Business structures for a successful family farm
Author: Crowe Horwath | Date: 09 Oct 2014
Disclaimer:
This paper provides general information only, current at the time of production. Any advice in it has been prepared without taking into account your personal circumstances. You should seek professional advice before acting on any material. Liability limited by a scheme approved under Professional Standards Legislation (other than for the acts or omissions of financial services licensees) in each State or Territory other than Tasmania. Crowe Horwath (Aust) Pty Ltd is a member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath is a separate and independent legal entity. Crowe Horwath (Aust) Pty Ltd and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath or any other member of Crowe Horwath and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath or any other Crowe Horwath member.
Crowe Horwath (Aust) Pty Ltd ABN 84 006 466 351. Date: October 2014
Introduction
Good farm management into the 21st century is based on solid foundations.
These solid foundations encompass:
- what entity you operate through and own assets in
- challenging existing structures to ensure that they meet the objectives of family members and the business
- carefully considering what entity new assets should be placed in to ensure that family objectives are met and both current and long term tax-effectiveness is achieved
- ensuring protection is in place for you and your family
- having knowledge around how structures such as Self Managed Super Funds can benefit you and your family
- having up-to-date estate and succession plans
Take home messages
- Each farming business operation is different and should adopt a business structure that is appropriate for its unique situation
- Business structures may need to change over time in light of legislation, family circumstances, the degree of business growth and the external business operating environment. However, the cost of change is often significant, and the ideal is choosing a structure that will suit for a long period of time (subject to regular review)
- Sound risk management and succession plans are vital for a viable farming business operation
There are a number of different types of structures that are available to operate a farming business.
The choice of entity is inevitably affected by a number of non-tax, commercial reasons as well as tax considerations. This report mainly focuses on the taxation implications of each structure. Non-tax implications should also be considered while selecting the appropriate structure. An example of this is the consideration of workers compensation insurance requirements, which differ for the incomes paid to owners depending on whether the trading entity is a company/trust or partnership. Whilst this is an additional expense, in some cases it is also attractive to have when no personal insurance is held or able to be held.
The report does not recommend the appropriate structure for your business. It will provide you with an understanding of the taxation implications of each type of structure and assist you in your decisions.
In conjunction with the business structure, a successful farming operation will always have a sound risk management and succession plan in place and access to finance facilities.
Commercial and tax considerations
Each situation will have its own specific requirements in regards to selecting an appropriate structure. From a general perspective, when selecting an appropriate structure, the following tax and commercial components should be taken into consideration.
Table 1. Commercial and tax considerations
Commercial Considerations |
Tax Considerations |
---|---|
Limited Liability / asset protection |
Rates of tax |
Formation costs / Wind-up cost |
Who bears the tax liability |
On-going administration costs |
Ability to utilise losses |
Control over assets |
Flexibility to split income |
Exposure of assets on marital breakdown |
Proposed Government legislation |
Social security implications |
Other legislative restrictions |
Method of financing entity |
Irrevocable elections |
Use of multiple entity structure |
Capital gains tax (“CGT”) consequences, including access to the general CGT discount |
Succession planning |
Access to CGT concessions |
Ease of entry and exit |
State duty consequences |
Governance by legislation and regulations |
Access to farm management deposits (“FMDs) |
Flexibility of the structure as the business grows |
Access to primary production averaging |
Industry practice |
Access to other primary production concessions |
Proprietor / Employees obligations |
|
Ease of Borrowing |
|
Insurances held/not held |
|
Estate planning and how asset ownership and control is passed on death |
|
Types of Structures
Table 2. Types of business structures
Sole ownership/ Sole trader | Sole ownership in the context of an individual (or natural person) having both legal and beneficial ownership of the assets generating the income. |
---|---|
Partnership | For the purposes of the Income Tax Assessment Act, the term ‘partnership’ is defined to mean “an association of persons carrying on business as partners or in receipt of income jointly but does not include a company”. The partners enter into a partnership agreement. |
Joint ventures | A joint venture is a special purpose 'entity' (or relationship) which, like a partnership, has no legal personality separate from its 'equity holders'. |
Unit trust | A unit trust is a trust arising by the vesting of property in a trustee pursuant to a trust deed governing, inter alia, investment powers, and where beneficiaries' entitlements as to corpus and income are fixed by reference to unit holdings. Each unit holder has real and effective control of his or her units in the trust and the income generated by those units. |
Discretionary trust | A discretionary trust is a trust deriving income, where the trustee has, under the deed, an unfettered discretion as to distribution of income and capital between beneficiaries who are referred to generally and/or specifically. The trustee has wide investment powers. The trustee is usually a proprietary limited company for the purpose of limiting liability. |
Company |
A company is defined to mean: (a) a body corporate; or (b) any other unincorporated association or body of persons; But does not include a partnership. It has its own legal identity |
Comparison of Structures
In establishing or carrying on a business or other income producing activities, consideration will need to be given to the appropriate structure under which the business or activity should be carried out. A combination of entities may provide the optimal tax structure. Common business structures and their characteristics include.
