly have a tax advantage over trusts. In recent years the tax legislation has started to reflect the fact that a corporate group of subsidiaries and a holding company can effectively operate as a single economic unit. As such, tax losses can be transferred between wholly owned members of the same corporate group as can excess foreign tax credits, and assets can be transferred between group entities without adverse CGT implications. In all areas the legislation consistently restricts these concessions to corporate groups and as such this flexibility is not afforded to trusts. It is not possible to review the various combinations of entities that may be used. However, it is important to note the flexibility offered by choosing different vehicles for specific functions. The acquisition of specific assets in a special purpose vehicle can provide flexibility in the future bearing in mind the possible impact of both income tax and CGT. For example, it may prove more tax effective to obtain a capital gain by selling the vehicle owning the asset rather than selling the asset itself. Discretionary trusts work best for family groups where kinship bonds can regulate the exercise of the trustee's discretion. For arm's-length joint ventures, unit trusts are a better vehicle as they give parties peace of mind in relation to their entitlements. A unit trust structure also allows arm's-length parties to undertake tax planning at their own respective levels -- profits from a fixed trust are distributed before tax and not after tax. Unit trusts are frequently used to conduct trading activities where different family interests are involved. Take the example of two brothers wishing to conduct a business jointly. Each establishes a family discretionary trust and the respective discretionary trusts take up units in the trading unit trust. An alternative to this is for the two discretionary trusts to form a partnership through which the trading business is conducted. The discretionary trust structures provide asset protection whilst the partnership structure allows for the division of losses and for the pass through of tax preferred amounts. Where negative gearing of an investment is planned, a unit trust is the preferred entity. An individual would borrow the funds required to undertake the investment (and, therefore, obtain the benefit of the interest cost deductions) and then invest the moneys as equity in units in the trust. A unit trust also provides flexibility as further units can be issued at a future date to other parties (for example, after family members) without the necessity to transfer "interests" in the property and incur stamp duty and CGT. Where it is commercially difficult to undertake borrowings at the unitholder level in joint venture arrangements, the use of a partnership of companies or trusts or a combination of both should be considered. This allows the respective joint venturers to select their own vehicle (whether a company or trust) as is appropriate for their own individual circumstances. The profits of the partnership are then distributed before tax. Any losses are distributed to partners of the partnership. The loss incurred by each of the partners can then be utilised within their respective groups based on their own tax planning needs. A company does not enjoy a discount on taxable income derived as the result of the CGT regime. Consequently, unless the company has offsetting losses it may not be appropriate for a company to hold an asset that is expected to appreciate, and hence generate a CGT liability. Individuals enjoy a 50% discount on taxable income derived from a capital gain under the CGT regime. Therefore, it may be advantageous for an individual to hold an appreciating asset and then to lease the asset to a company.The individual accesses the CGT discount while paying tax on the "rental" payments. However, in personally holding the asset, creditors of the individual may have recourse to it. An alternative approach may be to use a private superannuation fund to hold units in a unit trust which holds the

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asset and then to lease the asset back to the trading entity. Later on when the asset is disposed of, the unit trust will be able to stream the capital gain to the superannuation fund which can claim the CGT discount (though the discount is lower at one third of the capital gain). The in-house asset rules, however, limit the use of this approach to business real property and then only under certain conditions. Companies also suffer from the fact that tax preferred amounts (such as a tax free capital gain) are "trapped" in a company. For such amounts to be made available to individual shareholders, a dividend must be paid and this is subject to tax.Accordingly, tax is ultimately paid on the amount even though the amount was initially non-taxable to the company. This tax would not have to be paid if the tax preferred amount had been generated by a sole proprietor, partnership or unit trust (provided that the unitholder's cost base is not exceeded). Business operated with trust and partnership An example of a trust and partnership combination is that of two individuals wishing to enter business together who each decide to form a discretionary trust (with the discretionary beneficiaries being the members of their respective families).The two trusts then enter into a partnership which conducts the business. In this way, some of the disadvantages of conducting a business through a partnership as such can be avoided. One disadvantage mentioned earlier at [CC201.65] is the inability to pay wages to an individual being one of the partners. The benefit of paying wages is that you can take advantage of provisions within the fringe benefits tax (FBT) legislation. By adopting a structure with two discretionary trusts, as partners of a partnership it is possible for the partnership to: o o engage employees and take advantage of FBT, employee-employer superannuation and other matters; and mitigate or overcome the risk of unlimited liability attaching to general law partners who are natural persons.

The choice of structuring a business from a tax viewpoint may be of importance. An example of a change in available legal structure is that of legal practice in New South Wales. Until fairly recently, legal practices were not permitted to incorporate. Where there was more than one principal, then the practice was usually conducted through a partnership. However, because a partnership is not a taxable entity, many law firms established service entities. These entities were often unit trusts. These trusts then employed non-professional staff and provided other administrative services (such as office accommodation, photocopying and cleaning) to the partnership for a fee. The profits derived by the service trust were then available for distribution. Therefore, each partner might establish a trust or be a beneficiary in a discretionary trust or unitholder in a unit trust. That trust then may directly provide services to the legal practice/law firm. Often "service trusts" are discretionary trusts allowing for flexibility of income splitting among family members. The discretionary trusts, of course, require a trustee, and so each partner would normally set up a company for this purpose. Often partners formed a company for the purpose of engaging the practice's legal staff in respect to their non-legal activities, such as administration. This enabled access to employee/employer superannuation. Therefore, in many legal firms at one time or another you may have found the following entities: o partnership;

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o o o o

superannuation fund; administration company; unit trust; and discretionary trusts.

