Solutions : June 2010

Welcome to Solutions for June 2010

This week Australia has been rocked by a momentous development, with Kevin Rudd stepping aside as Prime Minister and handing leadership over to Julia Gillard.

Aside from being Australia's first female PM, Gillard is aiming to rescue Labor from electoral obvlivion by cutting a mining tax deal. Ms Gillard wasted no time in trying to reconcile the government with the mining industry, which Mr Rudd alienated with the resources super profits tax, pledging to immediately stop the government's $38 million advertising campaign supporting the new tax and called on the mining industry to do the same.

As developments unfold, we will be sure to keep you updated on any changes that affect your business.

In this month's Solutions, find more information on:

The new tax shake-up that will affect hundreds of thousands of small businesses
The importance of making succession planning a priority, even if you are not quite ready to sell yet
How you can take advantage of our new video conferencing system

We hope you enjoy this edition of Solutions.

- From the team at MGI Perth.

Small business owners to pay tax sooner

While everyone has been focussed on the Resource Super Profits Tax, another major tax shake-up has gone almost unnoticed in the media. This one will affect hundreds of thousands of small businesses.

Tax to be paid on reinvested profits

Many small businesses are operated through a family trust whereby profits are reinvested back into the business to fund working capital and business growth. The trust usually appoints those profits to a company with tax paid at 30%. The profits aren’t actually paid to the company and this is reflected in the trust owing those profits to the company, called a “present entitlement”. When the owners decide that it’s time to reward their hard work with a dividend, they draw on those profits and pay the balance of tax up to their marginal tax rate. If on the top tax rate, a further 16.5c in “top-up tax” is paid so that total tax of 46.5% is ultimately paid. But this is the key – you only pay the top-up tax when you take the money out of the business. That’s all about to change.

The Australian Taxation Office (ATO) has issued a ruling that reverses a long established view about these unpaid present entitlements owing by a trust to a company. The ATO now considers that, except in some limited circumstances, the present entitlement owing by a trust to a company is a “loan” made by the company back to the trust. The result is that the present entitlement will be deemed a dividend unless a loan agreement is put in place and the “loan” is repaid over seven years. To cut a long story short, the bottom line is that this will cause the 16.5c top-up tax for each year’s profit to be paid over the subsequent seven years – even if you haven’t taken the money out of the business.

The contrast with big business is brought into sharp focus. You can invest in a listed company, who pays 30% company tax and reinvests 70%, and only pay the top-up tax when you get paid a dividend. But if you invest in small business, you have to pay up to 46.5% even if profits are reinvested in the business and stay there.

Flawed support for change in ATO’s view

The support for this interpretation U-turn cited by the ATO in the ruling is seriously flawed. The appropriate course should have been to fund a test case or seek to have the statute law changed. However, the ATO’s approach is simply brute coercion under threat of punishing penalties if small business owners do not comply with the ATO’s view (even if it is wrong).

When the change takes effect

The ATO ruling on genuine unpaid present entitlements will only apply to appointments of trust income to companies from 16 December 2009, being the day a draft of the ruling was released. This generally means that appointments of income for the 2009/10 financial year onward will be subject to the new taxing policy. The ATO view is that the unpaid present entitlement “flips over” to being a loan in the next financial year. So, an appointment of trust income to a company for the 2009/10 year becomes a “loan” made by the company to the trust in the 2010/11 year. A complying loan agreement will need to be in place before the company’s due date to lodge its 2010/11 return (or earlier, if lodged early), usually in the first half of the 2012 calendar year. This is the first practical action that would be required and the seven year period over which the top-up tax will be paid starts with the 2011/12 financial year.

The government has essentially endorsed the ATO’s actions and so this effectively amounts to a change in government policy on the taxation of small business. Accordingly, the professional bodies have now shifted their lobbying efforts from the ATO to the government. On the basis one accepts having to comply with the ATO’s ruling, 2012 is not far off and so there is not a lot of time before businesses will need to act. Hopefully, this matter can be resolved long before then.

Succession planning: your questions answered

Less than half of private family businesses are thought to have a succession plan in place. Yet preparing for the owner's eventual exit demands careful consideration.

Early planning and informed decisions could help to secure the future success of the business - and its owner.

Here is a selection of the questions we are commonly asked on this topic.

Q) I'm not ready to exit the business, so why do I need a succession plan?

A) Early planning is paramount when preparing for your eventual withdrawal from a business. Sufficient forethought will help to ensure that a current owner has enough time to identify and groom a competent successor, and that the transitional period is as smooth as possible. Last minute of rushed decisions could jeopardise the future of the business. Knowing exactly how, when, and to whom ownership will be transferred could also help to avoid or reduce any tax on the change of ownership.

Q) Which options are available to me?

A) This really depends on the type of business and your individual circumstances. You may decide that you want to transfer ownership to a family member of bring them into the management team. However, if this is not a suitable option, you might consider coaching a non-family team member who understands the business and has the skills required to take the company forward. Alternatively, you may want to dispose of the business through a sale, management buy-out, management buy-in or voluntary liquidation. To discuss which option may suit you and your business, please contact us.

Q) What should I look for in a potential successor?

A) When selecting a potential successor, you will need to remain objective and consider the needs of the business. Does the candidate have the skills, experience, commitment and leadership ability to take the business forward? Once you have made your decision you will also need to consider what form the mentoring and training will take. Taking a step back and allowing your successor to make some important decisions ahead of time will enable you to test their readiness.

Q) What should I do next?

A) Once you have decided on a course of action for your withdrawal from the business you should formalise the plan. This can be a useful way of exposing weaknesses, which can then be addressed. You should also draw up a timetable of necessary actions, as a succession plan may take several years to implement. Remember, your plans for succession need to be communicated effectively to other members of staff as well as customers and suppliers.

Relinquishing ownership of your business requires careful planning and it is important to seek expert advice throughout. We can help you plan for this eventuality, whilst minimising your tax liability and maximising your personal wealth. Please contact us for a more in-depth discussion.

MGI Perth