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IT Start-Ups Tips and Traps. Part 1

In this 3 part series we discuss the issues you need to consider when starting your IT business including:
1. Choosing the best business structure for your business
2. Issuing Equity
3.The strategies you can implement to limit complications and conflict down the track.

Part 1 Choosing the right structure

Starting up a business in the IT industry requires much more than an idea. Among many important considerations is the fundamental question of which type of structure should be adopted.

The ideal structure depends on a business’ objectives, circumstances and long-term goals. Choosing the right structure can mean success and prosperity. Getting it wrong can see you losing personal assets to creditors and shutting shop, or paying hefty tax bills unnecessarily.

There are also concerns specific to the IT industry, for example:

• the nature of IT business assets (a business may see a significant capital gain when selling an IT business);
• the way in which people contribute their services to launch an idea, and how they can be rewarded for their efforts;
• if things don’t go as expected, the way in which people can exit the business;
• tax liability and any potential tax ‘traps’; and
• the way in which the management of the business will be governed.

Which is the best structure?

With these concerns in mind we have outlined the options available to those starting a business in the IT industry, balancing benefits against downsides and potential problems.

Discretionary Trust

A discretionary trust is commonly used as a vehicle through which to run a business. It can provide a high level of asset protection and is one of the most tax effective structures available.
For those looking to establish a business, this is a particularly attractive option due to the 50% CGT discount available to trusts. The discount applies where a trust or an individual sells an asset (such as a business) owned by them for at least 1 year: section 115-10 of the Income Tax Assessment Act 1997 (Cth) (“the Act”).

In the IT industry, you may turn an idea of zero monetary worth into software or a business of significant value. As the business itself can be a CGT asset, selling it later down the track may see you incur a hefty capital gain. The ability to halve that liability is a huge advantage.

In addition, a discretionary trust offers tax flexibility in being able to distribute income between family members on the lowest marginal rate of tax.

However, you should also consider the following disadvantages of running your business through a discretionary trust:
• discretionary trusts may need to make a ‘Family Trust Election’ which limits distributions to members of the family group;
• any income not distributed at the end of the financial year is taxed at the highest rate in the hands of the trustee, meaning that retaining earnings may result in a huge tax bill; and
• this structure is not appropriate where you intend on introducing equity participants.

Unit Trust

An alternative to the Discretionary Trust is the Unit Trust. It has the following attributes:
• like a Discretionary Trust, the Unit Trust can receive the highly desirable 50% CGT discount;
• the Unit Trust is more like a company structure, with people buying ‘units’ (similar to shares in a company) which entitle them to a proportion of business income;
• income is taxed in the hands of the unit holders;
• employees can be issued with units.

Company

Getting started with a company is a popular option as this is one of the most easily understood structures, with the required advice and documents readily available. It is relatively simple to operate, income is taxed at a flat 30% and it can retain working capital. It is also relatively easy to introduce investors, shareholders enjoy limited liability, and Directors are also shielded to a certain extent.

The biggest downside for an IT start-up is that companies are not eligible in any circumstances for the 50% CGT discount.

Seeking specific advice from Chamberlains Law Firm

Choosing the right structure for your IT start-up business and thinking carefully about governance and the way in which people participate in the business are essential considerations. With proper planning, you can ensure that your business is set up in a tax effective and asset protective manner that is appropriate for its business lifecycle: start-up, growth and sale. By seeking specific advice from Chamberlains Law Firm, you can put in place the best possible structure and launch your idea in a way that maximises your chances of success.

If you need assistance setting up your IT business, you can contact our Private Wealth Team using the details below:

Vik Sundar
Practice Leader – Private Wealth
E: vik.sundar@chamberlains.com.au
P: 02 6215 9100

Ellie Hobba
Lawyer – Private Wealth
E: ellie.hobba@chamberlains.com.au
P: 02 6215 9100

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