A recent article in the Australian Business Law Review – Not in isolation: The Rationale for a Combination of Business Structures in Australia[1] – analyses the nature of combined business structures of small to medium enterprises (SMEs) in Australia, and the reasons given by advisers to their clients for adopting those combined structures. The focus is on Australian SMEs including micro enterprises with a turnover of under $2 million. The article is based on interviews with 10 small business advisers – 6 accountants, one financial adviser, and 3 lawyers.
Based on ATO data, the article reports that trust structures account for 12% of SMEs, partnerships 9%, companies 34% and sole traders 45%. The larger the enterprises – $2-10 million turnover – companies prevail.
Tax minimisation and related objectives were the most frequent reasons for the business structure adopted, followed by asset protection and estate planning, and then limited liability. Transparency to others was important, including as to financial reporting, with trusts lacking in that respect. Other factors were simplicity, cash flow, raising of capital and retention of profits.
Combinations of companies and trusts, including discretionary trusts, feature highly, with tax, flexibility and asset protection being the main reasons. A family trust with a corporate trustee operating the business was one favoured combination, or a discretionary trust owning the company which runs the business, as another.
Comment
As I often remind myself, the insolvency administration of a business is infrequent in terms of the numbers. There are over 2 million small businesses in Australia, from which, in September 2023, there were 978 corporate insolvency appointments, including 74 of the so-called small business restructuring appointments,[2] and fewer bankruptcies. Understandably, the article barely gives the insolvency of a business a mention. However, in the background, the risk of insolvency does drive much of the advice to clients about asset protection, limited liability and the use of companies and trusts, when the merits of the options for exit from the various structures are discussed.
There is often comment in my area that those in business, and directors in particular, know little of the implications of the legal structure which has been set up for them, as to corporate, financial, tax, employee and insolvency law obligations. The article is very useful for insolvency law reform given its broad perspective. A number of issues relevant to small business operations come up in the July 2023 PJC Report on Corporate Insolvency,[3] presently with government for a response, with business structures featuring highly.
Trusts
In particular, there were numerous submissions to the PJC about the difficulties of winding up corporate trading trusts and the PJC has recommended that the government attend to long overdue law reform in that area. The use of corporate trading trusts themselves has long been criticised, famously as a ‘commercial monstrosity’, oddly confined mainly to Australia.[4] The PJC heard that ‘the law does not fully recognise them as commercial entities and does not properly protect people who invest in or do business with them [and that] nowhere is this [absence of regulation] more obvious than when it comes to insolvency’.[5]
Personal guarantees
As to another business combination, the PJC also heard that “the use of personal guarantees by company directors and shareholders for the debts of the company is widespread throughout the economy”,[6] potentially unwinding efforts at asset protection and limited liability. This combination also brings into play Australia’s two separate and often disconnected personal and corporate insolvency laws. Personal guarantees are hardly mentioned in the article, or perhaps the survey question was not asked whether clients were warned by the advisers of the consequences of operating both on a corporate and a personal liability basis, or slipping into that arrangement through commercial pressures.
Tax
Personal liability for company tax liabilities is also a common aspect of corporate business insolvencies flowing from directors’ non-compliance with lodgement obligations through to unlawful retention of tax moneys withheld; again, cutting through efforts at asset protection and limiting liability.
Advice as to compliance etc
The focus of the article on what advice SMEs are given, and why, is useful in that advice to a financially distressed business was a focus of the PJC inquiry, where ‘pre-insolvency adviser’ is a loaded term. It would be interesting to know not only what advice is given to clients up front – as to tax and financial compliance obligations, and in particular in relation to their employee obligations – but also as to what advice is given to a client in financial distress, and what expertise the advisers have, and the integrity of that advice. In issues of complexity involving trust law, and corporate, tax and employment law, accountants would not be able to give legal advice.
How SMEs operate
That perspective might come from what is said to be the next phase of the authors’ research – knowing more about how SMEs operate, including from the perceptions of SME operators themselves. Those perceptions are perhaps the more important, including as to SME operators’ attitude to and capacity for legal, tax and financial compliance, and the sources of their advice. Many an insolvency might have been averted if directors of businesses kept proper financial records and monitored performance of the business, or had their accountant do so, and acted early to seek proper advice when financial stress occurred. In light of evidence concerning the integrity of pre-insolvency advice, the PJC has recommended that regulation or other action be considered.
Data and teaching
The article comments that its data and analyses will assist in law reform, referring to tax neutrality and lower tax rates for trusts. Trusts are due for more attention than that. The PJC Report has raised the prospect of substantial reform of trusts, for example in applying corporate law concepts to the operation and regulation of trusts, and supporting the establishment of a register of trusts to ensure transparency. As to data, the article recommends that government report on combined business structures, rather than structure by structure. Access to business data is another recommendation of the PJC.
As to teaching, rather than students learning about business structure by structure, the article suggests that the reality of how SMEs operate in the ways described in the article should be the teaching focus.
Teaching of insolvency law might also think about this, whether it should break with tradition based on insolvency history and start to accommodate the business perspective of the debtor, including in academic research, even if the traditional teaching of personal and corporate insolvency and their separate laws and regulators be continued. The better co-ordination of personal and corporate insolvency is another recommendation of the PJC, and teaching might acknowledge this. AFSA advises that up to 40% of personal insolvencies arise from small business operations. Research into debtors’ perspectives, and the advice businesses receive in the face of insolvency, would likewise be useful.
The SME sector
Although the SME sector is a very large part of the economy, it is by its nature rather opaque in its composition and operations; and will possibly remain that way for longer in light of the collapse of many of the ABR reforms. As would be expected of an article in the ABLR, the report and analysis on the nature of the advice given to small business is a significant contribution to understanding that sector, and how its operations – profitability, compliance, productivity – can be better understood and improved.
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[1] (2023) 51 ABLR 162, Trad, Freudenberg, Cameron and Minas Australian Business Law Review: Parts & Bound Volumes – Thomson Reuters Australia
[2] Part 5.3B Corporations Act. ASIC Statistics.
[3] Corporate insolvency in Australia – Parliament of Australia (aph.gov.au)
[4] Commercial Trusts, Dr N D’Angelo, Lexis Nexis, 2014, citing HAJ Ford, Trading Trusts and Creditors’ Rights, (1981) 13 MULR 1 at 1.
[5] Citing evidence of Dr D’Angelo.
[6] Evidence of SCOLA
