If you think this photo is confusing, then wait until you read about Trusts ...

In the last few tutorials in this series, we’ve taken a look at two of the four main business structures in Australia – the Sole Trader business structure, and the Partnership business structure. Now it’s time to look at another business structure – the Trust. The main benefit of operating a Trust is that it gives you flexibility in how income is distributed. 

Now, If you need a quick recap on what “business structure” actually means (and why it’s legally imperative!), make sure you take a look at one of my previous tutorials. Then, once you’re ready, it’s time to look at Trusts.

I would also like to make a few more important points before we continue:

Firstly, this tutorial is not about every type of Trust. Trusts are a complicated legal area, and I am not suggesting that everything you need to know about the law of Trusts will be found in this post.

Instead, I will be primarily focusing on using Trusts as part of RUNNING A BUSINESS. So if you’re looking at Trusts for other purposes (eg. family and domestic purposes only, and NOT business), then I encourage you to look elsewhere. Having said that, you still might get some general information here that might apply too.

Secondly, this tutorial does not intend to provide a comprehensive outline of the tax benefits of operating your business as a Trust. Tax planning is an area that you REALLY should get expert advice on. Everyone’s circumstances are different. The aim of this tutorial is to simply give you a general idea.

Lastly, I always mention the importance of consulting a lawyer, accountant, or other business consultant when dealing with any sort of business legal issues (hence the disclaimer I have at the start of every one of these types of tutorials). But I must say this – out of all the possible business structures, a Trust is probably the structure you would be REALLY unwise to try setting up without the assistance of a lawyer or other paid advisor.

Why do I say that?

Well, because if you don’t set up a Trust properly, chances are you will accidentally destroy the advantages that Trusts have over other business structures (and you may very well have the Government knocking on your door too …). This will all make more sense by the end of this tutorial, but I REALLY want to reiterate it here. Setting up a Trust without the services of a lawyer is probably going to end up in tears … but at least this tutorial should save you some time and money by giving you an understanding of the way Trusts work, before you go and consult a professional advisor.

What is a Trust?

Great question, Jimmy!

But seriously, Trusts are a VERY complex area. Even the basics of it can be difficult to understand. So we’ll break it down now, and try to simplify it as much as possible.

The first thing you need to remember is that a Trust is NOT a separate legal entity (unlike, say, a Pty Ltd Company – which we will discuss in the next tutorial in this series). And a Trust isn’t YOU either (eg. unlike a Sole Trader or Partnership structure).

Basically, a trust is a LEGAL RELATIONSHIP between one person and another person (or persons). The first person is called “the Trustee”, while the second person is called “the Beneficiary” (or “Beneficiaries” if there are more than one). The Trust is set up by a person called “the Settlor”.

Don’t you just love legal terms!

So, the TRUSTEE holds and deals with property (eg. this could be assets, income, etc) in a certain way for the benefit of the BENEFICIARIES. Think of the Trustee as a “middleman” in this equation.

Some Trust definitions

Before we continue, let’s briefly define some of these fancy legal terms further:

The Settlor: The person who established the Trust (usually a lawyer, but could also be a close friend). The Settlor should avoid being the Trustee or Beneficiary, otherwise some serious legal questions will be raised!

The Trustee: The person to whom property is conveyed in Trust for another. The Trustee can be a “natural person” (eg. you or me), or a “body corporate” (eg. a Company, such as a Pty Ltd Company). The Trustee holds property as the legal owner of it, but the Trustee holds the property for the ultimate benefit of the Beneficiaries.

It is actually fairly common for the Trustee to be a Company (corporate Trustee) for asset protection purposes (more on that later). The additional benefit of having a corporate Trustee is that it allows more than one individual (eg. the directors of a Company) to make decisions about how income/capital is to be divided among the Beneficiaries.

The Beneficiaries: Persons who do not hold the legal title of the property held in trust, but for whose benefit the legal title is held by the Trustee. Note that the Trustee CAN also be a Beneficiary, but CANNOT be the only one (otherwise, again, you will face some serious legal questions!).

A Beneficiary can also be a body corporate (eg. a Company) to provide further taxation benefits.

The Beneficiaries are generally not liable for the debts and liabilities of the Trust.

Legal obligations of a Trustee

There are many laws that govern the way a Trustee MUST behave and perform his/her obligations in a Trust. The law also outlines the “duties” the Trustee owes to the Beneficiaries. These types of duties are called “fiduciary duties”. They are special duties, and they are VERY serious. In many ways, they are also similar to some of the duties you would have as a Company Director or a partner in a Partnership. Basically, what this all means is that you can’t just do what you want!

So as a Trustee, you actually have the following legal obligations and duties (among others):

• to act in good faith
• to avoid conflicts of interest
• to make full disclosure to Beneficiaries
• to not make a secret profit or gain
• to keep proper accounts
• to act in the best interests of the Beneficiaries

The last duty mentioned above really sums up the entire relationship. As a Trustee, your obligation is to place the interests of the Beneficiaries FIRST. Your interests (as a Trustee) are only secondary in this relationship. You MUST remember that.

