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

  1. Each farming business operation is different and should adopt a business structure that is appropriate for its unique situation
  2. 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)
  3. 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

  • Owner has complete control over the business
  • Low cost
  • Simplicity
  • Access to CGT discount and small business CGT concessions (provided all conditions are met)
  • Losses offset against other income of the sole trader subject to non commercial loss rules
  • No fringe benefits tax in reflect of benefits to the owner
  • Low tax rate in years of low income (could be 0%)
  •  No Income Splitting (100% of income goes to Sole Trader)
  • Unlimited Liability (sole traders assets are exposed to creditors)
  • More Proof required re. the substantiation of deductions (than companies and trusts)
  • Maximum tax rate 45% plus Medicare

Table 5. Partnership

Advantages

Disadvantages

  • Limited Income Splitting (income can only be split between the partners)
  • Low Administration Cost
  • Access to CGT discount and small business CGT concessions (provided all conditions are met)
  • Losses offset against other income subject to non commercial loss rules
  • No fringe benefits tax or workers compensation premiums payable in respect of benefits to partners
  • Rollover provisions apply for deprecation and trading stock on a change in the constitution of a partnership
  • Unlimited Liability
  • More proof required re. the substantiation of deductions (than companies and trusts)
  • CGT issues arise on introducing and retiring partners because fractional interests are acquired and disposed of for CGT purposes

 

Table 6. Discretionary Trust

Advantages

Disadvantages

  • Limited Liability (provided a Corporate Trustee is used
  • Income Splitting
  • Flexibility of Distributions on a year by year basis
  • Access to CGT Discount
  • Access to Small business CGT concessions (provided conditions are met)

 

  • Administration Costs
  • Complexity
  • Trust loss rules are complex and losses can not distributed to beneficiaries (must be retained in trust)
  • May need to make an irrevocable family trust and /or interposed entity elections.  This will limit the beneficiaries to whom a tax effective distribution can be made
  • Taxpayers often fail to understand a trust structure and how the concept of trust operates
  • Owners benefits may be subject to FBT and workers compensation premiums where the owner has an employment relationship with the trust
  • Income may be subject to personal services income measures
  • Trusts may be subjected to higher levels of state taxes (i.e. land tax)
  • Trustees may be personally liable for the debts of the trust (in certain limited circumstances)

Table 7. Unit Trust

Advantages

Disadvantages

  • Limited Liability (provided a corporate trustee is used)
  • Income Splitting by way of unit holding
  • Ease of introduction and retiring equity members
  • Eligible for 50% discount
  • Access to small business CGT concessions (provided conditions are met)
  • Administration Costs
  • Complexity
  • Trust loss rules complex and losses can not distributed to beneficiaries
  • Some non assessable amounts can not be distributed without a reduction of the cost base of the units for CGT purposes
  • May need to make an irrevocable family trust and/or interposed entity election(s). This will limit the beneficiaries to whom tax effective distributions can be made
  • Taxpayers often fail to understand a trust structure and how the concept of trust operates
  • Owners benefits may be subject to FBT and workers compensation where the owner has an employment relationship with the trust
  • Income may be subject to personal services income measures
  • Trusts may be subjected to higher levels of state taxes (i.e. land tax)
  • Trustees may be personally liable for the debts of the trust (in certain limited circumstances)

Table 8. Company

Advantages

Disadvantages

  • Limited Liability
  • Income Splitting
  • Tax Rate (flat tax rate of 30%)
  • Imputation (shareholders get the benefit of tax credits on the payment of franked dividends)
  • Ease of enter and retiring equity members
  • Access to the R&D concessions
  • Access to small business CGT concessions (provided conditions are met)
  • Administration Costs
  • Distributions are treated as Dividends and top-up tax may be payable
  • Capital assets do not get the same CGT concessions as other entities (e.g. no 50% general discounts).
  • Companies are regulated by Corporations Law and ASIC. This adds to the cost and complexity of operating a company
  • Revenue and capital losses must be retained until recouped, and are subject to tests
  • Loans to owners/associates may be treated as dividends (including unpaid distributions from related trusts)
  • Owners benefits may be subject to FBT and workers compensation where the owner has an employment relationship with the company
  • Income may be subject to personal services income measures
  • Directors may be personally liable for the debts of the company (in certain circumstances)

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
  1. Farm Management Deposits (FMDs)
  2. Primary production averaging
  3. 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?

  1. Do you have strategies, initiatives in place in the short, medium and long term so your family will achieve what is important?
  2. Is your accountant/advisor is your partner in assisting to achieve your family’s objectives? If they aren’t, find someone who will.
  3. 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.
  4. Before you buy new assets discuss with your accountant/advisor what structure would be most effective.
  5. Self Managed Super Funds are a structure which you can use to achieve family objectives.
  6. Review/establish income protection insurance, death and disability cover in place to cover your family.
  7. 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

Email: michele.wise@crowehorwath.com.au