YOUR BUSINESS STRUCTURE

What kind of structure is best suited to your business? Is it Sole Trader, Partnership, limited company or Trust? What are the advantages and disadvantages of each?

Before dealing with the different kinds of business structures, some preliminary words on Business Names would be in order. People are often confused between Business Names and business structures.

Any of the four structures mentioned above, Sole Trader, Partnership, limited company and Trust can have a Business Name registered. It is necessary to register a Business Name when the person or company does not trade under its true name. Take, for example, John Smith. If John Smith trades under any name other than John Smith, he must register the trading name. Examples of names that must be registered are J. Smith, John Smith and company, Smith Transport Services etc. If John Smith is in partnership with Paul Donovan, then they can only trade as John Smith and Paul Donovan. Any variant must be registered such as Smith and Donovan etc. Consequently, it is necessary in 99% of cases to register a Business Name when a partnership is in operation. If a company does not trade under its own name, it too must register a Business Name. For example, if a company called Transport and Haulage Pty Ltd owns a transport business and trades under the name, " Dial-a- truck", it must register a Business Name, "Dial-a-truck". However, under the Corporations Law, a company has the added requirement to publish its name on all documents and to have it affixed outside all its premises. In other words, if a company has a Business Name registered, it must also display its real name on documents and business places. A Trust must register a Business Name if it does not carry on business under the true name of its trustee. Registration of a Business Name is a relatively simple process. You go along to your local Business Affairs Office, fill out a form and pay a registration fee of $85. The registration last for three years and can be renewed indefinitely. The Business Affairs Office will not register a name which is similar to a name already on the register.

Often, there is a progression through the different business structures. Take John Smith who is employed as a delivery man by small transport company. He decides to become self-employed so as to get a higher hourly rate. He realises that his employer will now be able to afford the higher hourly rate since the employer will not now be paying workers compensation insurance, training levy, occupational superannuation, holiday pay, sick pay, long service pay etc. John Smith becomes a sub-contractor and goes onto the Prescribed Payments System. He then realises that it will bolster his claim to be regarded as a sub-contractor to have a Business Name registered so he registers the name Smiths Delivery Services. Next, John Smith lists his Business Name in the Yellow Pages and he gets jobs from the general public. He finds it necessary to hire employees. The bookwork becomes onerous. He persuades his wife to give up her job and join him in the business to do the office work. He makes his wife his business partner. He amends the registration of the Business Name to show two people are now trading as Smiths Delivery Services i.e. John Smith and Mary Smith. The business expands further. John and Mary are worried that if the business goes bust, they will lose everything including their family home and life savings. They therefore discontinue the registration of the Business Name, Smiths Delivery Services. They form a company, Smiths Deliveries Pty Ltd. The business continues to prosper. John has an invalid child, Tom, who is now 20 years old. John would like to give him an independent income and have him bear his own tax. One day, he goes to see his accountant who says to him, "John, why don't you form a trust? You can then distribute some of the profit to Tom and he will pay the tax on it, not you". John agrees and the business is converted to the Smith Family Trust with Smiths Deliveries Pty Ltd as the trustee. The business continues to trade as Smiths Deliveries Pty Ltd. The business continues to prosper and expand. It expands nationwide and the company now has hundreds of employees. John Smith decides "to go public". He lists the company on the Stock Exchange and sells 60% of the  shares to the public for 10 million dollars. The 40% of the shares that John Smith retains allows him to keep control of the company because very few shareholders attend Annual General Meetings and vote. The above tale shows a typical progression from Sole Trader to Partnership, to Limited Company, to Trust, to Public Limited Company.

SOLE TRADER

A Sole Trader trades by himself. He is liable for all the debts of the business. If the business fails, he can lose his family home and his life savings. He will normally pay Provisional Tax in one lump sum on the 1st April each year. As mentioned above, he may if he so wishes register a Business Name. Registering a Business Name will not in any way affect his taxation liability.

The disadvantages of operating as a Sole Trader are 1) private assets are liable for debts of business, 2) inability to split income with other family members.

