A mistake with a long shelf life

STRANGE, but the simple matter of putting down $750 or so to buy a shelf company could be your first business mistake.

Picture: Thinkstock

STRANGE though it seems, the simple matter of putting down $750 or so to buy a shelf company could be your first business mistake. And though you might be a tradie who’s ­decided to step beyond sole trader status, a hobbyist taking a passion one step further or a professional moving into ­business, thinking through this first decision is crucial.

It is highlighted by proposed changes to a complicated, but vital, piece of tax law, Division 7a, and it’s as mysterious as it sounds. It’s the subject of new recommendations from the Board of Taxation that could change the way small businesses operates.

This part of the Tax Act ­refers to the way businesses use trusts to siphon money to ­owners, directors and other beneficiaries. It’s a way for company owners to use the lower corporate tax rate while also taking full advantage of sliding personal tax rates.

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A typical example works like this: The business makes money. That money is paid into a company then through a trust attached to it. The best way to picture it is water being poured through a sieve.

The money from the trust is then distributed to its beneficiaries: owners of the business and perhaps even their adult children.

The reason you do this is the sliding personal tax scales. There is no tax on the first $18,200 any person earns. Yet, in a company, the 30 per cent tax rate starts from the first dollar of profit.

In the hands of a person, that flat 30 per cent tax rate is not reached until you earn $172,000 a year.

Hard to believe? It’s true.

So take a typical business of a couple and, say, one adult child. By using this trust structure they can siphon off $516,000 a year from their company in wages. They’ll pay $154,800 in tax, the same as a company that makes $516,000 profit. (I should point out, though, the majority of small businesses in Australia, do not make half a million bucks.)

But say they do. We’ll take the water-and-sieve example a step further. Rather than pour more money into the proprietors’ hands imagine another company — call it a bucket company — that catches any spare cash above $516,000 in our three-person family business. Rather than the owners paying 37 cents in the dollar, then 45 per cent for any personal income above $180,000 a year, the bucket company pays just 30 cents in the dollar.

Smart? You bet. And the Board of Taxation is proposing to make it easier, by allowing people to tax the surplus cash at 30 per cent without the need for that extra “bucket” company. Just one thing, though. ­Remember I told you your first step could also be your first mistake? Because the trust operates like a sieve, any profits left inside it will be taxed at the top personal rate (45 per cent).

Any properties owned (or even the business itself) may be subject to capital gains tax when you sell for a profit.

COLLECTIVE CORPORATES

AS the NSW start-up company of the year in last year’s Telstra Business Awards, you would imagine — correctly — that Justin and Dominique Hind thought deeply about their corporate structure.

The husband and wife digital marketing team spent 15 years working for big advertising agencies, but felt they could give a better and more flexible service for clients with a smaller team around them.

Justin Hind runs award-winning digital marketing company WITH / Picture: Braden Fastier

Because they were confident their business, WITH Collective, would grow into a mid-sized agency in a relatively short time, their tax lawyer and accountant gave them three pieces of advice before they started.

They were advised to create a Pty Ltd company “because companies will be taken more seriously by your clients”; that a private company would provide more legal protection for them and that a trust company incorporated within the company structure would provide tax benefits.

“We know at some time in the future there could be an investment in the business or a transaction (we want to do) and we knew we wanted a vehicle to do this, even before we’d opened the door,” says Justin.

Already the agency’s client list includes big names including Cisco Systems, Colonial First State, Symantec and Pfizer.

There’s also another advantage for the couple, who now have a child. “Though we have been motivated by the business opportunity, we also recognised that existing big agencies might not have afforded us the flexibility for a work-life-family balance.”

Ross Greenwood is Channel 9’s Business & Finance Editor and his program Money News is on 2GB. Twitter: @Ross_Greenwood