Checklist: how to minimise the risk and maximise the protection.
When contemplating a business structure for a client, there's many areas to discuss in terms of tax and compliance requirements, while giving business owners the best protection and liability separation from the business as possible, so they can grow their personal wealth while limiting their risk and exposure.
There's a tonne of sole traders out there. In fact, according to ABS statistics 31% of small businesses are sole traders1. Many of them may be contemplating a different structure given the struggles over the last few years. Particularly if those sole traders are becoming more aware of the significant exposure they have to being personally liable for all business debts including tax debts and want to close that gap going forward. Those risks inherently extend to the business owner's personal assets including their interest in a home/real property.
To support your clients who want to change their business structure from a sole trader to a company structure, what do they need to consider and implement?
Here's a short list:
- Taxation obligations.
- Assets (tangible and intangible).
- Debtors.
- Employees.
- Suppliers/creditors.
- Landlord.
- Utility accounts.
- Workcover/insurances.
- Director ID.
Taxation obligations
Significantly, the new entity must take all necessary steps to follow the Australian Taxation Office's (ATO) stringent requirements.
The ATO will require the new entity to register for the required tax obligations, including income tax, GST, and PAYG. It may also be the case that the old entity can now cancel any GST or PAYG registrations once final returns are completed and lodged.
Assets
If the business owns any physical or intangible assets, those assets could remain with the old entity (sole trader) and be hired/leased or transferred/sold to the new entity (company).
Firstly, seek professional tax advice regarding the transfer/sale of assets.
If transferring/selling these assets to the company entity, then an asset valuation would be recommended. The valuation amount (known as proper consideration) must be paid by the new entity to the old entity or if sold to the company on credit/vendor finance, make sure to document the transaction and take and register a security over the assets. Registering that security would either be on the Personal Property Securities Register (PPSR) or with land titles for real property.
Lastly, don't forget the intangible assets such as business names, domain names, phone numbers, emails and trademarks and patents. These are often missed when restructuring a business.
Debtors
All old debtors should be collected through the old entity—resist the temptation to collect them in the new entity. Any proceeds from collecting the debtors amounts owed can be used to payout the old entity's debts; and once collected, the old entity's customer accounts should be finalised.
New customer accounts should be setup in the new entity's name and payments made to the new entity.
Any new contracts for work must be setup in the name of the new entity.
Employees
Any employees attached to the sole trader structure must be transferred to the new entity. This involves terminating them from the old entity and getting them to sign a new employment agreement under the new entity as well as completing new tax declaration forms. Any accrued entitlements will transfer to the new entity.
Suppliers/creditors
Addressing the creditor position is critical for business owners to alleviate personal liability.
Just as with the debtor position, new accounts must be opened with all suppliers/creditors in the new entity and any old ones be paid out in full and closed. Otherwise, the potential risk is that debts will continue to accrue in the old entity's name. In setting up new accounts in the new entity, the credit application must be carefully read and considered, particularly regarding any director's guarantees (click here for more detail) and real property charging clauses (click here for more detail).
Conducting a search on the PPSR is be a useful tool—and cheap exercise for only a $2.00 fee—to investigate what supplier accounts have registered securities against the individual (as the sole trader).
Landlord
Importantly, any lease for the business premises must be transferred/assigned to the new entity. Alternatively, a new lease can be entered into. Again, just like the supplier accounts, care should be taken when reviewing any of the new documentation being signed.
Utility accounts
New utility accounts for power, phone lines etc. must be setup or transferred to the new entity. Again, phone lines may be a small business's lifeblood and may have an intangible value that consideration needs to be given when transferring any assets to a new company.
Workcover/insurance policies
A new Workcover policy must be taken out in the new company entity that will now employ staff. Failure to report correctly on wages to Workcover can lead to costly penalties. Likewise, any insurance policies must be setup in the new entity and cancel the previous policies in the sole trader entity. It's always best to speak with your broker about changes to your structure to ensure your insurance needs are met and the business and any assets/risks are appropriately covered.
Director IDs
Clients planning to become a company director must apply for a director ID before they're appointed. Their authorised tax, BAS or ASIC agent can help them determine if they must apply, but only the client can apply using their myGovID account. To read more about director IDs click here.
Summary
Considering all these issues and acting upon them as required is vital as an asset protection strategy. At Worrells, we see instances where the company did not setup new supplier accounts and upon the company becoming insolvent and under administration, the creditors under the previous supplier accounts then had the recourse to make a claim against the individual/sole trader (old entity). Not transitioning your business structure correctly and thoroughly can create very costly mistakes!
Seeking appropriate and qualified advice is vital for any sole trader considering setting up a new entity to ensure the process is undertaken correctly. To assist, here's a checklist: Sole trader to company structure.
Footnote
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.
