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Farming businesses and structuring options

November 2, 2023

Whether you are purchasing an existing business or starting a new one, it is important to determine the most appropriate structure for doing so before you enter into any binding contract, as changing structures down the track could be a costly and time-consuming process.

The most common structures we see are sole traders, partnerships, trusts (discretionary and unit trusts) or companies.

The major considerations in establishing the ideal structure for your business include tax implications, simplicity and cost of the structure, asset protection, nature and size of the business, potential for growth and the need for additional capital, the nature and extent of control and management required for the business and the cost and complexity of retaining the business and structure.

Sole traders

The acquisition of a business as a sole trader usually requires little or no formal documentation other than that required to register a business name and of course all necessary tax registrations such as TFN, ABN, GST and PAYG (if appropriate). A separate bank account through which the transactions of the business will occur is also necessary.

The sole trader is personally liable for all of the debts of the business and the ability to raise capital is largely dependent upon the credit rating of the individual or other assets which may be available for use as security for loans.

As a sole trader, the business is usually easier and less expensive to run from an administration and accounting viewpoint.

However, there is no flexibility to manage tax from the business as all income will be taxed in the hands of the sole trader.

Partnership

A partnership exists where there is a relationship between persons, or entities, carrying on business in common with a view to make a profit. Typically, the individuals operating a business as partners will enter into a partnership agreement which sets out their respective rights and obligations. If no agreement is signed, the relationship is governed by the relevant state Partnership Act.

Liabilities for debts and obligations of the business are borne jointly by the partners.  The liability rests with the persons who are, or appear to be, members of the partnership at the time the liability was incurred.

Unless otherwise agreed by the partners (and documented in writing), the death or bankruptcy of a partner will dissolve the partnership.  However, in the absence of any agreement to the contrary, the partnership is not automatically terminated upon a partner losing mental capacity.

The major deterrent to the establishment of a partnership is the unlimited liability of each partner for the partnership debts.

Whilst “partnership” is a legal term to define a contractual relationship rather than a separate legal entity, partnerships are required to prepare and lodge income tax returns. However, the partnership does not pay tax. The net income of the partnership is included in each partner’s taxable income according to their respective interests. In a similar fashion, partnership losses flow through to the partners.

Partnerships are usually only appropriate for smaller businesses and do not allow for ease of introduction of business partners or capital.

Discretionary trust

A discretionary trust gives the trustee discretion over what income and capital is distributed to which beneficiary. Where two or more independent people operate a business together, the discretionary trust structure is unlikely to be used, as more often than not each party will want certainty as to entitlement, rather than the trustee exercising their discretion as to what will be distributed and in what portions between the beneficiaries. However, a partnership of discretionary trusts could be used by having one trust for each family group.

The discretionary trust structure provides asset protection, estate and succession flexibility in terms of handing the business on to the next generation and ability for the trustee to distribute income tax effectively.

Because of their discretionary nature, these trusts are not suitable for the introduction of business partners or capital investors into the business.

Discretionary trusts are generally suitable for small to medium-sized family businesses.

Unit trust

Under a unit trust structure, participants acquire units in the trust representing a proportional interest in the trust property. Unlike a discretionary trust, unit trusts divide the trust property into fixed and quantifiable parts. A unit trust therefore provides certainty for unitholders.

The unit trust will distribute the profit of the business to the unitholders in proportion to their unit holdings. The unit holders will then pay tax on that profit.

To protect unit holders from the liability of the business, it is usual for trust deeds to limit the liability of unit holders to the amount of their subscription for their units.

Because of their fixed nature, unit trusts provide more flexibility in the change of underlying shares of business owners and the introduction of new business partners or capital investors. However, in most states (including Queensland and New South Wales), stamp duty will be payable on the issue and transfer of units.

 Company

 A business can also be owned by a private company. This has the advantages of limited liability in that the liability of each shareholder is limited to the amount unpaid on his or her shares.

Control of the business can easily be changed by changing the directors of the company.

A company structure also provides the ability to raise capital through an allotment of shares, the access to corporate tax rate and flexibility in structuring the shareholders’ rights.

Companies are appropriate for larger, more complicated businesses where a more formal management structure is required, or profit is expected to be quite high.

They are also suitable where it is intended to grow the business through attracting capital investors.  Because of their fixed nature, companies provide more flexibility in the change of underlying shares of business owners and the introduction of new business partners or capital investors.

Another benefit is that in most states, stamp duty will not be payable on the issue and transfer of shares as long as the company does not have significant landholdings.

Because companies are so regulated, the cost of their operation and management is generally higher than the other alternatives.

Summary table

The below table sets out a quick overview of the different business entity options:

Sole trader Partnership   Discretionary trust Unit trust Company with individual shareholder/s Company with discretionary trust shareholder  
Flexibility on income distributions   No No Yes No No Yes
Access to corporate tax rate No No Possibly No Yes Yes
Protection for individuals from business risks No No Yes Yes Yes, subject to directors’ liability Yes, subject to directors’ liability
Protection for business from individual’s risks No No Yes Yes No Yes
Estate and succession flexibility No No Yes No No Yes
Costs of establishment Lowest Lower Lower Mid-range Mid-range Higher

Contact a member of our Business Services team if you need advice on a business entity or if you are currently operating your business and want to change your existing structure.

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