So should you consider a company structure? There are some key factors that attract businesses to a company structure. These include asset protection, effective tax management of retained earnings and the ability to have a structure that will grow with you over time.
The advantages of using a company as your business structure include:
- Corporate tax rate of 25% for business entities;
- Ability to retain after tax profits for working capital and debt reduction;
- Income stream from company has ability to be fully franked;
- Liability can be limited, subject to director duties being undertaken in accordance with applicable laws; and
- Perpetual existence and ease of succession/change in control.
It is important to note that a company structure is a taxpayer in its own right and accordingly, the company is required to have its own Tax File Number, ABN and lodge annual income tax returns. Additionally, subject to turnover activity, it would need to be registered for GST and lodge business activity statements.
From an asset protection point of view, a company is a legal entity in its own right. Commonly referred to as a corporate veil, the activities and risks associated with a company remain those of the company, protecting the personal exposure of the parties associated with the company, subject to relevant laws being followed and disclosures being made. A company can have the same rights as a natural person, meaning it can incur debts/liabilities, sue others and be sued.
In addition to attending to the various ATO obligations which is a requirement for all taxpayers, a company must also comply with Australian Securities & Investments Commission (ASIC) obligations. For private companies these include lodging an annual company statement and declaring the solvency status of the company as well as notifying ASIC of any changes to the company structure by way of shareholders, directors etc. Subject to the type of company and its size there maybe further ASIC obligations to address that have not been outlined in this article.
What is a company?
As mentioned earlier, a company is a separate legal entity that is owned by members, also knows as shareholders. From a business structure perspective, it is the company that owns the assets and operates the business, not the shareholders. The company invoices the sales, pays the expenses, make the profits and pays the tax.
The shareholders are the owners of the company structure, their ownership providing them with a share of the business profits paid in the form of dividends by the company as well as capital appreciation on the value of the business through the value of the shares they hold in the company. Generally there is little risk to shareholders from a business perspective as they are not responsible for the day to day operations of the company, nor are they responsible for the companies debts. The level of exposure that a shareholder has is normally limited to the funds they have invested in the form of share capital. What this means in real terms is that if a company does not perform well and is closed then the shareholders will lose the funds they invested in the company upon its closure, ie. their loss is limited to what they originally invested.
A company will normally be established with ordinary shares, entitling the holder of the shares with a share in the profits, capital and voting powers of the company in proportion to their ownership percentage. It is possible however for shares to be issued with varying rights so it is important to understand the share structure of a company structure in order to understand what the shares entitle you to as an owner of the company. A company can be established with a single, or multiple shareholders. There are different rules for the various types and sizes of companies not outlined in this article.
In addition to the owners of the company there are the officeholders who look after the day to day operations of the company. The officeholders of a company include public officers, director/s and a company secretary, all of which hold different roles and responsibilities to look after the affairs of the company.
- A public officer is the company’s representative who is responsible for ensuring the company complies with their tax obligations. The public officer will be the one to sign off on a company’s annual income tax return and ensure it is lodged on time. They may also be the one responsible for signing off and ensuring the timely lodgement of any activity statements the company must prepare.
- The director of a company is responsible for the day to day running of the company. This includes making the decisions, paying the bills, entering into contracts and agreements etc – ie. running the business. A company can have multiple directors, all of which will carry the same level of responsibility regardless of the level of actual involvement they have in the company. The director/s of the company are responsible for ensuring that the company trades solvently and makes prudent financial decisions. If the director/s fail to do so, this can lead to personal exposure of the directors to the business risks of the company.
- A secretary has many of the same responsibilities as that of the director, however, they are also required to support the board of directors with ensuring the company information and administration is accurate and up to date. This includes ensuring all officeholders and shareholders of the company and their details such as addresses are correct.
What do the ‘Pty’ and ‘Ltd’ after the name mean?
Companies can be private or proprietary meaning they will often have ‘Pty Ltd’ after the company name; this means they will not sell their shares to the public and they have limited liability. A proprietary company needs at least one director and does not need to have a secretary (however, it is best practice to have both). Larger companies will often still limit their liability but be listed on a stock exchange and have shares held by the public, in which case they will often have an abbreviation of just ‘Ltd’ after their name.
The Corporate Veil – how does asset protection work?
As mentioned earlier in this article, there is what is commonly referred to as a “corporate veil” relating to the activities of a company. The analogy of this comes from the idea that the officeholders of the company are effectively shielded from the actions of the company which is in itself a separate legal entity. This corporate veil however, is not impenetrable and there are some instances that can cause the corporate veil to be pierced or broken. For example, if the company is used in the operations of fraudulent behaviour or a director knowingly breaches their duties and obligations, by trading insolvent for instance or not paying its bills, the shield is potentially lifted and the liabilities or exposure of the company can fall onto the officeholders. Another example of this shield being penetrated is when officeholders sign personal guarantees on behalf of the company, these personal guarantees allow the creditor to look through the company to the guarantor to be indemnified for the relevant debts.
Director Penalty Regime – personal exposure of directors!
Directors will automatically incur certain tax liabilities of the company where the company does not meet its own obligations. The obligations imposed by the Australian Taxation Office under the director penalty regime can be issued due to outstanding PAYG Withholding, GST and/or Super Guarantee Charges for employees. If action is taken by the ATO regarding recovery of debts of this nature there are only limited options directors can take to mitigate any personal exposure. Accordingly, payment of ATO debts along with all operational debts of a company should be taken seriously in order to maximise the benefits a company structure brings to a business and its owner.
Whilst there are many benefits to operating your business through a company structure, there are also some issues to navigate or understand before jumping in and setting up your structure.
A company cannot access the general 50% discount on the sale of assets the same way Trusts and individuals can. There may be other options to reduce any capital gains realised by a company under the small business concessions but it must be understood that companies will pay tax on the entire amount of any capital gains realised on the sale of its assets. Shareholders selling their shares in this company do not have the same issue, assuming the shareholder is not itself a company.
Losses incurred by a company cannot be distributed to be utilised by other taxpayers, such as the directors or shareholders. This can cause issues where you may be paying tax personally but have losses caught up in your company that you can’t use to reduce your personal tax bill. The key to navigating this particular issue is good planning with your accountant or financial advisor. Whilst losses cannot be distributed from the company, they can be carried forward for use against future profits assuming the company is undertaking similar business activities and/or has the same owners.
There are rules relating to funds taken from a company by associates such as shareholders or directors or if associates are using assets of the company personally. Your accountant can help you navigate these particular rules and if you take the general approach that if you take the funds you pay the tax on them personally then you won’t have any issues in this particular area.
Having shared this information with you, the key take out for you is to understand that in considering a company structure to own your new business or to utilize in restructuring your existing business does not need to be complicated and placed in the too hard basket. Generally, the benefits to this type of structure outweigh the costs to administer it. You just need a good advisor to help you work through the pros and cons to work out what suits you.
The secret to making the right decision is getting the right advice at the start of your business journey. We are here to help you identify which structure may best suit your business needs. Contact us on (03) 5221 6399 or at email@example.com for further information and to schedule a no obligation, no cost meeting to discuss your options with one of our Tax and Business Services specialists.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.