Our Principal, Christine Lau contributed a series of articles to Outlook, a publication by Tax and Super Australia, tracing the steps of “Paul” and “Jenny”, our protagonists in the series, from developing a business idea to acquiring a business of their dreams and beyond.
The Business Idea
Paul and Jenny want to purchase a food catering business together. They seek advice from their accountant, as to the best structure for them going forward.
Clients’ background
Paul is a nutritionist and has expertise creating customised nutrition balanced meals for a variety of customers’ needs. He is also a qualified chef and has management experience having worked as an executive chef in a major hotel chain in Singapore. However, he does not have any experience in Australia. Even though he has the right skills set to operate a catering company, he’ll need help from someone who is familiar with the food industry in Melbourne to help him build his business.
Jenny, on the other hand, has more than 20 years’ experience in the Australian food industry, having worked in and managed various sized retail food outlets and also at a central kitchen facility for a franchisor. She has the relevant contacts to enable the business to grow after its acquisition. She intends to continue with her current consulting role for her private company.
Purpose of the acquisition
Both Paul and Jenny want to expand on the existing business, which currently only has a very small commercial kitchen preparing pre-packaged (nutrition/calorie controlled) meals for fitness centres. The business is mainly wholesale but they are planning to cater for retail customers as well and eventually have a retail store selling not just pre-packaged meals but fresh, healthy food and beverages on site. They will need funding for the proposed expansion very soon after the acquisition of the business.
The trading vehicle
What are the crucial issues to consider when advising Paul and Jenny?
The nature of the business
Their intentions for the business
Funding requirements
Exposure of personal assets to creditors of the business
Ease of admittance of new business partners and the departure of existing ones
Taxing of profits
Considerations for specific structures that may avail them of tax concessions.
Options that could be considered, amongst others, include:
Partnership
Company
Unit Trust
How would a partnership work for Paul and Jenny?
Paul and Jenny essentially come together as two individuals, working together to pursue a joint venture. Points to consider here are:
Joint and several unlimited liability: The partnership is not a separate entity and both Paul and Jenny will be entering into contracts with third parties in their personal capacities. This means that each will be liable for the other’s actions in the conduct of the business and their liabilities to third parties are joint and several (meaning that third parties can pursue each of them for the full amount owed even though Paul and Jenny may be 50/50 partners in the venture).
Cannot draw a salary: They cannot be employees of the partnership and they can only be remunerated in the form of profits distributed to them. If Paul intends to be the chief operator and brain behind the creation and delivery of the meals and Jenny only works part time to bring in leads, then this structure will create problems for them. However, this problem could be rectified, for instance, by allowing Paul to draw a salary as a first cut of profits before the 50-50 split of profits.
Funding obstacles: Paul and Jenny will need to resort to personal assets as security for any debt funding required for the business. Equity funding is possible with the admission of new partners but issues will arise on the taxation front because this will involve a disposal of the partnership assets to the new partner with the tax consequences. The 50% CGT discount, however, is available to Paul and Jenny if the disposal occurs after 12 months of the business acquisition.
Profits distributed from the partnership will be taxed in the hands of Paul and Jenny: As Jenny is continuing with her existing consulting role, she may be subject to a higher marginal tax rate than if profits are taxed at company rates.
We will continue to look into the other trading vehicle structures in the Part 2.
Would a Company be a better structure?
Limited Liability: Paul and Jenny’s liabilities will be limited to any unpaid amount on shares issued to them.
Remuneration: Paul and Jenny can be paid a salary commensurate with the time and efforts they devote to the business.
Continuity: The company is a perpetual entity and will not be affected when either Paul or Jenny leaves the business or when new partners are admitted.
Reinvestment of profits: It is a cost effective way to reinvest earnings into the business to meet growth and operational needs as companies can retain earnings.
Security for funding: Funding can be accommodated by issue of new shares (without requiring a disposal of existing partners’ interests as is the case with partnership) or debt financing where company’s assets can be used as security. In practice, however, financiers will still require the directors to put up their personal assets as security.
Tax rate: Company tax rate is fixed at 27.5% (presently) for the proposed business (as this is a base rate entity).
CGT 50% discount: is not available to companies when they sell their assets. In the current scenario, it is unlikely that the company will accumulate assets that will be sold later for significant capital profits. Therefore, in reality, the benefit that may flow from this concession to Paul and Jenny is very limited . However, they will need to form a view about whether they consider the goodwill will increase significantly in value over time and this may influence their choice of structure.
Small business CGT concessions could be considered at the time of sale.
Can the Structure be a unit trust?
Limited Liability is possible: A unit trust with a corporate trustee will give Paul and Jenny limited liability as in the case of using a company structure.
Reinvestment of profits not as cost efficient: All profits of the unit trust will need to be distributed (to avoid being taxed at the highest rate) to the unitholders and taxed in the unitholders’ hands first. Post tax profits can then be lent back to the business.
CGT 50% discount is available to unitholders but the nature of Paul’s and Jenny’s business means that they will not derive much benefit from this concession.
We will continue to explore other business structures in Part 2.
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Note: The information contained in this article and on www.laulegal.consulting website is general information only and does not constitute legal or compliance advice.