Table 3. Comparison of structures
Issues |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
---|---|---|---|---|---|
Separate Legal Entity |
No |
No |
Yes |
Yes |
Yes |
Establishment Documents |
None |
Partnership Agreement |
Trust Deed |
Trust Deed, Unit holder’s Agreement (optional) |
Constitution, Shareholders Agreement (optional) |
Who Controls |
Individual |
Partners |
Trustee/ Appointor |
Trustee/ Unit holders |
Directors/ Shareholders |
Perpetual Existence |
Terminates on death |
Terminates on change in partners |
Must vest within a certain period |
Must vest within a certain period |
Yes |
Governing Law |
No specific act |
Partnership Act (State) |
Trustee Act (State) |
Trustee Act (State) |
Corporations Act (Cth) |
Limited Liability |
No limitation to liability |
Liable: Joint and several |
Yes (with a corporate trustee) |
Yes (with a corporate trustee) |
Yes |
Cost |
Lowest |
Low |
Medium |
Medium |
Medium
|
Table 3. Comparison of structures
Issues |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
---|---|---|---|---|---|
Tax rate |
Marginal rates 0‑45[1]% |
Partners’ Tax Rates 0‑451% |
- if distributed, beneficiaries tax rates 0 -451% 45%, if accumulated |
if distributed, beneficiaries tax rates 0 -451% 45%, if accumulated |
30% |
Income Splitting |
No |
Income is shared between the partners. Some flexibility with the use of partner’s “salaries” (refer TR 2005/7) |
Yes, but consideration must be given to PSI rules and IT 2503. |
Income is shared between the unit holders, consideration must be given to PSI rules and IT 2503 |
No, consideration must be given to PSI rules and IT 2503 |
Streaming of Income |
No |
No |
Yes –franked distribution and capital gains (provided the trust deed allows for it) |
Yes –franked distribution and capital gains (provided the trust deed allows for it |
No |
Immediate Availability of Tax Losses to owners of the business |
Yes – subject to non commercial loss rules |
Yes –subject to non commercial loss rules |
No, carried forward. Trust loss measures |
No, carried forward. Trust loss measures |
No, carried forward. Company loss measures |
Tax on Capital Gains |
Paid by the sole trader |
Paid by the Partners |
Paid by the Beneficiaries and/or trustee |
Paid by the Beneficiaries and/or trustee |
Paid by the Company |
[1] The top rate of tax will increase to 47% between 01/07/2014 – 30/06/2017 (not allowing for the Medicare Levy).
