CHANGE OF STRUCTURE

CHANGE OF STRUCTURE

It is not uncommon for clients to change the structure used to operate their business. While accountants will typically be the ones providing the strategic advice surrounding a change
of structure, once the decision has been made, much of the implementation will fall to the bookkeeper. A raft of practical, operational and tax consequences emerge when a structure is changed, which demands specialist knowledge of the subject matter and an appreciation of the correct bookkeeping techniques to use.

BACKGROUND

There are many factors that can lead to a business changing its trading structure, some of which include:

  • Growth in the business
  • Simplication or downsizing of the business
  • Asset protection
  • Limiting of liability
  • Taxation considerations
  • Management changes, namely the addition or removal of persons that control the operation of the business
  • Ownership changes, such as the facilitation of additional investors
  • Commercial / contract requirements
  • Operational reasons
  • Requirements imposed by lenders and financiers
  • Eligibility criteria for government grants.The rationale for, and strategic advice surrounding, a change in business structure will usually emanate from a tax agent, accountant, financial advisor, lawyer, or business strategist.

    While bookkeepers and BAS agents may not typically be proffering advice to bring about a change of structure, they will be heavily involved in many of the practical implementation steps.

    COMMON TRADING STRUCTURES AND CHANGES OF STRUCTURE

    The main types of trading structures used in a business which bookkeepers and registered agents and themselves deal with are:

  • Sole traders
  • Partnerships
  • Trusts; and
  • Companies.

Within each of these structures, there can also be different ownership structures at play. For example, a partnership involves 2 or more partners, but those partners could be any combination of individuals, trusts, or companies. In the case of trusts, a discretionary trust (otherwise known as a family trust) is the most common, however a unit trust might also be utilised, where the owners (unitholders) comprise any combination of individuals, trusts or companies.

When the ownership of a business changes from any one of these structures to another, then we have a change of structure on our hands. Theoretically, any combination of change is possible, however anecdotally, the most common change of structure scenarios which we observe in the small-to-medium business landscape are depicted in the following table (in no particular order):

Old structure

New Structure

Motivating factors

Sole Trader or Partnership

Trust or Company

  • Limited Liability
  • Asset protection
  • Taxation
  •  “Outgrowing” of structure

Trust

Company

• Flexibility of ownership
• Taxation
• Preference for being corporat-

ised

Partnership

Trust or Company

  • Limited Liability
  • Asset protection
  • Taxation
  • Change in partner circumstances

Regardless of what the outgoing and income structures are, the concepts and principles which will be discussed throughout this edition have broad applications.

IS THE NEW STRUCTURE PRE-EXISTING OR NEWLY ESTABLISHED?

In most cases, if a decision has been made to change a trading structure, a new entity will be established for that purpose. This approach is usually favoured because it provides the business with the opportunity to continue trading through a “clean skin” entity that has no pre-existing trading history or liabilities.

However, it is not necessarily the case that a new entity will be established. In some cases, the entity taking over the running of the business will be a pre-existing entity. There could be a number of reasons why this is the case:

  1. An entity may have been established in the past for a specific purpose, but that purpose did not materialize, meaning the entity has been “sitting on the shelf” since its inception;
  2. An entity may have been established in the past for a specific purpose and it carried out that purpose (e.g., running a business or holding investments) but has since become dormant;
  3. An entity may be active (e.g., running a business or holding investments) and a decision has been made that another business should be folded into this active entity.

If a client does have pre-existing entities already trading or “lying around”, then the existence of these entities will, or should, be taken into account in the advice being given to the client on the change of trading structure.

A number of factors, some of which are competing, would need to be weighed up in these circumstances in determining whether to utilize an existing structure or create a new one, such as:

BKB Edition 104

  • the availability of tax losses in the pre-existing entity;
  • tax implications of the transfer of the business, including the availability of capital gains tax concessions and rollovers;
  • commercial and lending considerations stemming from the utilization of an entity with a previous history (sometimes referred to as a “track record”) rather than a virgin entity;
  • asset protection considerations, including separation of risks;
  • the potential for liabilities (disclosed and undisclosed) to stem from the previous trading history of the pre-existing entity;
  • the administrative and practical advantages (if any) of utilizing a pre-existing structure that already has an established infrastructure, relationships with government agencies, systems, and processes, etc.

While our analysis throughout this edition will focus on the far more common scenario of a new entity being established to take over the operation of a business.

While acknowledging that in some cases, a pre-existing structure will be used, for the most part, our analysis throughout this edition will focus on the far more common scenario of a new entity being established to take over the operation of a business.

BROADER IMPLICATION OF A CHANGE IN STRUCTURE

A change of structure carries with it a raft of legal, tax, accounting and administrative implications:

New Legal Entity

A change in structure means that there is a new legal entity that will be operating the business and interacting with the outside world.

