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Protecting your wealth

Tax Telegraph, June 2013

Protecting your wealthBusiness owners face unique asset protection and estate planning issues. A well-defined estate plan should encompass all of the owners’ objectives, including appropriate tax planning. The owners should also engage in personal financial planning to ensure they satisfy and protect their own future and present needs separate to their business.

Business Dependency

Very often for the business owner their business itself, or assets associated with it, represent a large majority of their assets. Because of this, the owner is entirely dependent upon the success of their business. Should the business suffer financial troubles, this will carry over into the owner’s own personal financial affairs.

To mitigate this potential problem, the owner can enter into a long-range program to withdraw cash from their business. This would be done primarily for purposes of diversifying their portfolio. By doing so, they would be able to:

  • Protect themselves against the business failing
  • Free up money to buy tax advantaged investments
  • Maximise investment returns according to market trends.

Withdrawing Cash

It should be noted that asset protection advantages can be gained by extracting funds from a business vehicle (eg, as dividends) even if cashflow requirements dictate that the funds be loaned back to the business. Such a loan-back of funds can be on a secured basis giving the proprietor a priority over unsecured creditors in the event of business failure.

Some of the techniques that could be used to withdraw more cash from business interests are:

  • Distributing all profits out each year
  • Increasing proprietor remuneration
  • Increasing superannuation benefits
  • Reducing paid up capital
  • Sale of shares to children or employees working in the business.

More Strategies

Another area requiring innovative ideas as they relate to personal financial planning is in the area of income tax planning. Many of the techniques available to more liquid individuals may not be available to, or appropriate for, business owners. A few of the planning techniques which are most relevant to these individuals are:

  • Using a business vehicle which could provide better tax rates and/or maximise income splitting flexibility (eg a company or a discretionary trust)
  • Holding income producing assets in a discretionary trust separate from the business vehicle
  • Leveraged purchase of business assets (eg real estate, machinery) leased to the business entity
  • Deferred compensation arrangements (eg superannuation)
  • Insurance arrangements (eg “keyman”).

Disposing of Business Assets

Personal financial planning concentrates on a maintenance and enhancement of the individual owner’s wealth and assets. Estate planning concentrates on its disposition.

There are a variety of methods for transferring business assets. These include:

  • Wills and trusts created under a will
  • Other trusts, such as trusts for children, voting trusts, and property trusts
  • Put and call options, shareholders agreements, interest redemptions
  • Life insurance (ownership and beneficiary designation).

Although Australia does not levy estate or gift duties, capital gains tax liabilities may be crystallised upon a transfer of assets. Techniques to address capital gains tax exposure in the context of estate planning include:

  • Ensuring that assets intended to go to differing beneficiaries are not owned by a single vehicle and that they can be partitioned without a sale or transfer occurring (eg two properties in one company)
  • Transferring assets by gift or sale (with deferred payment if necessary) to family members at a time when no taxable capital gain has as yet accrued on those assets.

Estate Planning Keys

Regardless of which techniques and tools are used in estate planning, three factors should always be taken into account:

  • Continuity. The future management of a family business is crucial; planning must provide for its continuity. The eventualities that require planning are retirement, disability and death. The most critical step in preserving the assets of the principals is to avoid the forced sale of the company. Without planning, the decision to sell the business interest may not be voluntary or enforceable by the terms of a buy-sell agreement

  • Liquidity. The departure, through whatever means, of a principal in a small, family-owned business can create sudden demands for cash to pay income and capital gains taxes, family support, or provide retirement income. Effective planning requires estimates of the family’s future needs, the means to provide for them, and the necessary liquidity to pay personal taxes.

Family needs and associate relationships. Evaluating the financial needs of the family is the most important part of estate planning for a family business. The financial health of each family member must be kept in mind. Birth, death, divorce and other contingencies must also be considered.

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