PARTNERSHIP

A Partnership consists of two or more people carrying on a business. Important things to note are: Each partner is liable in full for all the debts of the partnership. For example, suppose the business goes bust with debts of $200,000 which it cannot pay. John Smith's other partners have decamped and cannot be found. John Smith has a family home worth $100,000 and life savings of $50,000. The business creditors can sell John Smith's home and take his savings in satisfaction of their debts. If John Smith's two partners had similar assets of $150,000 and can be found, then John Smith will only have to pay his share of the debts i.e. 1/3rd of $200,000. The second point to note is that each partner can take part in the management of the business. For example, normally, a partner can order goods and employ persons and the partnership will have to honour the agreements. As you can see, if John Smith had a son who had just left school, he would be loath to admit him as a partner immediately. A partnership can be entered into either orally or with a written agreement. A written agreement is the desirable course of action. If the partnership is to last for more than a year, it must be formed in writing. The agreement should set out the rights and duties of the partners such as a) the capital to be contributed by each partner, b) the responsibilities of each partner, c) the division of profits (and losses) between the partners, d) the amount each partner is entitled to draw in cash on a regular basis, e) how the partnership can be dissolved and f) how the share of a deceased partner is to be valued and paid out. However, If there is no partnership agreement on any point, then partners are presumed to be equal e.g.. they share profits and losses equally etc.

The profits of a partnership are divided between the partners and each partner is separately taxed on his share. If the partnership has paid tax under the Prescribed Payment System, then each partner will be allocated a share of the credit for tax paid.

A partnership is usually dissolved by death, bankruptcy, mutual agreement, notice by one partner to the others or Order of Court. Normally, when one partner retires, the others continue under the same name.

It is a sad fact of life that partners often fall out. A well drafted partnership agreement which tries to foresee problems and provide for them will often be of great assistance in preventing partnership disputes. In the last resort, any aggrieved partner can apply to the Supreme Court to have a receiver appointed and the partnership wound up.

The disadvantages of operating as a partnership are: 1) private assets are liable for all the debts of the business, 2) unwieldy structure, often leading to disputes between the partners.

LIMITED COMPANIES

Some industries are notorious for those who operate in them going bust. Such industries include small builders and transport operators. What safeguards can a person engaged in such a high-risk industry take to lessen the risk of losing his home, life savings etc if his business goes bust? The most usual solution is to form a private limited company.

In law, a company has a separate legal personality. The biggest advantage in forming a private limited company is that the liability of the company is limited to the assets of the company. Consequently, if the company goes bankrupt, the private assets of the directors such as family home, family car, savings etc cannot be taken by the creditors. The individual directors do not go bankrupt and they can start up in business immediately afterwards, on their own account, with no liability for the company debts. It should also be noted that only the company is liable for the negligence of company employees. The directors are not liable. However, in practice, the advantages of limited liability are often curtailed. Companies commonly obtain loans from banks. It is usual in such cases for the bank to insist upon the personal guarantees of the directors. Consequently, in such cases, the benefit of limited liability is lost so far as the loan is concerned. Directors are also personally liable if they knowingly allow the company to trade when there is no reasonable expectation that it can pay its debts. Directors are also liable for the debts of a company if they fail to inform the person with whom they are trading that he is trading with a company. Normally, if the words "Pty Ltd" are omitted from the name of the business, the person who trades with the business will not know that he is trading with a company. The directors will be liable for the debt in such a case. As far as shareholders are concerned, the most that a shareholder in a company can lose is the value of his shares. He is never liable for the debts of the company.

As mentioned, a company has, in law, a separate legal personality. Thus, it has the advantage of continuity. It never dies, provided certain formalities are complied with. If an individual partner dies in a partnership, the partnership must be wound up and a new one started. In such a case, the property must be legally transferred from the deceased partner to the surviving partner. Conveyancing fees may be incurred. Contracts must be renegotiated by the surviving partners. If a company has been formed, there is no need to transfer the assets or negotiate new contracts. If the company holds a lease, there is no need to get the consent of the lessor to the change in business ownership. When the business is being sold, the shares in the company can be sold instead and nobody need know that the business has changed hands. To put it succinctly, the shareholders, directors and employees may change from time to time but the company continues nevertheless.

There are control advantages in forming a private limited company. As has been seen above, if the business trades in the form of a partnership, all partners can take part in the management of the business. However, with a family company, it is possible for the owner to give shares in the company to his wife and offspring without appointing them directors. The owner of the business can be appointed Governing Director for life. Non-voting shares can be issued to family members. It is generally not possible to make a child a partner but a child can become a shareholder.

Up until 31st December 1990, company law was a State responsibility. Each State and Territory had its own Companies Act and its own Corporate Affairs office. From 1st January 1991 however, company matters became a quasi-Federal responsibility. The Australian Securities Commission was established to deal with all company matters. The ASC has branches in the capital cities of all States and Territories. All documents are lodged centrally in Morwell in Victoria. A national register of all companies incorporated anywhere in Australia is maintained there. This register can be searched at any branch office, using a computer terminal.