The complex nature of a combination of entities is "designed" to achieve certain commercial and taxation benefits. The structure is designed based upon the belief that no one entity alone could provide the advantages obtained through the use of a combination of entities. It may be noted that the Commissioner of Taxation may audit any arrangement and, in particular, has issued statements in relation to professional service entities providing services to legal practices. In summary, in giving advice the lawyer does not necessarily assume that "complex" is best. The choice of an entity to own and/or operate a business cannot be viewed in isolation from the specific requirements of the principals behind the business and the consequences (for those principals) of using that entity in terms of ownership of assets, taxation, exposure to liabilities, and later sale of the business. The adviser will also consider the impact of possible changes in personal, economic or legal circumstances.

35 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/[Commentary]/CONCLUSION CONCLUSION [CC201.170] There are a number of structures which can be used to carry on a business. Each business structure has varying legal requirements and liability limitations. In choosing the most suitable form of business organisation, it is important to have an understanding of the characteristics of each business form and consider its advantages and disadvantages.

36 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/APPENDIXES/APPENDIX 1 -- INSTRUCTION SHEET TO ESTABLISH A COMPANY

APPENDIXES APPENDIX 1 -- INSTRUCTION SHEET TO ESTABLISH A COMPANY

[CC201.200]

[CC201.95]

NEW COMPANY ORDER FORM Type of company: (please circle) 1. Pty Limited 2. Limited 3. Superannuation Trustee 4. Limited by Guarantee

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PREFERRED NAME: REGISTERED OFFICE: Name: Address:

Transfer date:

Date of birth: Place of birth: State/country:

Suburb: Director: Y/N Shareholder: Y/N Name: Address:

State: Postcode: Secretary: Y/N Class of shares:

Occupation: Public Officer: Y/N No of shares:

Date of birth: Place of birth: State/country:

Suburb: Director: Y/N Shareholder: Y/N Name: Address:

State: Postcode: Secretary: Y/N Class of shares:

Occupation: Public Officer: Y/N No of shares:

Date of birth: Place of birth: State/country:

Suburb: Director: Y/N Shareholder: Y/N

State: Postcode: Secretary: Y/N Class of shares:

Occupation: Public Officer: Y/N No of shares:

37 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/APPENDIXES/APPENDIX 2 -- INSTRUCTION SHEET TO ESTABLISH A DISCRETIONARY TRUST

APPENDIX 2 -- INSTRUCTION SHEET TO ESTABLISH A DISCRETIONARY TRUST

[CC201.205]

[CC201.130]

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1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

Name of Settlor (must not be a beneficiary of the trust): Address of Settlor: Name of Trustee: ACN of Trustee [delete if Trustee is a person]: ACN Address of Trustee: Name of Trust: The Discretionary Trust Name of appointor:* Name of beneficiaries or principal beneficiaries:** Directors of trustee company attending Directors Meeting: Chairman of directors of trustee company: Address of chairman:

Note
* The appointor has ultimate control (namely, can appoint and discharge the trustee). Accordingly, depending on the individual circumstances of the client, the appointor can be a single person or two persons jointly (for example, husband and wife). ** The deed provides that the beneficiaries include such persons as are related to the principal beneficiary as follows: the spouse, children and remote descendants of such children, brothers, sisters, parents, grandparents, children and remote descendants of such brothers and sisters and spouses of any of the foregoing. Generally, the principal beneficiary would be the husband, the wife or both the husband and wife. The latter is recommended where there are children of previous marriages.Note also that the beneficiaries include companies and trusts associated with all the persons named.

38 of 38 DOCUMENTS: College of Law Practice Papers NSW/Commercial and Corporate (CC)/Practice Paper CC201 Business Structures/APPENDIXES/APPENDIX 3 -- INSTRUCTION SHEET TO ESTABLISH A UNIT TRUST

APPENDIX 3 -- INSTRUCTION SHEET TO ESTABLISH A UNIT TRUST

[CC201.210]

[CC201.130]

One class of units; or Facility to distribute income to an "associate" 1. 2. 3. 4. 5. 6. 7. 8. 8A. 8B. 9. Name of Settlor (must not be a beneficiary of the trust): Address of Settlor: Name of Trustee: ACN of Trustee [delete if Trustee is a person]: ACN Address of Trustee: Name of Trust: The Unit Trust Name of First Unitholder: Address of First Unitholder: If First Unitholder is a company -- names of Directors attending Directors Meeting: Chairman of Directors of First Unitholder company: Name of Second Unitholder:

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10. 10A. 10B. 11. 12. 13. 14.

Address of Second Unitholder: If Second Unitholder is a company -- names of Directors attending Directors Meeting: Chairman of Directors of Second Unitholder company: Directors of Trustee company attending Directors Meeting: Chairman of Directors of Trustee company: Address of Chairman: Date of Deed:

---- End of Request ---Download Request: Current Document: 1-38 Time Of Request: Sunday, October 30, 2011

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