Structuring to be a small business entity

Is it possible for larger businesses to each take advantage of the $20,000 immediate depreciation write-off? What about the 1.5% company tax reduction?

Recent tax rate cuts and improved depreciation benefits for small businesses have increased public awareness of the advantages of being considered a “small” business. What has been less publicised is the opportunity for mid-sized businesses to access these same benefits and concessions.

The key is knowing how to correctly structure your client’s businesses.

What tax benefits are available?
The tax benefits available to small businesses are clear, and include the following:

  • The 1.5% company tax rate reduction for incorporated small businesses (i.e. a 28.5% tax rate);
  • The tax offset for individuals receiving income from non-incorporated small businesses;
  • The immediate $20,000 depreciation write-off;
  • The small business simplified depreciation, trading stock and prepayment rules;
  • The application of the small business CGT concessions; and
  • Eligibility to elect to record and pay GST on a cash basis.

In opening up eligibility for these benefits to more of your clients, it is necessary to understand what a small business actually is.


What is a small business?

For tax purposes, the definition of a small business is based on the concept of a ‘small business entity’. Under this definition, to be a small business entity in a particular year, the entity must generally carry on business in that year and meet a $2 million aggregated turnover test.

The aggregated turnover includes the ordinary income derived in the course of carrying on a business. Passive (non-business) income is excluded. Importantly though, the turnover includes that of:

  • The entity itself;
  • Connected entities; and
  • Affiliates.

Whilst the law surrounding connected entities is complex, 40% is generally an important number. That is, 40% ownership in a company, unit trust or partnership, or 40% of distributions from a discretionary trust will generally be enough to result in entities being connected. Having influence over the trustee of a discretionary trust (such as being an appointor) can also result in that entity being connected with the trust.

For an affiliate relationship to exist, the other party must be either an individual or a company who acts in accordance with your directions or wishes (or in concert with you) in relation to their business affairs. This implies a level of ‘pseudo control’.

It is the understanding of how to effectively manoeuvre through the connected entity and affiliate concepts which can provide scope for larger businesses to obtain the tax benefits designed for small businesses.


Structuring is where it all begins

The key to give a business the best chance of being a ‘small business entity’, and thus obtaining the tax concessions which go with that, is to get the structure right. This involves not only setting up an appropriate structure (or restructuring to a more appropriate structure) but also carefully managing the structure over time.

Consider this example:

Three unrelated colleagues come together to setup a women’s clothing store. They setup the trading entity as a company, Women’s Clothes Pty Ltd, with the shares in the company held equally by their family discretionary trusts:

After a year of trading, the company’s turnover has reached $1.5 million per annum and the company is profitable.

Given their success, they wish to branch out into men’s clothing and open a men’s clothing store. They expect it to have a similar turnover to their existing store.

From an asset protection perspective, they decide that the new store should be operated through a separate company, Men’s Clothes Pty Ltd, but are unsure as to who should own the shares in the company. They are weighing up having a holding company own the shares in both companies:

Or to replicate the current ownership structure:

From the perspective of accessing the benefits available to small business entities, the holding company structure will not be suitable as the three companies will be connected entities. This means their turnovers will be combined when assessing the eligibility to be a small business entity. Whilst Women’s Clothes Pty Ltd may initially remain as a small business entity for a short period of time, moving forward none of the three companies would be small business entities.

However, under the ‘mirrored ownership’ structure, the companies are not connected, as there is not a 40% ownership interest by the same shareholder in both companies. Provided the affiliate rules can be managed (which is often the case) the two companies will consider their eligibility to be a small business entity independent of one another. As their business turnovers are under $2 million each, they will each be considered small business entities.


Conclusion

The benefits available to small business entities shouldn’t be the only aspect considered when assisting clients in structuring their affairs. However, the benefits can be significant and with some clever planning even mid-sized businesses may be able to avail themselves of the benefits.

William Buck has significant experience in structuring private businesses and investment vehicles. If you would like assistance in tax effectively structuring, or restructuring your clients’ affairs, please contact Todd Want or Greg Travers on 02 8263 4000.