Additionally, a Trust is usually governed by an instrument (not musical, obviously …) called the Trust Deed. This Deed is a written, legal document (usually created by a lawyer) that outlines how the Trustee must perform their obligations in the specific Trust arrangement that has been set up. So apart from having to act in accordance with various Trust laws and fiduciary duties, as a Trustee you must always operate within the confines of the Trust Deed.

Trust deeds

So to set up a Trust, you WILL need a Trust Deed. This legal document will outline the purpose of the Trust, the property involved (eg. assets, income, etc), the rights and obligations of the Trustee and Beneficiaries, the rules within which the Trust must operate, and the way assets and income will be distributed to the Beneficiaries.

Generally speaking, it is probably unwise to consider setting up a Trust Deed without the services of a lawyer. However, there are websites that allow you to create your own Trust Deed through a guided template. Naturally, it is your decision if you choose that sort of option. I haven’t provided any links to such websites here, because I do not wish to be seen to endorse any particular website.

Trusts in business

Okay, so now you know what a Trust is, and you have some basic information about what’s involved. But I’m guessing you’re probably thinking, “what the hell does this have to do with running a business?!”.

Well, first of all – calm down, Jimmy. :P

On the face of it, it might look like setting up a Trust is completely irrelevant to running a business. But that’s not necessarily true.

Sure, Trusts are often created for other reasons (eg. family Trusts), but Trusts can also be used to carry on a business (or can form part of a more complicated business structure that incorporates a Company structure).

Let’s look back at the equation I mentioned a little earlier:

The Trustee holds and deals with property in a certain way for the benefit of the Beneficiaries.

Let’s replace the word “property” with “assets” or “income” (as an example).

So now we have something like this:

The Trustee holds and deals with assets and distributes income in a certain way for the benefit of the Beneficiaries.

So, realising that, and looking back at some of the definitions earlier (which indicate that the Trustee CAN be ONE of the Beneficiaries), we can see that it’s possible to set up certain beneficial arrangements. For example, you could run a business as the Trustee, and have several family members or business partners (including yourself) as the Beneficiaries of the profits.

Why would you do that, you wonder? What is the point?

We’ll look at advantages shortly (as well as disadvantages …), but primarily it’s important to realise the main benefit of operating a Trust. A Trust gives you flexibility in how income is distributed.

That’s really it.

This means that a Trust gives you the kind of tax planning flexibility that other business structures don’t. A Trust can also provide a form of asset protection (especially if the Trustee is a body corporate instead of a natural person), in that assets and income are technically held for the benefit of the Beneficiaries – which means that they can’t be touched by creditors, etc. HOWEVER, there are some exceptions to that statement. It’s NEVER that black and white!

So a Trustee in this sort of Trust arrangement owns the assets of the business, and carries on the day-to-day business activities on behalf of the Beneficiaries.

Naturally, you can see how there is scope here for misuse, and you can start to see why Trusts aren’t always given a good name. It’s true that many people have abused Trusts and have faced the rather serious legal and financial consequences.

I am by no means suggesting that you even attempt to do something that stupid! But’s it’s important to realise that many types of Trust arrangements can very easily border on illegality (or, at the very least, they might simply be unethical …). This is why it’s SO crucial to consult a lawyer before you contemplate setting up a Trust.

Advantages of a Trust

Generally speaking (and without looking at any SPECIFIC types of Trust), the advantages tend to be:

• flexibility of asset and income distribution
• asset protection
• easier to transfer assets
• can safeguard certain social security payments for Beneficiaries (did someone say “Trustfund babies”…?)
• reduced liability (especially if the Trustee is a body corporate)
• Trustee retains control of management and assets
• privacy
• great benefits for family (if they are involved in the Trust – eg. family businesses)
• ability to pass wealth from one generation to another
• taxation (facilitates income-splitting, and other tax minimisation strategies)

Disadvantages of a Trust

Not surprisingly, there are also many disadvantages in using a Trust for your business structure:

• expensive to set up and run (should REALLY use a lawyer, etc)
• complicated / complex legal structure
• difficult to make changes to the structure once set up
• compliance and running costs
• can be difficult to close down
• lots of paperwork
• lots of regulations and laws to adhere to
• can’t hold onto profits to “grow” the business, as these will incur penalty tax rates
• can’t distribute losses, only profits
• limited life of Trust Deed
• inflexibility since powers restricted by Trust Deed and the law

But the advantages and disadvantages mentioned above can be affected by the TYPE of Trust you select.

Types of Trusts

So to complicate matters further, there are several types of Trusts. For the purposes of this tutorial, we will only look at private Trusts (rather than Public Trusts – such as ones created for charitable purposes, or ones that are listed on the stock exchange, etc).

The most common types of Trusts for business purposes include Discretionary Trusts, Fixed Trusts, and Unit Trusts.

Discretionary Trust

This is also called a “Family Trust”. Primarily, people use a Discretionary Trust for the benefit of their families (and this can, of course, involve scenarios such as family businesses).

The primary feature of a Discretionary Trust is that the Trustee determines which Beneficiaries receive income/capital, when, and how. So there is no fixed entitlement for each and every Beneficiary – only the ones selected by the Trustee. In many ways, this type of Trust can be the best option – as it gives the Trustee flexibility in distributing assets and income.

