MODULE 1

Business organisations

Learning objectives

At the conclusion of this module, you will be able to: 1.1 define the key business structures used in Australia and list some of the factors to consider when choosing an appropriate structure 1.2 discuss the characteristics, regulatory processes, advantages and disadvantages of a sole trader structure 1.3 discuss the characteristics, regulatory processes, advantages and disadvantages of a partnership structure 1.4 discuss the characteristics, regulatory processes, advantages and disadvantages of a joint venture structure 1.5 discuss the characteristics, regulatory processes, advantages and disadvantages of a trust structure 1.6 discuss the characteristics, regulatory processes, advantages and disadvantages of a company structure 1.7 discuss the characteristics, regulatory processes, advantages and disadvantages of an incorporated association structure 1.8 outline business name registration requirements.

COPYRIGHTED MATERIAL

c01BusinessOrganisations 1 2 May 2016 1:45 PM Racing Parts

Congratulations! You have secured a graduate position with a large firm of corporate advisers. Sarah, a partner in the practice, asks you to attend an 8 am meeting on Monday with herself and David Douglas, a longstanding client of the firm. You will be required to take notes and prepare answers to David’s queries. David Douglas is married to Lisa Tan. They have one child, Caitlin. Caitlin attends a local private school. David is very entrepreneurial and has been running a car parts business in Dandenong, Victoria, by himself as a sole trader for the past five years under the business name of Racing Parts. A lot of David’s customers are other businesses, both local and overseas. Turnover was $285 000 in the first year and has now grown to over $3 million per annum. The business operates from rented premises, but David would prefer to buy a building. Currently, eight staff work in the office/warehouse/store. David has plans to expand the business further. He also wants to diversify into food and catering later on. David’s mother, Helen, is a retired accountant and he regularly asks her advice. Helen suggested recently that David should run his business as a company. David is unsure about this. He makes an appointment to see Sarah. Prior to the meeting, you review David’s file and note that he and Lisa have the following assets. • A family home in Hawthorn with a market value of $1.25 million. There is a mortgage on the property of $561 000. The house is owned by Lisa. The house was previously owned by David and Lisa, but when David started up his business, it was decided to transfer the house solely to Lisa for asset protection reasons. • A share portfolio. David and Lisa jointly own 1000 Telstra shares, which cost them $3.30 per share, and 500 Commonwealth Bank shares, which they bought when first married. They cost them $10.90 per share. The Telstra shares are currently worth $5.00 per share and the Commonwealth Bank shares are worth $75 per share. The shares are intended as an investment for Caitlin — they will be given to her when she turns 21. David and Lisa also jointly own a portfolio of blue chip Australian shares currently valued at $145 957. • Two motor vehicles. Lisa owns a BMW Series 7 worth $135 000. David owns a VW Transporter Van worth $18 000, which he uses for the business. • Office furniture and equipment. During the course of the year, David bought computers, desks, other office furniture and shelving for the business which cost him approximately $23 000. Their current value in the financial accounts is $8650. • Superannuation. David has $190 568 in superannuation and Lisa has $136 000 in superannuation. In addition, Lisa works as a sales and marketing manager in the city for a financial services company. She is on a total salary package of $155 000. At the meeting, David hands over last financial year’s business results and his draft budget of sales and expenses for the coming financial year. The budget for the new year shows expected sales of $3 764 000 and a net profit of $637 979. Issues During the meeting, David has a number of questions relating to important issues surrounding the future of his business. The issues arising include the following. • Should Racing Parts remain a sole proprietorship? • What other options does David have to structure the business?

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c01BusinessOrganisations 2 2 May 2016 1:45 PM • How would another business structure be different from just David as a sole trader? David still wants to run the business — he wants to be in control. • Is Helen correct to suggest that David should set up a company to run the business? Why? What are the advantages and disadvantages of the different types of business structure?

Introduction Almost every aspect of business today is regulated in one form or another. In establishing a new business or making changes to an existing business, the business operator will likely need to do some or all of the following: •• formulate a business plan in order to obtain finance, •• obtain an Australian Business Number from the Australian Taxation Office, •• register for GST, •• register a business name, •• select business premises, •• comply with town planning requirements, •• comply with environmental protection obligations, •• obtain any necessary government licences or permits, •• decide on branding, including, for example, letterhead, •• employ and train staff, •• pay staff in accordance with State and Federal employment legislation, •• comply with union awards or workplace agreements, •• arrange workers compensation for employees, •• comply with superannuation legislation, •• comply with health regulations and workplace health and safety requirements, •• take out appropriate insurances, •• keep records up to date for taxation purposes, as well as for internal management and securing external funds, •• file Business Activity Statements with the Australian Taxation Office, •• comply with other taxation requirements, including, where applicable, stamp duty, land tax, and payroll tax, •• establish and maintain systems for quality control of the goods or services sold so that their sale does not contravene legislation such as the Competition and Consumer Act 2010 (Cth) or the various State and Territory Sales of Goods Acts, •• ensure that any advertising or promotion of a good or service sold cannot be taken to be misleading or deceptive, and •• protect the intellectual property of the business by, for example, registering a trademark or design, or applying for a patent. Overarching all of those decisions is the choice of business structure. The main types of legal structure for a business in Australia are: •• sole trader, •• partnership, •• joint venture, •• trust, and •• company. Additionally, an organisational structure called an incorporated association exists and is often used by not‐for‐profit groups. Each structure has advantages and disadvantages and can be more or less suited to a particular organ­ isation’s needs. Choosing the most appropriate structure is the focus of this module.