Issues |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
---|---|---|---|---|---|
CGT 50% discount available? |
Yes – 50% |
Yes – 50% (provided that the partners are individuals |
Yes – 50% |
Yes – 50% |
No. Companies do not have access to this discount |
Ability to access the small business CGT concessions
|
Yes – if all conditions at met |
Yes – if all conditions are met |
Yes – if all conditions are met. Tests that need to be met are more complex |
Yes – if all conditions are met. Tests that need to be met are more complex |
Yes- if all conditions are met. Tests that need to be met are more complex |
Ability for new parties/ investors to enter and exit structure |
None |
May be permitted - see partnership deed |
Difficulties often arise |
Yes, by purchase/sale of units, or by issue of new units. Triggers CGT and sometimes stamp duty |
Yes, by purchase/sale of shares, or by issue of new shares. Triggers CGT and stamp duty |
Loans to Principals |
N/A |
Yes |
Yes – however Division 7A may apply if companies are involved in the group structure |
Yes – however Division 7A may apply if companies are involved in the group structure |
Division 7A |
Can Principal be Employed |
No |
No |
Yes |
Yes |
Yes |
Salary Packaging |
No |
No |
Yes |
Yes |
Yes |
Who Registers for GST |
Individual |
Partnership |
Trustee for Trust |
Trustee for Trust |
Company |
Issues |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
---|---|---|---|---|---|
Do Principals have a Fixed Interest |
Yes |
Depends on partnership terms |
No |
Yes |
Yes |
Regulatory Body |
N/A |
N/A |
N/A |
N/A |
ASIC |
Access to Important Tax Concessions |
Farm management deposits and primary production averaging |
Depreciating asset and trading stock rollovers on change in partners. Access to FMD’s and PP averaging |
No significant specific tax concessions apply. Access to FMD’s and PP averaging |
No significant specific tax concessions apply. Access to FMD’s and PP averaging |
R & D concessions |
Advantages and Disadvantages
It is also important to consider the advantages and disadvantages of each type of structures as follows:
Table 4. Sole Ownership/Sole Trader
Advantages |
Disadvantages |
---|---|
|
|
Table 5. Partnership
Advantages |
Disadvantages |
---|---|
|
|
Table 6. Discretionary Trust
Advantages |
Disadvantages |
---|---|
|
|
Table 7. Unit Trust
Advantages |
Disadvantages |
---|---|
|
|
Table 8. Company
Advantages |
Disadvantages |
---|---|
|
|
The operation of the chosen structure impacts on the choice of that structure. Not only will costs and complexity be of concern, but consideration should be given as to where income and capital gains produced by a business or investment venture will fall for taxing, and the ability to determine that incidence of tax.
On a regular basis, ask yourself:
- How much are you currently being taxed?
- How much paperwork is your business required to complete?
- Do you have the ability to raise money and grow your business?
- How much understanding do you have of cash flow in and out of your business?
- Do you have an effective accumulation of off-farm assets?
- Does your structure provide access to FMDs?
- How long do you want to keep your business in operation?
- Do you know the current and future intentions of your business, such as the land itself?
- How will the business continue if you were not around tomorrow?
- Is your business structured in a way that can continue to operate without you in it?
- Are you comfortable with your personal liability if things don’t go as planned?
- Does your risk management strategy include enough insurance cover?
You should have a comprehensive understanding of or answer to all of the above questions. If you don’t, working more closely and frequently with your accountant to take a considered and complete approach towards your requirements will help to ensure:
- You have adequate asset protection
- You take advantage of opportunities for legitimate tax reduction
- Your profits are distributed efficiently
- Your structure is reviewed and updated when circumstances change
Cash flow
Cash flow continues to be an area where many farming business operations fail. It is important to know the cost structure of the business which can be done by:
- Understanding fixed costs and overhead costs
- Understanding break even point (what the business needs to produce per ha or per head in order to break even, i.e. production targets)
- Cash flow budgeting. This provides an understanding of working capital requirements and the details of peaks and troughs in cash flow. It supports decision making in relation to, for example, financing and the timing of contracts for income.
Self Managed Super Funds
Superannuation funds can be used effectively for successful farming families in a number of ways.