Of course, the major weakness reveals itself when problems begin to emerge in the family unit!

Fixed Trust

As the name suggests, in a Fixed Trust the Trustee must distribute assets and income in specified proportions to Beneficiaries strictly in accordance with the terms set out in the Trust Deed. The disadvantage of this, obviously, is that there is no discretion whatsoever in the way the Trustee distributes assets or income.

Unit Trust

This can be the best type of Trust for non-family businesses. A Unit Trust is usually used for larger trusts. It has some similarities to shareholders holding shares in a company. But here you have Beneficiaries (instead of shareholders) holding “units” (instead of shares) in the Trust (instead of a Company). All units have a pre-determined value (like shares), so that way those Beneficiaries who hold more units are entitled to a greater (and fixed) share of assets and income.

This type of Trust is an excellent solution if you want to have partners in your business (and especially partners who are NOT your family members). It also provides more flexibility for Beneficiaries to enter and exit the Trust. They can transfer their units to others as easily as a shareholder can transfer their shares in a company.

So, how do I set up a Trust then?

Just like some of the other business structures (Sole Trader and Partnership), you will need an ABN, a TFN, and a business name for the Trust. For more information about how to apply for these, make sure you visit the ABN, TFN, and business name sections of either the Sole Trader or Partnership tutorials in this series.

You will also need to set up a Trust Deed (as mentioned previously).

Additionally, depending on the complexity of your Trust, you will probably be advised to register your actual business separately as a Company, and then set up a Trust to protect assets and distribute income in a certain way.

This probably sounds confusing and complicated – and it is. This is why you really should consult professional advisors if you’re serious about using a Trust in your business.

Should I use a Trust for my business?

Obviously, only you can know that. This tutorial is not intended as a full guide to the features of setting up a Trust for business (or any other purpose, for that matter), but hopefully it gives you some idea as to where to go next.

Your decision whether to structure your business using a Trust will most likely depend on the importance you place on the various items listed in the advantages and disadvantages mentioned earlier. Additionally, a Trust will generally be more useful when you are dealing with large amounts of property and money. Why? Because the following factors then become important:

• asset protection (especially if you have substantial assets that you want to protect)
• tax planning (ie. minimising taxation obligations and taking advantage of existing laws)

These are often the two major reasons for choosing a Trust as your business structure.

Regarding asset protection, you could put your business assets in a Trust for added protection, while running the day-to-day operations as a Company. Yes, this involves two structures, but it’s one that potentially maximises the advantages of both. Trusts can also be used as a vehicle for buying and selling other businesses (because it has tax advantages).

Regarding tax planning, the main advantage of a Trust is that it usually pays no tax itself (especially when it distributes all of its profits to the Beneficiaries each year). But there are always exceptions.

Additionally, a Trust allows the Trustee to take advantage of tax-free thresholds and lower personal tax rates for Beneficiaries. So the Trustee can then distribute assets and profits to family members, and/or other business associates in a way that minimises the amount taxed for everyone. In other words, the profts can be distributed to other members using PRE-tax dollars, rather than POST-tax dollars.

However, the above is an oversimplification of the taxation issues involved in a Trust. This is merely a quick summary. Remember, tax can be very complicated, and especially when you start dealing with things like Capital Gains Tax (CGT), etc. Expert advice from a paid professional is absolutely essential!

As you can imagine, the above features of a Trust are what makes them attractive for some people to use for tax evasion (or even money laundering!) schemes. It might seem like a Trust is a great way to siphon funds to yourself, screw creditors, and minimise your taxation obligations. But unless you want to become an accidental television “star” on the news, I’m hoping that you are thinking of creating a Trust for LEGITIMATE reasons!

There are, no doubt, other reasons (besides asset protection and tax planning) why you might (or might not) want to use a Trust for your business. You need to explore those with a professional paid advisor.

But hopefully this tutorial has served as a useful starting point for you – and it might help you understand what the hell your lawyer is talking about! :P

What if I don’t want to use a Trust?

The above are the basics of structuring a business as a Trust in Australia. Naturally, it’s important that you also consider the merits of the other three major business structures (and especially if setting up a Trust does not appeal to you – it’s definitely not for everybody!). It’s important that you consider your options carefully.

Additionally, you will usually find that using the Trust option will probably require you to ALSO use a corporate structure too (eg. for the Trustee and/or one of the Beneficiaries). A corporate structure always has that added level of protection due to its existence as a separate legal entity. After all, a Trust is only a legal relationship. It is NOT a legal entity.

Either way, remember that selecting a business structure is NOT an optional step if you want to ensure your business has been set up PROPERLY and LEGALLY. Some groundwork now will save you a whole lot of potential headaches in future. Besides, having a business structure makes your business look more professional and reputable.

In the next tutorial in this series, we will be looking at another type of business structure – the Company structure (eg. Pty Ltds companies, etc). In the meantime, if you’re also interested in other business structures,  make sure you check out the Sole Trader tutorial and the Partnership tutorial too.

In the last tutorial in this series, we looked at one of the four main business structures in Australia – the Sole Trader structure. Now it’s time to look at another business structure – the Partnership. 

If you need a quick recap on what “business structure” actually means (and why it’s legally imperative!), make sure you take a look at my previous tutorial in this series. Then, once you’re ready, it’s time to look at Partnerships!

