Business owners – whether small or large – and professionals face constant exposure to lawsuits and insolvency. Professional Indemnity insurance companies often wiggle out of not paying. You bet the house on a successful outcome with every client who comes in the door.
Like professionals with insurance, anyone who owns rental or commercial property is also a common target for a lawsuit. As a “deep pocket” defendant, a property owner is a virtual magnet for frivolous claims.
Some people incorrectly believe “my small business does not make much money, therefore, it has less risk”. That is absolutely false. The amount of profit (or loss for that matter) is not related to the level of risk. A small business can lead to the loss of your home and other assets – just as fast as a big profitable business.
Sound legal foundation:
Asset protection does not involve hiding or concealing assets. It is not about defrauding creditors. A properly constructed asset protection plan achieves your objectives while fully and truthfully disclosing all of your financial circumstances.
Discouraging Litigation: Discourage a potential lawsuit before it begins. Before suing, the plaintiff’s lawyer checks that the defendant has assets to pay if they win. The plaintiff’s lawyer performs a financial investigation of the target defendant’s assets. They seek to locate any real estate, bank accounts or other valuable property. If the defendant has substantial, reachable assets the lawsuit proceeds. If the investigation reveals that your assets are not in a seizable form, only the most self-destructive plaintiff incurs the expense of proceeding with the case.
Seek control – not ownership: Asset protection allows you to maintain control and enjoyment over the property – without the need for ‘ownership’.
Estate Plan & Asset Protection go hand in hand:
- Protective Trust (if children are bankrupt)
- Divorce Protection Trust (to preserve the capital from children divorcing)
- 3-Generation Testamentary Trusts (each child and then your grandchildren have their own trusts to reduce death duties such as Income Tax, Capital Gains Tax and Stamp Duty
- Superannuation Testamentary Trust (to stop the 32% tax payable on your death when your super goes to adult children)
- Special Disability Trusts – are put into every one of our 3-Generation Testamentary Trust Wills
Protect Family Assets: Above all else, the asset protection plan accomplishes its primary purpose of sagely insulating and preserving family assets from attack.
Asset Protection – strategies
Limit Liability in your Structure
The best time to consider Asset Protection is at a business start-up. The type of entity, where it is formed and how it is financed impacts on the security of your personal and business assets. Minimising income, CGT and death taxes are also forms of asset protection (here it is the government, not some creditor, who goes after your wealth). A common Australian business structure is:
A single person or couple:
* build a company (to run the business through, not preferred)
* build a Family Trust where the company is the trustee of the Family Trust
Two or more families, e.g. brother and sister, or two unrelated persons
* build a Family Trust for each Unit Holder. The Units are held in each Family Trust
Having all your assets in one trust – ‘one bad apple’
One asset in a Family Trust that goes bad contaminates all the other assets in that Trust. There are two types of assets. “Unsafe” assets like business operations. And there are ‘safe” assets like shares and real estate. Don’t mix unsafe business assets with shares and property. Build two Family Trusts. One is for unsafe business assets. The other is for safe assets.
Add firewalls & levels of protection
If your entity lacks assets to pay debt, the creditor often seeks to access the director’s or trustee’s personal assets. Companies no longer provide much ‘limited liability’ – and none against the ATO. Many old company Constitutions force you to have two directors. You can convert to a Single Director Company. Then one of your directors resigns. For a trust, replace the human trustee with a company – this provides another firewall.
Business Succession Planning
One key person gets sick and dies. Their whole business may fall apart. Business Succession Planning is all about the remaining partners getting the sick or dead partner out of the business with a fist full of dollars for the grieving spouse.
Safe havens – ‘man of straw and woman of substance’
The 3 safe havens are: ‘non-business spouse’, Superannuation and a clean skin Family Trust (the Family Trust only has safe assets in it)
The ‘man of straw’ and ‘women of substance’ is a powerful strategy. One spouse takes all the risk: directorships, trusteeships and runs the business or provides the professional services (like an engineer or doctor). The non-working spouse holds all the assets: home, bank accounts, shares and property. If they ever separate all the assets are divided up by the Family Court.
6. Bankruptcy Trusts and Divorce Protection Trusts in your Will
Bankruptcy Trusts and Divorce Protection Trusts in your Will protects your children and grandchildren from attack. See here: https://www.legalconsolidated.com.au/divorce-protection-trust-in-your-will/
Start building a 3-Generation Testamentary Trust read the hints and watch the training videos. As you go on this journey you will gain a lot of information and educate yourself.
7. Leasing out a property and setting up a ‘bed and breakfast’
You own a property. You decide to lease it out via a website. For example, Air B&B. Or you decide to set up a ‘Bed & Breakfast’. There is risk in running a ‘business’ – any business. Renting out a property short term is a ‘business’. It carries risk. You take out all the ‘landlord’ insurance that you can get. But there is still risk. The property, and in fact all your assets, are at risk if something happens and you are sued. To mitigate or reduce that risk you can put in an ‘interposed entity’. Instead of you, the owner of the property, a company as trustee of a family trust rents out the property. This is how to set up that structure.
Can I move the premises into a Family Trust? There is about 4.5% stamp duty and Capital Gains Tax when you transfer property. So it is generally not worthwhile to do this. Also, if you transfer your family home into a trust – such as a Family Trust – then you lose your CGT tax-free status on the family home. Instead, it is better to just have the Family Trust run the ‘business’ and let the Family Trust rent out the property.
If the family trust does not ‘own’ the real estate then where is the business? The Family Trust owns a right to rent out a property. The owner of the property (you) enters into a long term lease from you to the family trust. The family trust then goes out and markets the property to rent. The ‘asset’ of the family trust is the right to rent out a property.
