business taxbusiness activity 2 ears 7-10 structures€¦ · a business structure business tax...

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Business Tax Activity 2

BUSINESS STRUCTURES

Years 7-10

Fact sheet

Businesses are set up with differing structures. What are the advantages and

disadvantages of each structure? Why does it matter? Explore some of the

activities associated with starting up a business.

DIFFERENT BUSINESS STRUCTURESThere are different ways to set up a business, each with its benefits and drawbacks. The business structure chosen will affect the way tax is calculated and the amount of tax paid on the business profits.

There are four main types of business structure.

Sole traderA sole trader is a person who owns and runs a business as an individual. They may employ other people, but the sole trader owns and makes decisions for the business.

There is no separate legal identity for a business owned by a sole trader. The business profit is treated as the personal income of the sole trader and must be included in the owner's income tax return. The sole trader is taxed at personal income tax rates.

A sole trader has a limited life and unlimited liability for debts as there is no legal distinction between private and business assets.

Partnership A partnership is two or more persons who operate a business with the aim of making a profit or receiving income jointly. A partnership has limited life, and the business has no separate legal identity with any profits split equally between the partners, or as laid down in the partnership agreement. Net income (profits) must be included on the individual tax returns of each of the partners and are taxed at each partners marginal tax rate.

There must be a partnership tax file number and the business must lodge a partnership tax return showing how the net income or loss was distributed among the partners.

Companies and trustees can also be partners in partnerships.

Any losses from trading in a partnership are also split among the

partners, but these can be offset against other income.

Partners in a partnership have unlimited liability, they are responsible for the debts of the business, even where they were not the person who directly caused the debt.

CompanyA company has a separate legal identity distinct from its shareholders, and is incorporated in its own name. The capital of the company is contributed by a number of people, called shareholders. If you buy a share in a business, you become a shareholder and thus a part-owner of the business. You are then entitled to a share of the company’s distribution (profits), which is also known as a dividend.

Shareholders are generally not liable for the debts of the business because the company structure gives shareholders protection from having to pay for the debts of the company. This is called limited liability. The company directors, whether they are shareholders or not, can in some cases be liable for the debts of the company.

A company has unlimited life, meaning that a company will operate forever unless it is formally dissolved.

Public companies are generally listed on the Australian Securities Exchange and have many shareholders. The reporting requirements of public companies are very strict because they are able to obtain capital (funds) from the general public. Private companies are not listed on the Australian Securities Exchange.

Activity 2: Fact sheetPage 4


A company must have its own tax file number and lodge its own tax return. Companies differ from individual taxpayers as they incur a flat rate of tax on the company’s taxable income, regardless of the company’s income level. Companies do not have a tax-free threshold and tax is payable from the first dollar of taxable income.

TrustA trust is an obligation on a person (or a company), known as the trustee, to operate a business and hold property or assets on behalf of certain people who benefit from the trust. These people are called the beneficiaries. The primary role of trusts is asset protection. However, they also have a significant role to play in taxation.

There are two common types of trusts: discretionary trusts and unit trusts.

In a discretionary trust, the trustee has the power to decide how the profit will be distributed among the beneficiaries. Family trusts are usually discretionary trusts.

In a unit trust, the profit is distributed according to the number of units held by the beneficiaries.

A trust must lodge a tax return, although in general a trust does not pay tax. The beneficiaries who receive a distribution from the trust pay tax on their distribution. The profits can be distributed in a variety of ways to legally minimise the amount of tax paid. This is one of the main reasons many family businesses are established as trusts.

Trusts are an extremely complex area of law, as there are many different types of trusts with different methods of distributing profits. This material on trusts is very general and only deals with the most common types.

TAXATION AND DIFFERENT BUSINESS STRUCTURES

Sole traderThe profit from a sole trader business is taxed at personal income rates (Table 1). This means there is only one amount of tax-free threshold ($18,200) and no opportunity for the owner to distribute any of the income to any other party. Sole traders must also pay the Medicare levy (2%).

PartnershipProfits are split among the partners and will be taxed at each partner’s personal income tax rate (Table 1). Husbands, wives or family members may go into partnership to get lower tax rates if they split the income. There are special tests under the tax law to ensure they are really partners in business, and are not just using the structure to avoid tax. Each partner must also pay the Medicare levy (2%).

