What stops Australian small and medium enterprises (SMEs) from business structuring? Prior research has revealed advisors’ perceptions that most SMEs had not adopted an appropriate business structure due to an absence of advice at the inception stage of the business.
There are many reasons why business structuring may be considered necessary by advisors and operators of SMEs. These can include facilitating new investors, facilitating a business succession plan, allowing access to generous tax concessions only available to certain business structures, and to address legacy issues (such as a complicated structure).
We found a difference between the factors that impact an established business compared to a new business. Our analysis demonstrates that for established businesses, transfer costs such as capital gains tax (CGT) and stamp duty are more frequently mentioned by advisors as inhibitors. Whereas for new businesses, the more frequently mentioned inhibitors are establishment costs and client understanding.
Research methodology
In our research, we used an experimental case study to investigate the factors that advisors may consider inhibitors when recommending business structures. Forty-eight professional advisors from across Australia were selected to participate in this study.
The 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. Each advisor was given a scenario of either an established or new business one week before the interview.
After recommending their business structure, advisors were asked whether there were any inhibitor(s) for the adoption of their recommended structure. The key questions for the purpose of the research reported in this article are:
- Do you think there could be any inhibitors for the adoption of your recommended structure? If so, what are they?
- Is there anything to reduce these inhibitors?
Key findings
The results demonstrates that for all scenarios, CGT and stamp duty were identified most often as an inhibitor (35 per cent of advisors), followed by establishment costs (27 per cent), client understanding (23 per cent) and complexity and compliance cost (17 per cent). However, nearly one-fifth (19 per cent) of advisors thought there would be no inhibitors for their recommended structure being adopted, although most advisors in this category advised on the ‘new’ business scenarios.
The results also demonstrate that new and established businesses have different inhibitors for adopting business structures. For instance, the transfer cost of CGT is more frequently mentioned as an inhibitor for established businesses compared to new businesses (67 per cent vs 4 per cent), along with stamp duty (62.5 per cent vs 8 per cent).
For new businesses, the most frequently cited inhibitor was client understanding which was higher than established businesses (29 per cent vs 17 per cent). Two inhibitors were similar for both new and established businesses: the initial establishment costs of setting up a business (29 per cent vs 25 per cent) and the complexity in adopting multiple structures (17 per cent vs 17 per cent).
Overall, advisors perceived that there are inhibitors from enabling SMEs to alter their business structure to the recommended structure – which in most circumstances in this study was a trading company with holding trust. These transaction costs are concerning, as they indicate SMEs may be using less than ideal business structures for their needs.
For all advisors that reported inhibitors (both established and new scenarios), the three most frequently mentioned techniques used to reduce inhibitors were client education (30 per cent), explaining the benefit of advice (30 per cent) and Division 152 CGT concessions (30 per cent).
The less frequently mentioned techniques were Subdivision 328-G small business restructure roll-over (14 per cent), Subdivision 122-A (11 per cent), no change in property ownership (8 per cent), fewer entities (6 per cent), Division 115 CGT 50 per cent discount (3 per cent) and Subdivision 122-B (3 per cent).
These tax roll-over reliefs have been implemented by the government in recognition of how tax may inhibit business restructuring from occurring. For instance, the small business restructure roll-over aims to allow small businesses to transfer active assets from one entity to another entity without incurring an income tax liability.
Subdivision 122-A provides CGT rollover relief for a sole trader or a trustee on the disposal of business assets to a company. Subdivision 122-B allows a partnership to dispose of assets by a partner to a wholly owned company. Division 152 provides four concessions to small businesses that allow them to reduce, defer or disregard capital gains, if the conditions for relief are satisfied.
Recommendations
We have two recommendations, focusing on advice and the restructuring provisions.
Incentivise advice
The government can consider offering incentives to encourage SMEs at the inception stage to seek advice. For example, a tax offset (or inflated tax deduction) to lower the cost of advice could be implemented. This could be aimed particularly at small businesses.
A tax offset could be offered for the first year, capped at AUD 5,000, for advice. This could also include education concerning the implemented business structure and the obligations in terms of the structure. In the second year, a tax offset, capped at AUD 3,000, could be considered for further consultations. A rebate of AUD 2,000 for the third year would be beneficial for further consultations and education related to the business structure if these were needed.
Enhance restructuring provisions
To facilitate the restructuring of an established business, it is recommended that the scope of small business restructure roll-over provision be extended to restructuring that involves trading companies owned by discretionary trusts. Otherwise, SMEs will continue operating with inappropriate structures, or potentially incur significant transfer costs which may jeopardise their working capital.
Implications
We hope that these findings assist SMEs to appreciate the benefits of obtaining advice in terms of implementing a business structure at the inception stage, which helps reduce the need to restructure in the future. The findings could also assist the government in implementing policy changes to the taxation of business structures, which could assist the SME sector to realise the benefit of adopting an ideal business structure, a structure that maximises business opportunities and minimises the risks for SMEs.
Journal article
Barbara Trad, John Minas, Brett Freudenberg and Craig Cameron, ‘Inhibitors for Business Structuring for Australian Small and Medium Enterprises’ (2024) 22(2) eJournal of Tax Research 347.
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