New Tax File Number (TFN)

The new legal entity will need to obtain its own tax le number (TFN), something that will typically be done shortly after its establishment.

New Australian Business Number (ABN)

The new legal entity will also need to obtain its own Australian Business Number (ABN). Commonly, the ABN application will be done at the same time as the TFN application.

New Bank Accounts

The new legal entity will need to establish its own bank account.

New Merchant Facilities

In most cases, merchant facilities through banks and other major financial institutions will be established in the name of a particular legal entity and therefore, linked to that entity’s bank account. Accordingly, when a new legal entity is established to operate the business, a new merchant facility will also likely need to be established.

For payment platforms and e-commerce facilities, the same may or not be the case. You will need to contact the individual provider to ascertain whether a fresh facility will need to be established for the new legal entity or whether in fact the existing facility can merely be transferred to the new legal entity.

New Credit Cards

The credit cards of owners and key employees will often be used in the running of a business and, in many cases, these credit cards will feed directly into the business’ accounting software.

If the credit cards are personal credit cards – in other words, the “borrower” is the individual, albeit that the cards may be paid by the business – then they may be largely unaffected by a change of structure. That said, if a direct debit is in place whereby the credit card’s closing balance is paid each month from the business bank account, then this arrangement will need to be updated so they are paid from the new legal entity.

On the other hand, if the credit cards are business credit cards – in other words, the “borrower” is the business entity – then with the establishment of the new legal entity to run the business, new business credit cards will need to be established and the old cards eventually canceled.

New accounting software file

The new legal entity will require a fresh accounting software file. One of the most common mistakes we observe in the bookkeeping sense surrounding a change of a structure is when the accounting software file for the old entity is merely “renamed” to that of the new entity and the bookkeeping carries on as usual.

The reality is that the old and new entities are separate legal entities. As such, the accounting software file for the old entity must remain separate from that of the new entity. Separation of these files is crucial to ensuring that the respective entities are correctly reporting for BAS and payroll/ STP purposes. Moreover, the separation of the old and new entities is vitally important to the tax agent when preparing end-of-year income tax returns.

New relationship with the ATO

The new entity will need to establish a new relationship with the ATO. The application for a TFN and ABN will be the starting point of that process. Once these identifiers have been obtained, a new Online Services for Business facility can be established to streamline the business’ dealings with the ATO.

Staff, payroll, super

The establishment of a new entity for the purposes of operating the business will usually give rise to the need for staff to be terminated in the old legal entity and re-employed in the new legal entity.

Customers

Customers will be dealing with a new legal entity. There can be many documents and agreements in place between a business and a customer which will require attention as they will typically need to be re-issued in the name of the new legal entity. Some of these include:

  • engagement letters
  • contracts
  • rental agreements
  • scopes of works
  • tenders
  • supply agreements
  • credit agreements
  • director and personal guarantees
  • direct debit agreements
  • warranties; and disclaimers.

    Typically, legal advice will be required in relation to these items.

    Aside from the above, there are some practical tasks involving customers that bookkeepers will tend to take the lead on.

    Firstly, a new tax invoice template will need to be created in the accounting software file of the new legal entity bearing, among other things, the new legal entity’s name, ABN and bank account details.

    Secondly, it is advisable to write to recurring customers (especially those who pay on account) to let them know of the change in structure. Apart from reassuring them that it is business as usual, this communication also provides an opportunity to advise customers that from a certain date, they should make payments into the new bank account.

    Suppliers

    The raft of documents and agreements that are potentially affected on the customer side of things is also relevant on the supplier side of things. It will be necessary to take stock of any of the following which is in place with suppliers and then contacts the relevant supplier to discuss the impact of the change of structure on these documents:

    • engagement letters
    • contracts
    • rental agreements
    • finance arrangements
    • scopes of works
    • tenders
    • supply agreements
    • credit agreements
    • director and personal guarantees
    • direct debit agreements
    • warranties
    • lease agreementsAgain, legal advice will be required in relation to these items.

      Of particular relevance is the final point above regarding lease agreements. If the old legal entity is a lessee under a lease, then steps may need to be taken with the lessor to have that lease re-assigned to the new legal entity. This may carry with it implications for any lease guarantees or rental bonds which are in existence.

      For recurring suppliers where none of the above documents and agreements are in place, it may still be worthwhile writing to them to let them know of the change in structure. Among other things, this communication provides an opportunity to pass on the full legal name of the new entity and its ABN so as to ensure that future Tax Invoices received from that supplier bear the correct details.

    To read the full article, please click the following link: https://drive.google.com/file/d/1FhYzNR8GS-bNeuTlRKqRQvcg8hA7hj-S/view?usp=sharing

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