Partnership

In my previous tutorial in this series, I mentioned that the main underlying concept of operating as a Sole Trader was the fact that as a Sole Trader YOU (and ONLY you) are the business.

In many ways, a Partnership is similar – but the difference is that TWO or more people TOGETHER are the business. This is both the main strength, AND the main weakness. :P

The way the law likes to define a Partnership is “the relationship which subsists between persons carrying on a business in common with a view to a profit”. So in other words, YOU ALL own the business, YOU ALL are directly in control of everything, and all money the business makes belongs to ALL OF YOU JOINTLY (although all of these things can be modified somewhat through the use of a Partnership Agreement … more on that later).

But remember – just like with the Sole Trader business structure, with a Partnership the business is NOT a separate legal entity either (although from an accounting point of view it should certainly be treated as separate, otherwise it just gets too messy).

Limits of a Partnership

By law, the size of a Partnership is not unlimited. Generally speaking, a Partnership is limited to between 2 and 20 partners. However, there are some interesting (and bizarre!) exceptions.

For example, according to the Corporations Regulations 2001 (Cth), a Partnership can consist of:

• 50 actuaries, medical practitioners, patent attorneys, sharebrokers, stockbrokers or trademark attorneys;
• 100 Architects, pharmaceutical chemists or veterinary surgeons;
• 400 legal practitioners (God help us all …)
• 1,000 accountants (need I say more …)

Now, let’s look at some of the advantages and disadvantages of setting up a business as a Partnership.

Advantages of a Partnership

Starting business as a Partnership can be almost as simple as starting off as a Sole Trader. Both these structures are the simplest ways to structure your business.

Advantages of forming a Partnership include:

• It’s relatively easy to set up (I’ll tell you how shortly)
• There is less paperwork (in comparison to business structures like Trusts and Companies)
• It’s inexpensive
• There is less government interference and regulation (at least in comparison to a Company)
• It offers more privacy (in comparison to the reporting requirements of a Company)
• There is less need for hiring lawyers, accountants, and other consultants (at least in comparison to a Trust or Company)
• There is a broader management base (compared to that of a Sole Trader), which also means a wider pool of expertise, shared risk (which can be both good and bad…) and more sources of capital
• There may be tax planning advantages (such as income splitting)

Obviously, the above are broad generalisations, but they should give you a good idea of why some people choose this business structure.

And just like a Sole Trader, in a Partnership you can still employ people (NOT partners though – partners CANNOT be employees of the business), engage other contractors, apply for financing (although this last part might be more difficult compared to a Company), and do many other things. Again, there is a lot you can do.

And when your business expands, you can always change the business structure more easily than if you had set up the business as a Trust or Company.

So, what’s the catch, I hear you say?

Disadvantages of a Partnership

Interestingly enough, the main strength of the Partnership structure (eg. having more than one person in control of the business) is  probably also the main weakness!

Why? Well,  each and every one of you (as partners) has control of the business. This also means that each one of you is an “agent” for the business. This is where the law of “agency” can become an issue.

Since all of you have authority as joint owners, each one of you can contract with a third party (without the knowledge of any of the other partners), and you will ALL then be bound to that contract, regardless whether the partner in question actually had the permission of the other partners.

Naturally, this means that each and every one of you face the very real prospect of becoming personally liable for a bad business decision made by any one of the other partners (even if you didn’t know about it!). In fact, one of the “features” of a Partnership is that all partners are “jointly and severally liable” for all debts and liabilities incurred by the business. A Partnership can, of course, make it easier to pay off such debts, since all partners take a share of this risk.

But what if we take the example mentioned earlier even further … what if one of the partners decides to pack it in, clean out the assets of the business, and then flee to Majorca? Well, that’s too bad for you and the other partners. The Partnership will still have all its liabilities to pay off, and the remaining partners will be liable to pay off your scumbag partner’s share of the debts too (unless you are able to track down and sue the absconding partner for his/her share of the debts).

And if we take this example EVEN further (please let me indulge myself here…), if your remaining partners decide to follow the excellent example set by the partner now living up the high life in Majorca, you will then be left holding the ball. Since as a partner you are jointly and severally liable, this now means that you will become personally liable for ALL the debts and liabilities of the entire Partnership (unless you can track down the other partners and sue them for their share of the problems)!

Anyone who wants to sue the Partnership won’t care where the other partners are, and they are under no obligation to follow that up. They can sue whoever they want – and they will probably sue the person who is easiest to get to. In other words, all partners are “jointly and severally liable” for any debts or liabilities the Partnership incurs. And, just like the Sole Trader business structure, as a partner in a Partnership you have unlimited personal liability if anything goes wrong with the business.

In fairness, the above situation can be controlled (to a limited extent) with appropriate insurance cover. Additionally, you CAN actually avoid personal liability altogether in a Partnership by becoming a limited partner. But more on that shortly.