Table 1: Resident tax rates 2018-2019Taxable income Tax on this income

0 – $18,200 Nil$18,201 – $37,000 19c for each $1 over $18,200$37,001 – $90,000 $3,572 plus 32.5c for each $1 over $37,000$90,001 – $180,000 $20,797 plus 37c for each $1 over $90,000$180,001 and over $54,097 plus 45c for each $1 over $180,000



CompanyCompanies lodge their own tax return and pay tax on their taxable income (assessable income less allowable deductions). Companies with a turnover of less than $25 million pay income tax at a flat rate of 27.5%. Turnover of $25 million and above is taxed at 30%. A company does not have to pay the Medicare levy.

A company’s distribution to shareholders can be as fully franked, partly franked or unfranked dividends. If company tax has been paid on the company’s distribution to shareholders, the dividend is said to be 'franked' and a franking credit is associated with the dividend. Franked dividends can be either fully franked (the whole dividend carries a franking credit) or partly franked (only part of the dividend carries a franking credit). An unfranked dividend has no franking credits.

TrustsTrusts generally distribute their profits to beneficiaries who will pay tax at their own personal income tax rate, including the higher rates for children aged less than 18 years.

Find out about how different structures affect tax by reading the scenario to the right.

ScenarioMax and Hanna, both aged 26, run a business that has an assessable income of $200,000 for the financial year. They have spent $60,000 in allowable deductions. They are married and they do not pay the Medicare levy surcharge as they have private health insurance. The following table shows how much tax they would have to pay under the different business structures. Trust tax rates are not included, as there are many different types of trusts and they are a complex area of law.

Table 2: Tax payable for different business structures

Business structure Taxable income Total tax payable

Sole trader Hanna operates the business as a sole trader

$140,000 $42,097 which includes Medicare levy of $2,800

PartnershipHanna and Max share the profits equally

$70,000 for each partner $15,697 for each partner which includes Medicare levy of $1,400 for each partnerTotal tax: $31,394

CompanyHanna and Max receive no salaries and the profits are not distributed

$140,000 $38,500Company tax is 27.5% on profit.No Medicare levy

Company paying salariesHanna and Max each receive $38,000 as director’s fees (salaries) and the profits are not distributed9.5% super guarantee payments must also be made as they are both directors of the company.

$64,000Assessable income of $200,000 less allowable deductions of $60,000 and salaries of $76,000

Company tax on profit at a rate of 27.5% is $17,600Personal tax on $38,000 each is $3,897, plus Medicare levy of $760 = $4,657x2 = $9,3149.5% super guarantee payments of $3610 x2 = $7,220Total tax and super (Personal and company) = $34,134

Remember that tax is only one

of many considerations when choosing a business

structure.It is recommended that you

obtain professional advice from an accountant or lawyer before

deciding on a business structure.



TASK 1 FEATURES OF A BUSINESS STRUCTUREBusiness Tax Activity 2: Business structures

Worksheet

Years 7-10

YOU WILL: � test your knowledge about the features of different business

structures � calculate the tax payable for different business structures

and scenarios � decide on the most appropriate business structure based

on tax implications � develop evidence-based advice on the most suitable

business structure taking into account a range of criteria

YOU WILL NEED: � Fact sheet: Business structures � Answer Sheet: Task 1- Features of a business structure

TEST YOUR KNOWLEDGE1. Complete the paragraphs by using the terms from the list provided. A term may be used more than once and all terms should

be used at least once.

losses partnership company agreement

shareholders unlimited liability dividends regulation

trustee profit decision making beneficiaries

capital sole trader knowledge and skills workload

A ……….......…… business structure is an individual running a business. One advantage of this business structure is that any

……………...does not have to be shared with anyone else. On the other hand, there is usually only one person able to contribute

…………… to the business and be responsible for important ……………........ A ……………........ is a business owned by two or more

people. When people decide to form one of these, they should prepare a written ………….......… which sets out the important features

such as the aims, ……........……… contributed, sharing of …………….......and ……………............... and how decisions will be made. A

major advantage of this business structure is that partners contribute different ……………............. to the business and can share the

…………….............. Both a sole trader and a partnership structure have …………….............. for the debts of the business.

A ……………............. is established as a separate legal entity which can make contracts in its own name. The owners of this business

are known as …………..............… They usually receive …………..............… when the business makes a ………….............… They are

subject to greater ………............…… than sole traders. A trust is a business structure where a …………............… is responsible for

managing property for the benefit of one or more people, known as ……............………

2. Calculate tax payable for each business structure (Table 1) to investigate the tax implications of changing from a sole trader format. Remember to include the Medicare levy of 2 percent where applicable.