These include:
- As a structure in which to build wealth for retirement funding
- Cover expenses in relation to income protection, death and disability insurance
- Key role in Estate planning as the SMSF is not an estate asset
- Business succession
- Asset protection as assets held in Super as not as exposed to creditors
Advantages of acquiring direct property with super include:
- Tax Efficient, all assessable income taxed at 15% in accumulation phase and 0% in pension phase (generally)
- Capital gains tax, reduction of rate on CGT (10%), no CGT upon sale of asset in pension phase
- Opportunity to increase balance held within super
- Certainty with lease of rural land if held by your SMSF
Disadvantages of acquiring direct property with super include:
- Land equity not available to assist in year in year out lending requirements
- Additional complexity and annual cost
- Strict liabilities for incorrect administration
- Potential for additional stamp duty costs in the future when passing land to family members
Succession Planning
You’ve worked your whole life to care for and protect those you love. But have you considered:
- An exit plan for you to successfully enjoy your retirement? (note that retirement can mean working when you want to or letting the next generation take the business risk, rather than quitting work completely)
- What will happen when you’re no longer around to take care of your family?
- Will there be sufficient funds to cover debts and to pay for essential living expenses and your children’s education?
- How the sudden loss of a key person would affect your business operation? Have you trained a younger generation to run the business, as well as do the work?
- How the sudden loss of a key person would affect other important stakeholders in your business, such as your family, your employees, your customers and suppliers?
The consequences of inadequate estate planning can be disruptive and distressing for family members and there are a number of pitfalls to avoid. Planning your estate helps to make sure your hard-earned assets pass into the right hands.
Succession is a difficult issue to raise and sometimes to deal with. It involves working in partnership with professionals, including accountants, lawyers, bankers and financial planners, to design and implement succession, retirement and estate plans that are tailored specifically to your needs. These are also likely to change over the years as your circumstances change, and should be viewed as an essential part of the regular business review cycle.
By identifying and working through your business succession issues with your family and these professionals, you will uncover which areas of your business require attention and the various options available. The outcome forms a succinct succession plan which includes strategies to address to the critical issues identified.
The benefits of discussing business succession can be significant. It focuses you and your team on your business vision, in particular how this will be achieved, and the risks attached to the “who” aspects. Sometimes the most important tangible benefit arises only if the worst happens. Think of a business succession plan as an insurance policy that will lessen the impact should something unforeseen happen to an important person in your business.
Building a plan to protect your business and your family will ensure consideration is given to your assets and liabilities, and that these are distributed according to your wishes, in the most tax effective way. Your plan will affect the management and structure of your business which is why it is important to develop this plan in conjunction with professionals listed earlier.
Times change, people change and relationships change. Good planning is always part of any successful business and part of that is recognising that all business’ and business relationships will ultimately come to an end. The question is when, and in what circumstances. Are you prepared?
Making informed decisions about your succession means a better outcome for you, your family and the people in your business.
Summary
- Business structures must be appropriate for your family’s unique situation
- Business structures should be reviewed regularly in conjunction with your accountant as they are complex and many need to be altered when circumstances change
- Business structures for a farming operation should provide you with access to
- Farm Management Deposits (FMDs)
- Primary production averaging
- Various other primary production concessions
- It is important to understand the process of cash flow in your business
- Farming operations require access to finance facilities. Obtain advice from your accountant prior to taking any action
- Ensure your risk management plan is reviewed regularly so that you have adequate insurance cover at a cost-effective rate
- A succession plan should be developed and implemented in partnership with professionals
Items we suggest you discuss with your family in the coming days:
What are your family and business objectives?
- Do you have strategies, initiatives in place in the short, medium and long term so your family will achieve what is important?
- Is your accountant/advisor is your partner in assisting to achieve your family’s objectives? If they aren’t, find someone who will.
- Challenge your existing structures to ensure that they meet your personal and business objectives. There may be better options. At a minimum, make sure you have a full understanding.
- Before you buy new assets discuss with your accountant/advisor what structure would be most effective.
- Self Managed Super Funds are a structure which you can use to achieve family objectives.
- Review/establish income protection insurance, death and disability cover in place to cover your family.
- Review/establish your estate and succession plan with your accountant/advisor
Contact details
Stuart Thomas
Principal
Crowe Horwath Forbes
02 6852 1455
Email: stuart.thomas@crowehorwath.com.au
Michele Wise
Senior Manager
Crowe Horwath Orange
02 6361 5200
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