Other disadvantages of forming a Partnership include:

• Lack of continuity
• Divided authority (can be a good thing or a bad thing)
• Friction between partners, personality clashes, etc
• Limitations on size (generally speaking the maximum number of partners in a Partnership is 20, but with some exceptions …)
• Less flexibility in transferring ownership interest
• Bankruptcy or death ends a partnership. Partnership must then be re-formed (which incurs costs, paperwork, and lots of time …)
• If a partner absconds or dies, other partners are left with that partner’s debts and liabilities (as discussed above)
• Transfer of ownership is difficult
• Adding partners is difficult – generally requires the agreement of all partners
• If a partner decides to dissolve a business, it may bring the Partnership to an end
• If a partner wants to join or leave, all the partnership assets, etc may need to be valued (which is costly and time-consuming!)

Looking at the list above probably makes a Partnership seem like a very unappealing proposition. But it doesn’t have to be, and ESPECIALLY if you consider what is at the crux of most of the above negative points – a combination of lack of organisation, lack of communication, and – consequently – lack of trust.

A Partnership Agreement can be used to counter many of the above disadvantages, or at least make provision for what should happen if certain scenarios ever arise. More on Partnership Agreements shortly.

Limited Partnership

For the most part, this entire tutorial deals with Partnerships consisting of what the law calls “general partners”.

There is, however, provision to set up an alternative form of Partnership called a “Limited Partnership”. Unlike a general Partnership (which I have simply referred to as “Partnership” throughout this tutorial), a limited Partnership actually needs to be separately registered with your State’s Fair Trading Office/Consumer Affairs department (almost every State/territory calls it something else … the joys of Federalism …).

A limited Partnership must consist of at least one general partner, and one limited partner. A Partnership (of any kind) can only have a certain maximum number of general partners in the business (which I will discuss shortly), but there are NO limits to the number of limited partners that can be involved in a limited Partnership.

However, limited Partnerships are only an option in certain States/Terroritories in Australia (again, the joys of Federalism…). These are as follows:

• the Australian Capital Territory
• New South Wales
• the Northern Territory
• Queensland
• South Australia
• Victoria

If you’re planning on starting a business in any of the other States, then you’re out of luck – you will simply need to settle on a general Partnership (which is what the rest of this post deals with anyway).

To recap the differences between a general partner and a limited partner: a general partner is simply the type of partner I have referred to throughout this tutorial. Basically, a general partner is a full partner in the Partnership, and hence has managerial control and authority to act on behalf of the business. A general partner also has the personal liability issues mentioned earlier.

A limited partner, however, does not have such powers, or liabilities. A limited partner cannot take part in the management of the business, and generally has no authority to act on its behalf (although some of these things can be modified to an extent with a Partnership Agreement). But, more importantly, a limited partner has LIMITED liability (which counters a lot of the disadvantages mentioned earlier).

So, why would anyone consider a limited Partnership then?

For the most part, limited Partnerships are useful in situations where potential partners simply want to contribute capital and share in the success of the business (but without having control or authority in the business). In many ways, a limited partner is more like a passive investor in the business. They take a risk in providing the business with capital (eg. to help launch or grow the business), but if things go wrong they do not have the liability associated with general partners. If they did, this would not encourage investment!

The above is a really simplified explanation of limited Partnerships, but it hopefully gives you a general (or should that be “limited” – woohoo, lame pun!) idea of what limited Partnerships are.

There is also a more complex version of this kind of Partnership called an “Incorporated Limited Partnership” (where the Partnership actually becomes a separate legal entity like a Company), but I will not discuss that here. Anyone considering such an advanced structure will generally be doing so because they are considering a joint venture with another business (or businesses). And if that’s the case, you really should be arranging appointments with lawyers, accountants, and other business advisors right now!

Partnership Agreements

It is nice to think that your word alone is good enough to form the trust required to run a Partnership. But let’s face it – a written document that CLEARLY outlines all important aspects in this sort of relationship will ALWAYS be a better option. It’s like marriage – you’d be crazy to go into it without a pre-nup! It’s a simple risk management strategy. Remember – statistically, there is a STRONG possibility that something will eventually go wrong. And when that happens, you’ll be kicking yourself if you didn’t have that initial agreement set down on paper!

So think of a Partnership Agreement as a form of a protection … a form of insurance for ALL of you in the Partnership.

Yes, drafting a good Partnership Agreement DOES take time. It will also most likely require the services of a lawyer (did I just hear you groan …?) or other business consultant. So it will probably also cost a bit to get right. You DON’T have to use the services of a lawyer, etc to draft a Partnership Agreement – but since it will probably be used in some sort of legal context eventually, it’s probably a good idea to use a lawyer from the very start.

Remember, though, that a Partnership Agreement isn’t actually compulsory (unless you’re forming an Incorporated Limited Partnership – which I am not covering in this tutorial). Should you wish to proceed without a Partnership Agreement, then you can.

HOWEVER, realise that in the absence of a written Partnership Agreement, the law will consider you all to be EQUAL partners in the business (both from a management perspective, and also from a profit/loss and liability perspective). This might become especially problematic if profits are to be distributed in a certain way that isn’t intended to be equal.

So, what sorts of things can be included in a Partnership Agreement?