Activity 2: Task 1Page 7


APPLY YOUR KNOWLEDGE

Scenario 1Jen and Jed have a business making and selling outdoor tables. The assessable income of the business for this financial year was $145,000, with allowable deductions of $40,000. At present, Jed owns the business and runs it as a sole trader, and Jen keeps the accounts for the business. Calculate what the tax payable would be if Jed uses a different business structure?

Table 1: Calculating tax 1Business structure Calculations

Sole trader (All 'profits' included on Jed's personal tax return and assume no other income or deductions for Jed)

Tax payable

Partnership ('Profits' divided evenly between Jen and Jed. Assume no other income or deductions for Jen or Jed)

Tax payable

Company (No salaries to Jen or Jed. Assume a 27.5% company tax rate)

Tax payable

Company with director’s fees ($30,000 paid to both Jen and Jed. Assume a 27.5% company tax rate)

Tax payable

3. Based on tax implications, which business structure would you advise Jed to use for his business?

Scenario 2Jed wanted to increase the profits of his business by at least 50% and developed a business plan to achieve this objective. This involved rethinking the what, how and for whom he produces.

Jed implemented his business plan and the assessable income of the business for the financial year was $290,000, with allowable deductions of $60,000.

Jed’s business plan resulted in more profit. This might have implications for the business structure Jed chooses.

Help Jed decide:

4. Calculate tax payable for each business structure (Table 2) to investigate the tax implications of different business structures given Jed’s most recent figures ($290,000, with allowable deductions of $60,000). Remember to include the Medicare levy of 2 percent where applicable.



Table 2: Calculating tax 2Business structure Calculations

Sole trader (All 'profits' included on Jed's personal tax return and assume no other income or deductions for Jed)

Tax payable

Partnership ('Profits' divided evenly between Jen and Jed. Assume no other income or deductions for Jen or Jed)

Tax payable

Company (No salaries to Jen or Jed. Assume a 27.5% company tax rate)

Tax payable

Company with directors’ fees ($30,000 paid to both Jen and Jed. Assume a 27.5% company tax rate)

Tax payable

5. How does increased profit affect the tax implications of the business structure selected?

6. Based on tax implications, which is the best business structure for Jed now?

MAKE AN INFORMED DECISION

Jed decides that he will choose a business structure based on tax implications only. Should saving money be Jed’s only consideration?

7. Read the advantages and disadvantages of each business structure in Table 3.



Table 3: Advantages and disadvantages of different business structuresBusiness structure Advantages Disadvantages

Sole trader

� has fewer formalities and costs in setting up the business

� has full control of the business � receives the full benefit of profits made by the

business � keeps all of the after-tax gains if the business

is sold.

� has a limited life span, as it will cease to exist when the owner dies

� has limited access to capital and no one to share any losses with

� is legally responsible for all aspects of the business – which means the sole trader can lose all their private assets if the business goes into debt.

Partnership

� fewer set-up costs � greater access to finance, because more

people are involved � more people to share the workload � more people to share any losses and legal

responsibilities.

� net income (profits) or losses must be split between the partners, giving less to each person

� a limited life span, as the partnership ends when any one of the partners leaves or dies

� all partners are responsible for the debts of the partnership

� partners can lose private assets if these are needed to pay off the debts of the partnership.

Company

� has far greater access to capital (funds) for the running of the business

� shareholders are not liable for the debts of the company

� is its own separate legal entity; as shares can be traded or transferred, a company can potentially have an indefinite lifespan

� generally, pays a lower rate of income tax than individuals, meaning tax overall may be less.

� is more expensive to establish � has greater reporting requirements than a sole

trader or partnership � limits the shareholders' say in the running

of the company; they can only vote for the directors who control the company.

Trust

� provides the opportunity to minimise tax through the distribution of net income to beneficiaries

� has limited liability if the trustee is a company � has perpetual existence and does not cease

with the death of a beneficiary � can provide increased asset protection.

� is more expensive to establish � has higher compliance costs, such as regular

legal and accounting expenses � can distribute profits to children under the age

of 18, who may be taxed at a high rate � has beneficiaries who can have complex

PAYG instalment calculations.

8. Develop criteria that will enable you to evaluate the relative costs and benefits of each type of business (examples include establishment costs, tax implications)

Advantages and

disadvantages of each alternative

Develop criteria by

which each alternative

can be judged

Evaluate each alternative in relation to criteria to decide on the best option



Criteria for selecting business structure

¤

Sole trader Partnership Company Trust

Establishment costs

Tax implications

Use the legend below for evaluating each business structure against each criterion you identified in Table 4.

