How to strucure small business and invest?

Need advice on structure.

Is forming a company to buy and operate an established small business and use the business profit to invest in realestate the right structure?

No partner, no kids.

 

If you are proposing to operate a business out of a company and then use the profits generated to invest in real estate in the same company - then no that is the wrong structure.

The answer to your question needs a lot more detail about you - including your long term hopes and dreams.

 

Get some legal advice

 

Thankyou for your replies.
Will definitely be seeking legal advice next week, im just doing as much self educating before i go.

I would like to have 5 to 10 investment propertys ($1 - 3million worth) within the next 5 - 10 years.
Buy rent hold.
Im targeting the wa market.
I will assess as i go as to whether i buy more or sell depending on the market at that time or my interests change.

Lets just assume that ive bought $3m worth of realestate and the market rises to the point that my assets have doubled in price.
I then sell these assets, pay the bank what is owed and have whatever is leftover to do what i like with it.

 

You would want to consider a company to limit liability. But this could be a company operating in its own right or as trustee. If operating in its own right you should consider a discretionary trust to own the shares as this will give flexibility to distribute dividends and asset protection on the bankruptcy of an individual behind the structures.

The terms of the trust will need to be considered and possibly it should be an open class trust with no default beneficiaries. Foreigners may be excluded as potential beneficiaries depending on what the trust will do.

Consider the succession aspects of all roles on death and incapacity - shareholders, trustees, directors, appointors etc

Consider asset protection within the trading company too - it should perhaps own nothing but licence use of things from another entity.

 

Its truly a broad topic which can take an hour to discuss during most consultations

Accountants cant advise on legal issues

Given company tax rate is lower they are now preferred structures. Trusts distributing to bucket companies dont get the same treatment they are not small business entities.

 

The lower small business corporate tax rate may be lure that disguises other options. A disc trust which enables income to be split may achieve a lower overall tax rate but all other aspects must be considered. A company can (typically) choose to allocate income where a disc trust may be obliged to do so.

Depends what the small business is. If its personal services income the issue could be different too. Then there may be issues with intellectual property rights (eg Business name, trademarks etc) if the small business could grow its value to a franchise - You dont want that owned by the trading entity.

Workers comp, PAYG withholding, franking, super, financing and many other issues can affect or be influenced.

And why a consult on issues surrounding structure arent typically 10mins discussions and require legal considerations. You also want to address the risks and issues if the company profits are invested in real estate. This could expose the investment to creditors.

 

If you have a business then you want the entity that owns that to be just a part of a wider structure.

An oft forgotten aspect is protecting the equity used to purchase the business. It should be a secured loan so that you are at least no 2 behind the banks if not no 1.

 

One of the new issues that is emerging is the change to the company tax rate (still before Parliament with changes unknown). The small business test is being replaced by a revised passive income test. This means some that were eligible to the 27.5% rate may lose it and others that were not eligible will access it....This could also lead to inconsistency in franking credits between one corporate entity and another.

At present a bucket company may not be capable of meeting the small business test. The revised rules would recognise the income from the trading entity passed through as franked income as being active income and access to the lesser 27.5% rate more easily occurs. However if the company produces assessable income (not net income) from other investments (rent etc) then this must be less than 80% of the bucket company income. But this comes with a trade off. If CGT gains occur these may affect the mix of income and mean in a year when a CGT profit occurs that the lower tax rate is lost and is temporarily at the 30% rate.

 

New proposed law - if 20% or more of income for a company is passive the rate will be 30%.

I had a strategy designed where a trust distributed to a trading company so it could get the 27.5% tax rate, but this won't work now. But it can still offer some tax savings. but the asset protection issues need to be considered.

 

Business has 2 employees and the owner (myself hopefully) that all work full time doing spraypainting for a smash repairer.
Turnover is 300,000.
Owners income plus profit will be $110,000 a year.
Running as a sole trader would expose me to a very high tax rate .
Structuring this as a company would allow me to pay myself as an employee of the business at $50,000 a year leaving $60,000 in profit left over.
This business is unlikely to grow anymore than a $500,000 turnover shop.
It wont be franchised.