The steps to be followed in registering a private company have been simplified. Often, these days, when a business is thinking of forming a company, it buys a ready-made "shelf" company. These "shelf" companies are companies kept in stock until required and carried by organisations whose sole business is the formation and sale of newly-formed companies. One can buy a "shelf" company for around $800. The following are the steps to be taken in forming a private limited company.

Decide on the name of the company, the registered office, the directors, the shareholders and the issued share capital.

Go along to your local ASC office. Carry out a search there to find out if your proposed company name is available. If it is, reserve the name. You may, if you wish, use the number of the company as the name of the company, for example "A.C.N.123 456 789 Pty Ltd".

Draw up the Memorandum of Association and the Articles of Association. These are two legal documents. You must either obtain assistance or copy them from somewhere else. The Memorandum states 1) the name of the company, 2) that the liability of the members is limited, 3) the amount of share capital, 4) the subscribers (i.e. first shareholders) names, addresses and occupations, 5) that the subscribers wish to form a company and agree to take the stated shares.

The Articles of Association usually state 1) the right to transfer shares is restricted, 2) the number of shareholders is limited to 50, 3) there will be no invitation to the public to subscribe for shares or debentures in the company, 4) there will be no invitation to the public to deposit money with the company. The Articles are the rules governing the running of the company like the constitution of a club. A model set of rules is contained in the Corporations Law. Most companies adopt these rules. The Memorandum and Articles must be signed and witnessed. However, you do not now have to lodge them with the ASC office. You must keep a copy of them at the registered office of the company. The next step is to obtain the consent of the directors. However, you do not have to lodge this form of consent with the ASC.

Next, complete form 201. This form requires you to state a) the company name, 2) the class and type of company, c) the registered office details, d) the principal business office details, e) share capital details, f) details of the subscribers to the Memorandum. You lodge this signed form together with the prescribed fee of $540 at the ASC office.

After your application has been received and processed, the ASC will issue you with a certificate of incorporation.

Once you receive your certificate of incorporation, the subscribers meet and appoint Directors. You can now commence operating as a company.

Within one month of incorporation, you must lodge form 215, "Notification of initial appointment of office holders". You should also lodge form 207, "Notification of allotment of shares", if applicable.

You should also have a company seal made by a rubber- stamp maker.

Each year, a company must lodge an Annual Return with the ASC, setting out current details of its shareholders, directors, secretary, registered office and financial details. The filing fee for the Annual Return is $150. All documents held by the ASC, including the Annual Return, may be inspected by members of the public.

The disadvantages of trading as a company are 1) initial cost of forming company, usually around $1000, 2) ongoing administration costs.

TRUSTS

Trusts are relatively easy to form when compared with company formation. In practice, trusts are formed in writing and the trustee is often a private company. There is usually a clause allowing the settlor to remove the trustee. In this way, the settlor has indirect control over the trust. The trustee is given wide powers to acquire or dispose of property, to carry on business and to borrow money. He is given power to distribute the profits as he pleases to a named list of beneficiaries. This means that, each year, he can vary the profit amount distributed to each beneficiary. This is often useful for tax purposes. The trust deed will contain many other provisions but the above-mentioned are the most important provisions. It is usual for a trust to trade under the name of the trustee. No mention is made of the trust and the public need not know that they are trading with a trust. If the trustee is a limited company, the trust will appear to be trading as a limited company. It will have the advantage of limited liability. A trust, as such, does not have a separate legal personality like a company has. Consequently, a trust is not taxed as a single entity. The profit of the trust is distributed to the beneficiaries and the beneficiaries pay the tax. It is similar to a partnership in this regard. Trusts were very popular in the 1970's and early 1980's as tax-saving vehicles. They were mainly used to distribute income to children. However, in recent years, their popularity has waned because of the penal tax imposed on the unearned income of children. A trust combined with a limited company as trustee will involve high annual administration fees. The disadvantages of trading as a trust are 1) the cost of setting up the trust and ongoing costs of maintaining it, 2) its imprecise nature and also the fact that it is often not fully understood by the operators of the trust. This gives rise to problems. If care is not taken in setting up the trust, an unexpected liability to Capital Gains Tax can accrue.

DISCLAIMER: See disclaimer on home page.

Copyright 1994.

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