Highly suitable option Somewhat suitable option Not a very suitable option

PP P O9. Develop advice on the most suitable business structure for Jed based on the criteria.

When writing your advice, remember to use PEER to structure your paragraph.

Advice about the most suitable option

Point State your proposed option (one sentence)

Elaboration Explain in a little more detail why you chose this option (one or two sentences)

Evidence/Example Discuss the advantages and disadvantages of your proposed option in detailExplain why the other options were less suitable(several sentences)

Relate Restate your proposed option (one sentence)


Table 4: Decision-making matrix


TASK 2 STARTING A BUSINESSBusiness Tax Activity 2: Business structures

Worksheet

Years 7-10

YOU WILL: � use a SWOT analysis and a PMI to make an informed

decision on a business to start � justify your decision using evidence from your analysis � select an appropriate business name and design a business

logo � justify your choice of language and design � use your existing knowledge to select and justify an

appropriate business structure

YOU WILL NEED: � Fact sheet: Business structures

For some time, your ambition has been to start and run a business in your local area. You have worked in a variety of businesses over the last eight years, as an employee and as a manager, to gain knowledge and experience in a variety of retail businesses. You and your partner have built up savings and a recent inheritance has ensured you now have sufficient funds to follow your dream. Your partner enjoys working as a teacher and so is going to continue teaching, which will provide money to live on while you concentrate on developing the business. You expect you will need to hire staff, at least one person full-time as well as some part-time staff.

After surveying the local business area, you have shortlisted the following opportunities for a retail business:

Option 1A mobile DJ business, specialising in school functions and parties

Option 3Babywear shop selling organic and chemical-free baby wear and supplies

Option 4Leisure clothing aimed at young adults who want something a bit different

Option 2Sporting equipment marketed at individuals who can afford to pay for unique and specially designed gear

MAKE AN INFORMED DECISIONA useful tool for making informed business decisions is a SWOT analysis. A SWOT analysis is a decision-making tool which requires an examination of the Strengths, Weaknesses, Opportunities and Threats for alternative options.

Strengths and weaknesses refer to the internal factors that can be identified and controlled; the opportunities and threats refer to the external factors that cannot be controlled. The structure of a SWOT analysis is provided below.

Positive Negative

Internal Strengths Weaknesses

External Opportunities Threats



1. Identify and record the Strengths, Weaknesses, Opportunities and Threats for one of the four business options. Repeat this process on a new table for at least TWO of the other business options.

SWOT ANALYSISSelected option number: _____

_____________________________________________

Objective: To start a successful business

Strengths Indicate your individual strengths that will contribute to this particular business

Weaknesses Identify any shortcomings that may impact on the success of this business

Opportunities (external, positive factors) E.g.: a market for the product or service exists in the area

Threats (external, positive factors) E.g.: Competitors

2. Evaluate the business options using the PMI chart in Table 2. To do this, identify from the SWOT analyses what is positive, negative and interesting for each of the business options. Allocate 1 point to every positive, -1 to every minus and 0.5 to every interesting point. Total up points for quick view to compare.

Table 2: PMI chartBusiness option Plus Minus Interesting Total points

DJ business

Points

Babywear shop

Points

Sporting gear shop

Points

Leisure wear shop

Points



3. Decide on the business option that best satisfies the objective of starting a successful business. Justify your decision with evidence from the PMI chart. Use PEER to structure your response.

Advice about the most-suitable option

Point State your proposed option (one sentence)

Elaboration Explain in a little more detail why you chose this option (one or two sentences)

Evidence/Example Discuss the advantages and disadvantages of your proposed option in detail. Explain why the other options were less suitable (several sentences)

Relate Restate your proposed option (one sentence)

Now that you have selected a business, complete the following:

4. Decide on an appropriate name for your business. Choose a name that gives a clear, positive message to potential customers about what your business provides. Design a suitable logo.

BUSINESS NAME:LOGO:

An evidence-based conclusion is a conclusion that is based on research and analysis of data and information



5. Explain the choices you made when selecting a business name and designing a logo in terms of how your choices (use of language, colours, design) meet purpose and audience.

6. Select the 'right' business structure for your business. Give reasons for your choice. Explain and clearly identify the tax implications of your choice.

TASKbusiness name and

logo

Purposeto

persuade

AUDIENCEpotential customers


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