 

When you are looking at business structuring it is important to note that we now have the Small Business Restructure Rollover. It allows you to transfer active assets (like a business asset) within a family group and not incur capital gains tax on the transfer.

In essence it allows for a business operator to start with a "dumb and cheap structure" and then move things around when they start making a dollar.

It is important to note that the rollover only applies to income tax and stamp duty still applies. And the rollover has a raft of hooks in it to stop mischief. In essence the transfer has to:

1. Be part of a genuine restructure
2. Not change the ultimate economic ownership

Importantly the sale of an asset to a family trust might still satisfy the definition the rollover which is an unusual position in tax law.

However the key takeaway is that you do not have to spend a fortune on professional advice fees to start and run a business. Of course other business considerations need to be taken into account - like the attitude of insurance companies towards run-off cover for people who previously owned the business.

Sadly property investments that are not connected to a business are not eligible.

 

The test isnt quite like that....Base rate passive income includes:
- Distributions from a corporate tax entity expect non-portfolio dividends
- Non share dividends
- Franking credits
- Interest, royalties and rent
- CGT gain on qualifying securities
- Net assessable CGT amounts
- Partnership or trust distributions to the extent that the distribution direct or indrect base rate entity passive income
Provided the entity derives no more than 80% as base rate passive income its all OK.

Unfortunately Its not as simple as just saying rental income must be 20% or less. The franking credits from the trust could also impact that % in a simple scenario.

For a bucket company the issue could work backwards so that the entity does comply. But it may limit the sum distributed from a trust so the 80% test is met.

Its damned confusing to be honest. And the effect on franking accounts is even more so.

 

Michael,

On your rough numbers I think you are better off to go for a very simple structure. Do the numbers on what the tax cost will be and then go through the extra work needed to create and maintain these entities.

 

But the Small Business SMSF property transfer seems such a opportunity for some premises however the ATO views are somewhat problematic under the small business CGT concessions (retirement - rollover concession).

In ATO ID 2010/217, it does not contemplate the CGT retirement exemption being claimed simultaneously with the actual in-specie transfer. The ATO view appears to be that all these events cannot occur simultaneously under the law. This is despite there being existing private binding rulings that allow it. And new binding rulings are not issued !!

What should be a simple small business benefit can actually be highly complex and costly when it need not be.

 

If those are the figures it's doing then it may be worth considering other options.

Some of the accountants on here would be better placed then I to know profit percentages, but a profit of over 30% when you are in a business that, I assume anyway, has significant consumables and high electricity costs seems high.

Unless at $500k you would be making significantly more than $110K then you are likely buying yourself a job with a very poor hourly rate.

If it is systemised and/or one of those employees does all the admin, billing, chasing debtors, marketing etc that would be a different story.

You may be better off spray painting for someone else and then taking a second job at night and on weekends, you will likely do less hours than you would have to do in the business, earn more money and not have the stress of running a business at the same time.

We do quite a decent amount of business sales and I see people who have built up these sorts of businesses to a decent size over decades and still get a very poor sale price on their way out.

To me the above business would be worth no more than $100k - the labour costs you would need to pay someone to do the job you are going to have to do once you are in there.

 

Hmmm this is what has been playing on my mind for the last 12 months.
Im currently on $75,000 gross as an employee and the business purchase price is $100,000 wiwo.
A loan will have to be taken out to buy this.
The mentor i have atm has told me i will never get far with property investing being an employee and that i must buy a business.

 

Depends on its scalability. If its a small factory unit and incapable of growth then it cant grow the number of jobs etc. Insurance work is under screws and the poor tradie has to drop his pants to get the work. You get the mix of work wrong and its just (example) $40 a hour plus parts. There is no scope for turning it into a $400K a year site.

Its like owning a coffee shop with one machine. It can only produce X coffees a hour no matter how many customers ask for. Buy another machine + same staff and costs dont actually rise but income does.

Often cheap businesses lack that leverage potential and expose you to risks - eg Is its a small factory unit it will lack space etc. In bad weather more accidents but you cant fit them so you get zero growth.

 

you also won't get much further by buying a business. Why not establish one?

And RPI is right, this sounds like you are buying a job. But you are also increasing risk doing so.