Professional advisors may be guided by a variety of factors when recommending a business structure for their small and medium enterprise (SME) clients. This includes tax, exposure to personal liability, asset protection, access to equity capital, and costs of compliance.
A mixed-method study
The survey findings reported in this article are part of a mixed-method study of SME advisors in relation to business structures.
During the qualitative phase of the research, 48 professional advisors were provided with one of 12 SME business scenarios, with each business scenario having different circumstances such as industry, turnover, number of active owners, number of employees and family circumstances. They were then requested to provide their recommendation of a business structure for the scenarios described.
The most frequently recommended structure was a trading company with shares held by a discretionary trust. The second most common structure was a trading discretionary trust with a corporate trustee, with the discretionary trust operating the business. This was then followed by a tax consolidated group with the shares held by a discretionary trust, with only one advisor recommending a trading company with shares held by an individual.
At the end of each interview, a short survey was administered. Advisors were asked to evaluate their recommended structure from a matrix of 23 listed factors, which prior research indicated were important for SMEs.
Specifically, the advisors were asked to evaluate the factors on a Likert scale in terms of the question:
‘On a scale of 1 to 10 (1 low/bad, 10 = high/good) given your recommended structure what do you think [the recommended structure] means for… [the listed factor]?’
Survey results
As the survey results indicate, the business structure of a trading company with a holding trust was popular due to tax and non-tax attributes.
The five highest ranked factors from a weighted average score out of 10 were: ‘limited liability’ (9.24), ‘retaining income at a lower tax rate’ (9.18), ‘control for owner’ (9.03), ‘providing for family members’ (8.97), and ‘income splitting/flexibility in distributions’ (8.93).
The lowest ranked five factors consisted of: ‘tax compliance cost’ (5.69), ‘CGT discount – Division 115’ (5.96), ‘simplicity’ (6.34), ‘regulatory compliance cost (non-tax)’ (6.48), and ‘client understanding of the structure’ (7.45).
In comparison, the five highest ranked factors for adopting a trading trust (with a corporate trustee) were: ‘income splitting/flexibility in distributions’ (9.67), ‘flow-through of tax concessions’ (9.56), ‘small business CGT concessions – Division 152’ (9.56), ‘CGT discount – Division 115’ (9.56), ‘providing for family members’ (9.22) and ‘control for owner’ (9.22). The lowest five factors were: ‘access to R&D tax incentive’ (2.78), ‘raising equity’ (3.67), ‘overseas business operations’ (3.75), ‘simplicity’ (4.78), and ‘tax compliance cost’ (5.33).
The five highest factors for the tax consolidated group structure were ‘control for owner’ (9.57), ‘business expansion in Australia’ (9.29), ‘access to R&D tax incentive’ (9.29), ‘retaining income at a lower tax rate’ (9.14), ‘asset protection’ and ‘succession planning/exiting’ (9).
The five lowest factors were ‘tax compliance cost’ (5.86), ‘regulatory compliance cost (non-tax)’ (6), ‘simplicity’ (6.14), ‘small business CGT concessions — Division 152’ (6.5), and ‘flow-through of tax concessions’ (6.86).
Recommendations
A key recommendation from the survey results relates to the alignment of the taxation of trusts and companies. While discretionary trusts featured in all business structures recommended by advisors (with one exception), there is clearly an issue with retention of income. A well-recognised disadvantage of a trading trust is the inability to retain business income in a tax effective manner. The weighted average score for ‘retaining income at a lower tax rate’ was only 7.33 for the trading trust with a corporate trustee, compared to a score of 9.18 for the trading company with holding trust. A trading company can retain income, pay a capped tax rate, and then reinvest the profit to grow the SME business.
Given the extent to which discretionary trusts feature prominently in business structure advice, it is important to consider if their taxation treatment can be enhanced, particularly whether greater tax neutrality can be achieved. Taxation models from other jurisdictions may be worthy of further consideration.
For example, Australia may consider the approach adopted in New Zealand. In New Zealand, the trustee pays tax on behalf of the beneficiaries for income allocated to beneficiaries. The beneficiaries then claim a tax credit for the tax paid on their behalf. The trustee is the entity taxed as per the Income Tax Act 2007 (NZ) (Subpart HC 2 — Trusts). Income may also be taxed at the hands of beneficiaries if distributed; here the trustee can elect to retain received income in the trust or to distribute part or all the income to beneficiaries, with beneficiaries being taxed at their marginal tax rate on the distributed income.
Overall, this study advances our understanding of how advisors evaluate the tax and non-tax related factors impacting a business structure recommended for their SME clients and provides further insight about potential tax policy development in Australia. We argue that tax neutrality among business structures is central to tax policy, minimising costs and complexity so that Australian SMEs remain an integral part of the Australian economy.
Journal article
Barbara Trad, Brett Freudenberg, John Minas and Craig Cameron, ‘How Good Is Your Business Structure? A Survey of Australian SME Advisors’ (2023) 18(1) Journal of Australasian Tax Teachers Association 84-136.
Recent Comments