This is quite often this is one of the first questions we get asked and the answer is always, “it depends!” (don’t you just love that). It does depend on so many circumstances and is very specific to each client’s situation. However, I will provide some generalized information in an attempt to answer the question as best I can (without knowing the individual circumstances).
There are four main tax structures that we will go into; sole trader, partnership, company and trust. That is also the order of complexity of each structure, the least complex being sole trader and the most complex being a trust. The more complex the structure, generally the more expensive the accounting fees. What business structure you choose affects how your business operates in the law, and what it is protected against if something goes wrong.
The sole trader structure is where you operate under your personal name, so all income and expenses are taxed in your personal name. Individuals are taxed at marginal tax rates starting at 10.5% for income earned up to $14,000 and increase to 39% for income earned over $180,000. I quite often find that people think they need to set up a company to go into business, however that is not the case. As a sole trader you can employ staff, be GST registered and operate any type of business you like.
A partnership is where two or more people go into business together. This may be set out in a partnership agreement, which details how you are splitting the profits and debts, and the day to day running of the business. However, in most farming partnerships involving a husband and wife (or partners) this isn’t the case. A partnership involves a high degree of trust as all partners must operate in good faith. There can also be tax consequences if there is a change in partners, if for example the partnership owns depreciable property or livestock. The benefit is that the profit is split between all the partners thereby utilizing the lower individual tax rates. The profit can also be split depending on who does what work, for example if one partner works an off-farm job we can allocate less profit to them which avoids the higher tax rates.
A company is a separate legal entity from the people that own it (shareholders) and run it (directors). This means that if something went wrong and your company owed a debt to someone, the company would be liable rather than the directors and shareholders. This is called limited liability. It gives protection to assets owned in the directors and shareholders personal names. However, it is becoming more common for directors to liable for company actions too as they are the ones operating the company. Another advantage is that the company tax rate is a flat 28% so offers tax advantages compared with individuals who are taxed at 30% or higher on income earned over $70,000. The disadvantage of a company is the extra compliance involved with annual returns, minutes and resolutions, and the maintenance of an Imputation Credit Account.
For a contract milker earning around $100,000 a sole trader is generally the best option if you are single or have a partner who earns a decent off farm income. If your partner doesn’t have an off-farm job, a partnership is generally best as you can split the profit and utilize the lower individual tax rates.
Once you get into sharemilking, that is the time to think about a partnership or company. During the high milk price years sharemilkers can make in excess of $200-300,000 so it is beneficial to have a structure that allows more tax planning. The point at which we start recommending a company is around $200,000 profit if both partners are working on farm. Up until this point in a partnership, each partner is earning up to $100,000 each and at anything more than this, the tax saving is usually greater than the additional compliance cost of a company.
If one partner earns a decent off farm income (over $70,000) the threshold for recommending a company may be lower.
Its not the end of the world if you are operating a partnership and need to transition to a company, its just that there are some tax issues that arise when this occurs (eg. Depreciation recovery) so it is best to get it right from the start. Of course this all depends on what your plans are and how long you plan to stay in the industry.
When entering into farm ownership might be the time to think about settling a trust and the trust buying the land. This enables asset protection and allows assets to be passed from one generation to another. Trading trusts are not recommended so usually a company or partnership will operate the farming business and pay a land lease to the trust. The trust may own shares in the company, which enables dividends to be paid to the trust, which can then be distributed to the beneficiaries. Trust legislation is becoming more onerous and costly so careful thought needs to be given when settling a trust. Trusts are also expensive to set up, maintain and wind up.
These are quite complex issues, especially concerning trusts so please seek advice when considering these options.