The Developer Handbook - Choosing the best business structure for your development project
Have you considered the commercial, legal and taxation issues when deciding on a suitable structure for your project.
There are many commercial, legal and taxation issues that should be considered when determining the most suitable structure for a particular project. This can make for a difficult decision.
Some of the key considerations when choosing a business structure include:
- liability (of both the developer and its investors);
- risk management;
- management control;
- distribution or repatriation of profits from the project; and
In our experience, separate business structures should be established for each new project that is undertaken. This assists with managing and quarantining the risk of each particular project.
We set out below some of the issues to consider with each of the main business structures.
A company is a separate legal entity to its owners (being the shareholders) and those who manage the affairs of the company (being the directors). Whilst there are a number of different types of companies, the most common in a property development context is a proprietary company limited by shares.
Pty Ltd Co
A proprietary company limited by shares must have no more than 50 non-employee shareholders and has limited liability. That is, the shareholders of the company are only liable up to their investment in the company. This is important as it limits a shareholder’s risk from the development project to their investment in the developer company.
Key governing documents
A company will be set up with a constitution and the shareholders may want to enter into a shareholders agreement. These agreements set out the rights and obligations of each shareholder regarding their investment in the company and the underlying development project.
Companies in Australia are taxed at the corporate tax rate, which for the 2019/20 financial year is 27.5% for companies with aggregated turnover of less than $50 million and 30% for all other companies. As a separate legal entity the company will lodge its own income tax return.
For the shareholders of a company to receive the proceeds of the development, the company must declare and pay a dividend. To the extent that the company has paid income tax on the proceeds already, franking credits may be attached to the dividend. In broad terms, a franking credit gives a shareholder a credit for tax paid by a company so as to avoid double taxation.
A trust is not a legal entity, but rather represents a fiduciary relationship between parties, being the trustee (usually a company) who manages the affairs of the trust and the beneficiaries (to whom income from the trust can be distributed).
One form of trust is the discretionary trust. A discretionary trust differs from other trusts in that the trustee has a broad discretion as to the distribution of the income and capital of the trust between the various beneficiaries (or, they may decide to not make distributions at all).
This can be advantageous as it provides flexibility for distribution of the profits from the development. However, this structure may not be appropriate where the investors wish to have certainty as to their share of the proceeds from the development.
Key governing documents
A document known as a trust deed sets out the rights and obligations of the trustee, the beneficiaries (or class of beneficiaries) of the trust and the terms upon which the trustee may distribute income and capital to the beneficiaries.
For tax purposes, a discretionary trust is regarded as a ‘flow through’ vehicle. That is, the beneficiaries are taxed on their respective share of the trust income distributed to them for a given year at their respective marginal income tax rates.
To the extent the trustee does not distribute all the trust income to beneficiaries in a given year, the trustee itself will be subject to tax at the highest marginal income tax rate. For this reason, trusts typically do not accumulate undistributed income and profits like a company.
Trusts are required to lodge an income tax return, notwithstanding they are not a separate legal entity.
Similar to a discretionary trust, a unit trust also has a trustee who manages the affairs of the trust and beneficiaries (called unitholder's) to whom profits from the trust are distributed.
Key governing documents
Unit trusts also have trust deeds that set out the rights and obligations of the trustee. However, unlike a discretionary trust where the class of beneficiaries is set out in the trust deed, a person becomes a unitholder in a unit trust by subscribing for or acquiring units (similar to being issued or acquiring shares in a company).
In addition to the trust deed, the unitholders may wish to enter into a unitholders agreement setting out the rights and obligations of each unitholder in respect of their units in the unit trust. This document is similar in effect to a shareholders agreement for a company.
The income and capital of a unit trust is typically distributed by the trustee to the unitholders based on their relative ownership stake of the units in the unit trust (similar to how dividends are paid to shareholders based on shareholdings).
Unit trusts are also regarded as a ‘flow through’ vehicles for tax purposes. The unitholders are taxed on their share of the income of the unit trust (based on their proportional unitholding in the unit trust) at their respective marginal income tax rates. Once again, to the extent the trustee does not distribute all the trust income to beneficiaries in a given year, the trustee itself will be subject to tax at the highest marginal income tax rate.
As stated above, trusts are required to lodge an income tax return.
A partnership is not a separate legal entity. Rather, it is a relationship between parties carrying on a business in common with a view of profit. Each state and territory in Australia has its own legislation governing partnerships.
Key governing documents
A partnership will typically be governed by a partnership agreement. Whilst not essential, it is highly recommended to have a partnership agreement setting out the terms of the partnership.
Joint and several liability
Each of the partners in a partnership is jointly and severally liable for all the debts and obligations of the partnership. Further, each partner is able to contract on behalf of the partnership and their actions are binding on the partnership (and therefore the other partners). Accordingly, it is often appropriate for the partners to appoint a ‘partnership manager’ (usually a special purpose company) to act as agent for the partnership and manage its affairs and operations in a centralised manner.
Each partner is entitled to their share of the partnership profits from the development, based on their share in the partnership and the terms of the partnership agreement.
A partnership is also regarded as a ‘flow through’ vehicle for tax purposes, and the partners will report their share of the partnership income in their respective income tax return. The partners will be taxed on their share of the partnership income at their respective marginal income tax rates. Similar to a trust, a partnership is still required to lodge an income tax return notwithstanding it is not a separate legal entity itself. A partnership cannot accumulate undistributed income and profits.
Similar to a partnership, a joint venture is not a separate legal entity. A joint venture is an arrangement between parties to share in the product (rather than the profit) of the venture.
The term ‘joint venture’ is often misunderstood and can often refer to a number of other legal structures as joint ventures, while not technically being joint ventures at law. Often a partnership for legal purposes will be described as a joint venture.
However, a true joint venture will involve parties coming together (contributing money, real property, skill or some combination of these) to develop a property, with a view to taking the product of the development, for example, the subdivided lots of the property, which they can they deal with on their own (as opposed to a partnership which would sell the subdivided lots and the partners share the proceeds from the sales).
Key governing documents
The terms of a joint venture should be governed by a joint venture agreement (which would be similar in nature to a partnership agreement).
A joint venture is not subject to tax and the joint venture is not be required to lodge an income tax return. Rather, the parties to the joint venture are subject to tax at their respective marginal income tax rates at such time as a taxing event occurs (e.g. the sale of the subdivided lots arising from the development).
In The Developer Handbook, we dive further into key considerations for developers when choosing the best business structure for their project, including the tax arrangements for each option. You can sign up to receive the full edition of The Developer Handbook and view previous extracts here on The Developer Handbook web page.
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