Elements of a Partnership Agreement

A typical Partnership Agreement may include some of the following key items:

• Names and addresses of all partners
• Nature and purpose of the Partnership business
• Name of the Partnership business
• Business address
• Start date and duration of the Partnership
• Capital to be contributed to the Partnership by each partner
• How profits and losses will be shared among the partners
• Arrangements for Partnership salaries/drawings/income
• Managerial roles of each partner
• Any limitations on the authority of each partner in making decisions or signing financial and legal documents
• How decisions will be made by the Partnership
• Agreement to engage certain consultants, such as a lawyer, accountant, or other business advisor in certain matters
• Accounting details for the Partnership
• Details of bank accounts for the Partnership
• Provisions for the death, bankruptcy, or retirement of a partner
• Provisions under which partners can change or assign their interest in the Partnership
• Provisions for dispute resolution between partners
• Provisions for the addition of new partners
• Provisions for the dissolution of the Partnership (including the method of valuation and distribution of assets, etc)

The above is a summary of some of the key elements a Partnership Agreement should contain. Again, it is adviseable to seek the services of a professional to assist with drafting such an important document. The last thing you want to find out when the proverbial hits the fan is that your Partnership Agreement has missed a key item, or is even completely invalid from a legal point of view!

Should I Set Up My Business As a Partnership?

Obviously, only you and your potential partners can know that. I cannot advise you on what YOU should do. This tutorial is not intended as a full guide to the features of operating a Partnership, but hopefully it gives you some idea about what to look out for.

Additionally, WHO you partner with will be crucial.  Should you simply partner with some friends or your family? Probably not. You need to approach this with your sharpest business mind, and base your decision on more than just “friendship”. There are many examples of friends falling out soon after setting up a Partnership. Some of this might simply be attributed to a lack of thought and discussion between the partners beforehand. They may have just assumed that since they are friends and get along, that this will automatically transfer to the serious business relationship that is a Partnership. But it generally won’t.

So basically you need to TRUST your partners, and you need to be on the “same page” regarding your goals for the business. Sounds simple, but it is often overlooked in the rush of enthusiasm at the beginning. Remember – running a business properly is a hard “slog”.

If, however, you CAN find partners to work with that you can trust, and that you have had serious discussions with about forming a Partnership, then you also need to make sure that the advantages of setting up as a Partnership outweigh both the disadvantages, and also the advantages of running other business structures (eg. such as a Company).

There are, no doubt, other issues you will probably need to ponder too (depending on your individual circumstances and also the industry you want to operate in). But hopefully the above gives you a useful starting point.

So, How Do I Set Up a Partnership Then?

First of all, you need to decide if you want to run the Partnership business under just the names of all the partners (eg. “Adam Wozniak, John Smith, John Citizen, and Joe Sixpack”), or whether you want an actual business name (eg. “Super Duper Abracadabra Solutions” …).

If you want to run your business under the personal names of all the partners (with NO other additions), all you need to register for is an Australian Business Number (ABN) for the actual Partnership (eg. one ABN for ALL the partners together, rather than individual ABNs like you would have as a Sole Trader).

Obtaining an Australian Business Number (ABN) for the Partnership

Regardless of whether you decide to run the Partnership business using the personal names of all the partners, or whether you register a business name, you will still need to obtain an Australian Business Number (ABN) for the Partnership.

To obtain an ABN, you will need to apply for it through the ATO. Thankfully, these days you can obtain an ABN in about 30 minutes without even leaving your computer. Click here to apply for an ABN. But just make sure you and your partners have agreed on how you will fill out these types of applications.

Obtaining a Partnership Tax File Number (TFN)

The Partnership will also need its OWN Tax File Number (TFN) – unlike a Sole Trader, who uses his/her own personal TFN.

For the Partnership, this means that all partners will still have their own personal TFN for their own personal individual income tax return, but the Partnership as a whole will have its own TFN on top of that. Yes, this means that in addition to lodging your own personal tax return, the Partnership itself will have to lodge its own, separate tax return too. Woohoo!

But note that a Partnership in itself is not liable to pay income tax or PAYG instalments. Instead, the individual income (and share of profits/losses) you, as a partner, make from the Partnership will need to be included in your own personal income tax return. THAT is how tax is paid on income generated by the Partnership.

So to reiterate – the Partnership itself does NOT get taxed, and that’s because it is NOT a separate legal entity (unlike a Company business structure).

That means that come tax time any income you make through your Partnership is counted together with your own personal individual income (so that means it is lumped in with income you make from other sources too – such as a job you might have on the side). By default, the law will assume that all Partnership income/profits/losses will be split equally among all partners, but it doesn’t necessarily have to be so. This is one of many areas where a proper Partnership Agreement can be useful, as mentioned earlier.

To obtain a TFN for your Partnership, you can do it online while you are applying for the ABN. Simply click here to visit the ABR website to get started. Again, make sure you and your partners have agreed on how you will fill out these types of applications.

Registering a Business Name

If you want to operate under an actual business name (rather than the personal names of all the partners), then you MUST register the business name in your particular State. If you intend on operating your business in multiple States, then you will need to register your business name in every State where your business will be operating.

Registering a business name in one State generally costs about $150 for 3 years. Naturally, if you intend on registering in more than one State, these costs will begin to add up quickly.

