When contemplating the acquisition of an asset or commencing a new business, the first question that should be considered is the form of ownership. When more than one family group is involved, the usual options are a company or unit trust.
When determining the suitability of a structure, you must bear in mind the particular advantages and disadvantages of the entity being considered. No one entity is suitable in all circumstances.
In recent times, some suggest the use of a partnership of discretionary trusts. The purpose of this article is to set out the key advantages and disadvantages of the Partnership of Discretionary Trusts structure which will identify key planning points for this structure.
The advantages and disadvantages of the Partnership of Discretionary Trusts are identified by comparison with the features of a company/unit trust alternative.
Maximum Net Asset Value Test
The small business CGT concessions enable most privately owned businesses to sell their business without triggering a capital gain. To be eligible for these concessions there are a number of conditions to be satisfied. One of those conditions focuses on a size test – either a $2 million turnover test or a $6 million net asset value test. The test applies to the relevant taxpayer. In the case of an asset sale by a company or unit trust, the taxpayer is the company or unit trust. If the net value of the business exceeds $6 million, a company or trust structure will not be eligible for the concessions on an asset sale.
The same result does not apply to a partnership of discretionary trusts where you have a partner with a less than 40% interest. In this case, the relevant taxpayer is each partner. What that means is where the partner has a less than 40% interest, you only take account of the value of the partner’s share in the business. If for example you had four equal partners of the business (25% each) and they did not own any other assets required to be taken into account, the net value of the business could be up to $24 million and still be entitled to the maximum net asset value test.
A condition for the small business CGT concessions on a sale of equity (shares in a company or units in a unit trust) is that the company or trust has a significant individual and the selling taxpayer is a significant individual or a spouse of a significant individual. An equity owner that has a less than 20% interest in a company or unit trust will not satisfy this condition. However, in a Partnership of Discretionary Trusts structure, the partner is the taxpayer and a minority owner (even say 2% or 5%) will be entitled to the small business CGT concessions (providing the other conditions are satisfied).
Access to Losses
Losses by company or trust are trapped within the entity. They are only available to be used against future profits that are made by the company or trust. The same does not apply to a partnership. Losses of a partnership flow down to the partner which can be offset against other income of the partner. The client may have another discretionary trust that generates income that can make distributions to the Discretionary Trust partner which can be offset against the partnership losses (Note: the trust loss provisions must also be complied with). In this way, partnership losses are not trapped within the entity.
Like a Company or Unit Trust, the Partnership of Discretionary Trust provides a fixed interest, each partner has a specified percentage interest in the Partnership in accordance with the terms of the Partnership Agreement.
One of the disadvantages of a partnership is each partner is jointly and severally liable for the debts of the partnership. It is said this is a disadvantage of a Partnership of Discretionary Trusts. However, if the only asset of each Discretionary Trust partner is its interest in the business it is no different to a Company or Unit Trust structure. The business will be exposed to meet debts incurred for the business in each case. The assets that are available to meet the debts incurred by any other Partner are limited to the interest of the Discretionary Trust partner in the business.
A disadvantage that is sometimes suggested for a Partnership of Discretionary Trusts is that there are multiple entities. Whenever there is a contract to be signed or transaction entered into, each Partner must be a party to the contract or transaction. Where this is considered a disadvantage, the usual recommendation is to appoint a manager or agent to act on behalf of the Partnership. It is important that the appointment of the manager or agent is formalised to prove that the manager or agent is not acting in the same capacity. A common error when setting up these arrangements is for the documentation (irrespective of the title that might be given to the document) to create a nominee arrangement. It is dangerous to use nominee arrangements because nominees are trusts, which may cause the trapping of losses as described above. While some suggest that nominee/bare trust arrangements do not give rise to the trapping of losses (because, it is suggested, they are not subject to Division 6) this is not accepted by the ATO.
The key advantages of a Partnership of Discretionary Trusts are:
- access to the small business CGT concessions where the business is anticipated to have a value exceeding $6 million
- access to the small business CGT concessions for minority owners
- utilisation of losses
Only when these advantages are relevant will there be real benefit in using a Partnership of Discretionary Trusts structure.
By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)
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To discuss forms of structuring and the most appropriate structuring for your asset or business, please contact Domenic Festa on + 61 7 3648 9900.