Can I put shares and other ‘safe’ assets in my ‘trading’ Family Trust? That is naughty and wrong. Remember Michael Jackson’s song: One bad apple spoils the whole darn bunch. Do not mix ‘risky assets’ (such as a business) with safe assets (such as shares). Instead, build a family trust for the ‘risky’ business assets. And build a separate family trust (‘clean skin trust’) for the safe assets. Remember, as well as a ‘clean skin trust’ you may have other ‘safe havens’. These include your ‘non-working non-risk spouse’ and superannuation.
8. I am a professional with my own Professional Indemnity insurance
Do not rely on insurance to save you. Insurance companies do go insolvent. For example, HIH Insurance was Australia’s second-largest insurance company. It went bankrupt. It is the largest corporate collapse in Australia’s history. Big insurance companies can and do fail.
Insurance companies may not want to pay out because that lowers their profits. You may act outside the scope of your profession. Therefore, your PI insurance cannot cover you. E.g. lawyer gives financial planning advice. E.g. engineer gives interior design advice. E.g. GP gives medical specialist advice. E.g. Dentist gives medical doctor advice.
Instead, it is better to have 1. good business systems 2. good business structure 3. no assets in your name. Depending on the State, some professions such as doctor, auditor and lawyer cannot share profit or operate through a family trust or a unit trust. They should 1. consider setting up a service trust agreement; and 2. not have any assets in your own name.
9. Personal Guarantees
Banks and trade creditors love to lock in as many people as possible to secure the debt. You, your spouse, your mum and dad, your children are all useful cannon fodder to a lender. Often you spend years setting up your asset protection only to find the ‘safe house’ spouse signs an ‘innocent’ looking piece of paper called a ‘personal guarantee’. At times this may be fine. For example, if your spouse is buying a house then it may be fine to guarantee the mortgage. But fight back.
We had one situation where (by mistake) mum and dad were both directors of a company. The bank demanded both sign personal guarantees for the companies’ new overdraft. We got involved and Mum refused to sign. Instead, they amended the company constitution to allow a one director company. Dad then applied as a single director to the same person at the same bank. The wife was no longer required to sign a guarantee. The company got the overdraft.
Think twice before allowing the ‘safe house’ spouse to sign guarantees.
Does a sole trader count as owning a small business?
Irrespective of the structure (Family Trust, Company, Unit Trust or Partnership) you are running a business if you are providing a product or service to the public. Otherwise, you are an employee. A sole proprietor or not.
I don’t earn much and the chances of being sued is low
Risk is risk. If you are running a business there is risk. Risk is not related to how much money you are making from your business. But you have to weigh up the cost of operating out of business structures like trusts. These factors suggest you need a company as trustee of a family trust:
- high risk of being sued
- a lot of assets in my own name
- a lot of children over 18 or other family members to distribute income to (point 3 is more about reducing tax, rather than asset protection)
In contrast, if you have little risk of being sued and, in any event, you have no assets in your name – then the value of a business structure is less.
Most common questions asked for asset protection
Can I transfer my assets into a ‘safe harbour’, such as a ‘cleanskin’ Family Trust or spouse?
It is a good idea to transfer assets out of your high-risk name or business into a safe harbour. Good idea. However, when you transfer an asset there may be transfer duty (stamp duty) or Capital Gains Tax. For example, on real estate, you pay about 4.5% transfer duty. You also pay Capital Gains Tax. With shares, you pay CGT, if they have gone up in value.
In contrast to land and share, you can often move money from an unsafe spouse to a family trust or the ‘spouse of substance’ for no transfer duty or CGT.
Can I move business assets out of my name?
It is also a good idea to get risky assets, like a business out of your name and into another entity: such as a company as trustee of a family trust. You can move a business name for no stamp duty or CGT if the business name has no value. Get a note from your accountant to say that the business name has no value. Or you can register a new business name in the family trust.
Can I negatively gear in a family trust, unit trust or company?
Negative gearing is where you make an ‘income loss’ which is tax-deductible. This is with the hope that the asset goes up in capital value. In Australia, you generally only pay tax on this ‘capital gain’ when you sell or dispose of the asset. If you own the asset in your own name or in a partnership you claim this ‘income loss’ straight into your income tax return. But they are not good for asset protection. They are not good for income splitting.
You are better to have a family trust, unit trust or a company structure. But, those structures trap the ‘income loss’. You cannot those losses out to the beneficiary or shareholder. The only way to ‘use up’ the ‘income loss’ is to have some ‘positively geared’ or other income in the same trust or company.
Am I an employee or a contractor?
Employees are usually low risk. It is generally your employer that gets sued. Even when employees are on a frolic the boss is still liable. The opposite is true for ‘independent contractors’. This is the difference between an employee and a contractor. There is also ‘in-betweens’. For example, a person on 100% commission is generally still an employee. But you need to look at the contract between the parties. What if your employer makes you get an ABN? If you have an “ABN” (Australian Business Number) then you ‘own’ a business – with all the risk of running a business. If you have an ABN you are likely to be a contractor – not an employee.
Can I use my company to be trustee of many trusts
A company is an expensive mouth to feed so you want to get your money’s worth. A company can wear many hats. It can trade in its own name and it can be a trustee of 100s of family trusts. But should you? Let’s say you have two family trusts: one runs the business (high risk) and the other owns shares (low risk). You could have the same trustee for both of those family trusts. I don’t mind. That is fine. But be aware of two problems:
- mixing assets – often you make a mistake and use the company for the wrong purpose. E.g. you purchased shares for the safe family trust using money from the business family trust. Things get complex.
- telling the story to the liquidator – if the business family trust fails you have to carefully explain to the liquidator that the company as trustee for the business is not related to the trustee company of the (safe) family trust (that just owns passive shares). Make sure your records are perfect.
Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
Australian national law firm
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