To find out more about the costs and paperwork required, please visit the relevant State office and look for “Business Names”:

• Australian Capital Territory – Office of Regulatory Services
• New South Wales – Office of Fair Trading
• Northern Territory – Department of Justice
• Queensland – Department of Employment, Economic Development and Innovation
• South Australia – Office of Consumer and Business Affairs
• Tasmania – Consumer Affairs and Fair Trading
• Victoria – Consumer Affairs Victoria
• Western Australia – Department of Commerce

Some notes to remember about registering a business name though:

• You can’t register a business name that is already registered in your State
• You can’t register a business name that is already taken as the name of a registered Company
• You can’t register a business name that is already registered as a Trademark (eg. “Coca-Cola”, “Google”, etc)
• Even if the business name partly contains the personal names of some of the partners, you STILL NEED TO REGISTER A BUSINESS NAME. Eg. although you wouldn’t have to register “Adam Wozniak, John Smith, John Citizen, and Joe Sixpack”, if you decided to call the business something like “Wozniak and Partners”, then you MUST register a business name. This is the part that MANY people get wrong!
• Registering a business name is more about consumer protection than it is about protection for your business. In other words, registering a business name does not necessarily give you any legal rights to your business name. It gives you less rights than registering your business as a Company, and it gives you even less rights than registering your business name as a Trademark. Basically, a business name has NO legal status in itself.

Despite all of this, registering a business name can be very quick and affordable. And there is a LOT less paperwork required compared to other business structures (such as a Company).

Once you have obtained an ABN, TFN, and registered your business name (if applicable) for your Partnership, you need to ensure that the Partnership ABN is actually linked to the business name. By default, it probably WON’T be. To link the Partnership ABN to the business name, telephone the ATO on 13 28 66.

What if I Don’t Want to Operate as a Partnership?

So those are the basics of structuring a business as a Partnership in Australia. Naturally, it’s important that you also consider the merits of the other three major business structures (and especially if registering as a Partnership does not appeal to you – it’s definitely not for everybody!). It’s important that you consider your options carefully.

Remember, selecting a business structure is NOT an optional step if you want to ensure your business has been set up PROPERLY and LEGALLY. Some groundwork now will save you a whole lot of potential headaches in future. Besides, having a business structure makes your business look more professional and reputable.

In the next tutorial in this series, we will be looking at another type of business structure – Trusts (a structure which holds property in trust for its beneficiaries). If you’re interested in reading about the Sole Trader business structure instead, then make sure you check out the previous Sole Trader tutorial.

In my last tutorial in this series, we looked at one of the first steps in starting a business – ensuring that you have the right licences. Now it’s time for the next major step – choosing a “business structure”.

A “business structure” refers to the way your business is structured legally. And – just like licencing – it’s ABSOLUTELY crucial that you choose a business structure and actually register it.

It’s amazing how many people either don’t get this right, or skip this step completely. Don’t be one of them. Getting this wrong could destroy your business, and it could destroy YOU.

Business structures are rarely explained well. Even some business books get this stuff wrong at times! Hopefully by the time you finish reading this series of articles you will have a much clearer idea about business structures, and which structure best suits your particular business. Remember, not all businesses will have the same business structure.

Types of Business Structures

Broadly speaking, there are four major types of business structures:

• Sole Trader
• Partnership
• Trust
• Company

Arguably, the Sole Trader business structure is the most popular one – but it might not necessarily be right for you. Additionally, you may need to change business structures eventually, depending on the needs of your business.

But what do all of the four structures actually mean? In this article, we will look at the Sole Trader business structure.

Sole Trader

The first thing to realise about structuring your business as a Sole Trader is that YOU (and ONLY you) are the business.

In other words, YOU own the business, YOU are directly in control of everything, and all money you make with your business is YOURS. The business is NOT a separate legal entity to you.

That means that come tax time all income you make through your business is counted together with your own personal individual income (so that means it is lumped in with income you make from other sources too – such as a job you might have on the side).

Sounds good so far, doesn’t it? But what does this all really mean?

Advantages of a Sole Trader

Starting off as a Sole Trader is the simplest way to begin a business.

• It’s easy to set up (I’ll tell you how shortly)
• There is less paperwork (in comparison to the other structures)
• It’s MUCH less expensive
• There is less government interference and regulation (at least in comparison to a Company)
• It offers more privacy (in comparison to the reporting requirements of a Company)
• There is less need for hiring lawyers, accountants, and other consultants (at least in comparison to a Trust or Company)

Obviously, these are broad generalisations, but they tend to be true much of the time.

As a Sole Trader, you can still employ people, engage other contractors, apply for financing (although this last part might be more difficult compared to a Company), and do many other things. There is a lot you can do.

And when your business expands, you can always change the business structure much more easily compared to other structures.

So, what’s the catch, I hear you say?

Disadvantages of a Sole Trader

Well, the major problem is that the business is YOU (no offence intended …). If you die or become permanently incapacitated, your business ceases to exist. Why? Because your business is YOU. It does not exist outside of YOU. So if you aim to pass on your business to other people in future (eg. family), this could be an issue. This area of the law is called “succession”.

This brings up a further complication, and one of the major weaknesses of this business structure.

Because the business is YOU, YOU are personally liable for any debts, negligent acts, etc that you commit while running your business. You assume ALL the risk and responsibility whether your business succeeds or not.

