A business structure is generally right when it is set-up by an accountant; however, business like life is subject to constant change. This may mean that your business structure is no longer appropriate for you given the evolution in your business and personal affairs. This can result in bad outcomes as outlined in our case studies below.
Case Study 1
We were recently approached by a new client that was looking for a new accountant. He was concerned he was paying too much tax and wanted some advice. He had approached his former accountants first to get some assistance from them but was advised against a change. Something didn’t seem right, so he came to us for a second opinion.
The client had started a business 3 years earlier and as it was a new business at the time it was set-up as a sole trader. However, the business had grown rapidly in both the size and complexity of its operations. Unfortunately, the former accountant did not take the time to understand the change in circumstances and as such the structure had not been reviewed or changed.
This resulted in the client paying an extra $35,000 in income tax over a 3-year period plus triggered additional liabilities for PAYG instalments.
This could have been avoided with the establishment of a company for less than $1,000 upfront which would have resulted in a better tax outcome for past and future years as well as improved the client’s risk management by separating the business from their personal affairs. That tax saving could have been used to grow the business, pay off debt, take a holiday, or any number of other uses better than paying unnecessary tax.
Case Study 2
We also had another new client that had a company which they had used to previously operate a business. The business was not successful and resulted in a small loss which was trapped in the company. Prior to becoming a client, they decided to start a second business and buy a substantial investment property.
They decided to:
- set-up a new company for the new business; and
- buy the investment property in the old company with the losses.
Their logic was that the new business would lose money for the first year and they did not want to pay tax on the rent from the investment property while they got up and running to improve cash flow. Unfortunately, while they paid no tax on rent for the first year they also lost entitlement to the general discount on capital gains which allows most entities (but not companies) to disregard 50% of the capital gain on the sale of capital assets (i.e. investment property).
This will result in an additional $200,000 of tax to pay at the time of disposal (at its current valuation alone).
In hindsight the new business should have gone into the old company and the investment should have been bought in a trust. This would have allowed the client to benefit from the general discount and still utilise the losses from the old business. Again, that tax saving could have been used for any number of other uses that are better than paying unnecessary tax.
The solution in both situations is simple: get good advice before major decisions.
How do you know if it is good advice? If you don’t understand the advice this is a big red flag. Also, get input from your other advisors or get a second opinion.
Business and investment structures often have competing short-term and long-term results, and these can be difficult to manage and get right. In addition, the complexity created when things change (which is inevitable) requires assessment and consideration up-front. This often involves input from your lawyer or others. We work with all your advisors to get the right results. We love helping clients to solve difficult issues and can help you weigh up various options to get the best outcome possible.
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