Australia: Business licensing and future tax changes

It's hard to believe it but it's now almost eight years since the Commissioner issued his ruling and practice statement (TR2010/3 and PSLA 2010/4) on unpaid present entitlements and apart from some imprecise comments in the 2016-17 Federal Budget1, we have seen little movement on the recommendations for change which were made in the Board of Taxation's Post implementation Review into Division 7A2. As a consequence we are still seeing a reasonable volume of clients taking a restructuring approach in solving the perennial issue of how to attract reasonable rates of tax for working capital in trust owned businesses.

Consider two competitors in town, with the only difference between them that one is structured in a discretionary family trust and the other a company. Economic conditions are favourable and both are seeking to drive improved profits into long-term growth. Our company competitor will simply apply retained profits towards his expansion plans, but as we know for our trust competitor, the issue is not so simple. Accessing the same or a similar corporate tax rate will generally involve only short to medium term use of those funds by the trust for long-term investment.

With the carrot of meaningful legislative change being tantalisingly dangled in front of us, many trust clients are reluctant to abandon the reasons why they chose a trust structure in the first place. More flexible arrangements are needed and this is where business licensing can play a role.

Essentially, a business licence arrangement involves packaging up the components of the business and making them available to a private company in the group under licence, to carry on the business in return for a fee. With a private company doing all the heavy lifting and the trust taking on the role of passive asset owner, the taxation of an appropriate amount of profit can similarly move to a corporate environment where profit can be retained rather than distributed, with ready access for working capital requirements. But how do we structure this arrangement with the prospect of an easier tax life for trusts being perhaps on the horizon?

The essential elements of a successful arrangement in the current environment are:

  • a short licence term that moves to a periodic tenancy style arrangement upon expiry
  • building in an appropriate and recurring licence fee without any premium, and
  • ensuring that ownership of the assets under licence remains with the trust, including any improvement to those assets (such as business goodwill).

By structuring the term of the licence to accurately reflect the client's commercial objectives, the arrangement is highly responsive to any future legislative changes that 'hopefully' materialise in a positive form, so that the only major concerns that the participants have when deciding what to do about those changes, are how they would impact them under either structure. When properly implemented, the arrangement also provides a high level of asset protection for the business by separating the valuable assets (which remain in the trust) from the operational risks, which are borne by the company. If desirable, by changing trustees of the trust before the licence is implemented, the former trustee in its own right, can set up as the business operator under the new arrangement, which can avoid transition costs and complications usually associated with moving a business to a new entity.

From a NSW duty perspective, the grant of a business licence, without more, was not dutiable in NSW before the abolition of duty on business assets (effective 1 July 2016) and that continues to be the case. In Queensland, the granting of a licence is the grant of what is referred to as a "new right" under the Duties Act 2001 (Qld), and is a dutiable transaction. However, careful drafting of that licence agreement may ensure that any value attributable to the licence itself is nominal (reducing any duty payable to a similarly nominal amount).

In respect of capital gains tax (CGT), provided there is no premium paid to the licensor for granting the licence, there ought to be no CGT consequences of entry into that agreement. However, care needs to be taken that the licence fee set and paid by the company to the trust does not exceed a commercial rate, otherwise, Division 7A consequences may follow in respect of those payments. It is useful to recall that amounts paid by a private company are not considered to be payments for Division 7A purposes if they are discharging a monetary obligation (i.e. the obligation to pay the licence fee) and are no more than what that payment would be if the parties (i.e. the trust and the company) were at arm's length to each other. This means that if the fee is too high, the whole fee risks being subject to Division 7A, not just the excess.

As far as fixes go for managing access to corporate tax rates for working capital in trust owned businesses, a business licence has proven to be an effective tool for advisors which retains flexibility for clients in relation to how they choose to respond to future changes in their operating environment, including tax law.

Footnotes

1 Budget Paper No.2, Budget Measures 2016-17, Part 1: Revenue Measures at page 42 with changes announced for commencement on 1 July 2018.

2 Released by the Assistant Treasurer on 4 June 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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