Every time you sign a contract with someone, is is YOU who is contracting – NOT your business. So if things go wrong, you could lose all your assets, your house, and your future. It’s a risk that you need to bear in mind.

Having said that, with the appropriate insurance cover, you might be able to lower your risks substantially.

Should I set up as a Sole Trader?

Obviously, only you can know that. This entire article is not intended as a full guide to the features of operating as a Sole Trader, but hopefully it gives you some idea as to where to go next.

Your decision whether to structure your business as a Sole Trader might depend on some of the following questions:

• Do you have a lot of money to start the business with? Can you afford the expenses associated with setting up, and operating, the business as a different structure (eg. as a Company)?
• Do you want the business to be a separate legal entity? If yes, then consider structuring it as a Company instead.
• Does it bother you that your business will cease to exist upon your death or permanent incapacitation? If yes, then you may want to consider structuring your business as a Company instead.
• Does the personal risk and liability issue concern you? Are you in a particularly risky industry where you may need greater protection (in addition to insurance cover)?
• How have your competitors structured their own businesses?
• Are the tax benefits greater than structuring your business as a Company? For example, the current tax rate on a Company is 30% (before tax is applied again to employee salaries). So depending on the rate of personal tax you might need to pay as a Sole Trader, sometimes it may actually be more effective to structure your business as a Company instead (which you would then become an employee of). This would be especially useful if you wish to use a lot of the profit to further grow your business, rather than adding it to your personal income (where the tax rate may often be much higher than 30%).

There are, no doubt, other questions that might also apply to you. But hopefully the above questions are a useful starting point.

So, how do I register as a Sole Trader then?

First of all, you need to decide if you want to run your business under your own personal name (eg. “Adam Wozniak”), or whether you want an actual business name (eg. “Wozniak’s Tools” or “Vandelay Industries” …). If you want to run your business under your own personal name (with NO other additions), all you need to register for is an Australian Business Number (ABN).

Obtaining an Australian Business Number (ABN)

Regardless of whether you decide to run your business using your own personal name, or whether you register a business name, you will still need to obtain an Australian Business Number (ABN) and a Tax File Number (TFN). If you have already been employed in the past (or are still currently employed), chances are that you already have a TFN. If you DON’T have one, you will need to obtain one through the Australian Tax Office (ATO). Click here to apply for a TFN.

To obtain an ABN, you will need to apply for it through the ATO too. Thankfully, these days you can obtain an ABN in about 30 minutes without even leaving your computer. Click here to apply for an ABN.

Registering a Business Name

If you want to operate under an actual business name (rather than your own personal name), then you MUST register the business name in your particular State. If you intend on operating your business in multiple States (eg. if you intend on having a physical presence there), then you will need to register your business name in every State where your business will be located.

Registering a business name in one State generally costs about $150 for 3 years. Naturally, if you intend on registering in more than one State, these costs will begin to add up quickly.

To find out more about the costs and paperwork required, please visit the relevant State office and look for “Business Names”:

• Australian Capital Territory – Office of Regulatory Services
• New South Wales – Office of Fair Trading
• Northern Territory – Department of Justice
• Queensland – Department of Employment, Economic Development and Innovation
• South Australia – Office of Consumer and Business Affairs
• Tasmania – Consumer Affairs and Fair Trading
• Victoria – Consumer Affairs Victoria
• Western Australia – Department of Commerce

Some notes to remember about registering your business name though:

• You can’t register a business name that is already registered in your State
• You can’t register a business name that is already taken as the name of a registered Company
• You can’t register a business name that is already registered as a Trademark (eg. “Coca-Cola”, “Google”, etc)
• Even if your business name partly contains your own personal name, you STILL NEED TO REGISTER A BUSINESS NAME. Eg. although I wouldn’t have to register “Adam Wozniak”, if I decided to add even ONE additional word that wasn’t part of my name (such as “Adam Wozniak’s Tools”), then I MUST register a business name. This is the part that MANY people get wrong!
• Registering a business name is more about consumer protection than it is about protection for your business. In other words, registering a business name does not necessarily give you any legal rights to your business name. It gives you less rights than registering your business as a Company, and it gives you even less rights than registering your business name as a Trademark. Basically, a business name has NO legal status in itself.

Despite all of this, registering a business name can be very quick and affordable. And there is a LOT less paperwork required compared to other business structures.

Once you have obtained an ABN, TFN, and registered your business name (if applicable), you need to ensure that your ABN is actually linked to your business name. By default, it WON’T be. To link your ABN to your business name, telephone the ATO on 13 28 66.

What if I don’t want to register as a Sole Trader?

So those are the basics of structuring your business as a Sole Trader in Australia. Naturally, it’s important that you also consider the merits of the other three major business structures (and especially if registering as a Sole Trader does not appeal to you). It’s important that you consider your options carefully.

Remember, selecting a business structure is NOT an optional step if you want to ensure your business has been set up PROPERLY and LEGALLY. Some groundwork now will save you a whole lot of potential headaches in future. Besides, having a business structure makes your business look more professional and reputable.

In the next tutorial in this series, we will be looking at another type of business structure – Partnerships (where you set up business with additional people).