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c01BusinessOrganisations 3 2 May 2016 1:45 PM 1.1 Choosing a business structure

learning objective 1.1 Define the key business structures used in Australia and list some of the factors to consider when choosing an appropriate structure. One of the main business decisions owners and managers will make is the choice of legal structure under which the business will operate. Choosing the most appropriate form of business organisation when estab­ lishing or growing a business is an important decision. The decision will depend on the size and nature of the business as well as many other factors (see figure 1.1). Some issues to consider are as follows. •• How much will it cost to set up? •• How can funds be raised to grow the business? •• What are the ongoing costs to comply with regulatory obligations? •• What records will the business need to keep? •• What disclosures will the business need to make to the regulators? •• What are the tax advantages and disadvantages? •• Can personal and business assets be protected? •• What personal legal liability will the owners and managers have? •• Does the type of business or industry affect the business structure? •• How do changes in ownership of the business work? •• Does the structure allow for succession planning?

Tax issues Asset Disclosures protection

Record Personal keeping liability

Compliance Industry costs issues

Financing Ownership options changes

Choosing Establishment Succession a business fees planning structure

Figure 1.1 Issues to consider when choosing a business structure

In addition to choosing an initial business structure, as a business changes the need may arise to modify the business structure or create new or additional legal structures to meet particular requirements. There are a number of choices of structure including sole trader, partnership, joint venture, trust or company, as shown in figure 1.2. A business may also use a combination of these. A not‐for‐profit organ­ isation may become an incorporated association.

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c01BusinessOrganisations 4 2 May 2016 1:45 PM company Unlimited Large shares Company limited by association Incorporated company Proprietary company Unlimited Small shares Company limited by Company company No liability company Unlimited Public company Company limited by guarantee trust structures Constructive Organisational shares Company limited by trust Trust Resulting trust Discretionary trust Express Unit trust Fixed trust Joint venture limited Limited partnership partnership Incorporated Organisational structures Organisational Partnership General partnership Sole trader Figure 1.2

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c01BusinessOrganisations 5 2 May 2016 1:45 PM Of the structures used for business, the company structure is the most commonly used, followed by the sole trader as shown in table 1.1.

Table 1.1 Proportion of business structures in Australia1

Business structure Number Percentage

Sole trader 555 292 26.4

Partnership 299 545 14.3

Trust 497 230 23.7

Company 747 579 35.6

Note: Each participant in a joint venture is counted as its type of business structure, so joint ventures do not appear separately in the table.

1.1.1 Sole trader A sole trader or sole proprietorship is a business that is owned by one person and that has no legal existence separate from that person. It is the simplest form of business structure and involves very few legal formalities. It is quick and inexpensive to establish, and inexpensive to wind down. Because the business has no separate legal existence from its owner, a sole trader is personally responsible for the debts of the business. 1.1.2 Partnership Another possibility is for individuals to join forces with other individuals to form a partnership, in which all partners share control. A partnership is a relationship or association between two or more entities, carrying on a business in common with a view to making a profit. Each partner in a partnership is per­ sonally liable for all the debts of the partnership, even if they are caused by decisions or acts by other partners.

1.1.3 Joint venture A joint venture is another way to structure a business involving multiple people. A joint venture is where two or more people or parties come together in business. The parties in a joint venture are only responsible for their respective obligations, not for the obligations of any of their joint venture partners.

1.1.4 Trust A trust is a relationship or association between two or more parties, whereby one party holds property (e.g. investments or assets) in trust for the other; that is, they are vested with the property. A trust, in its simple form, has: •• a settlor (who sets up the trust), •• a trustee (who manages the trust property), and •• beneficiaries (the people, or person, for whom the investments or assets are held and to whom income is paid). Trusts can range from relatively simple to very complex arrangements.

1 Data from Australian Bureau of Statistics, ‘Counts of Australian Businesses, including Entries and Exits, Jun 2010 to Jun 2014’, cat. no. 8165.0 (ABS, Canberra, 3 February 2015).

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c01BusinessOrganisations 6 2 May 2016 1:45 PM 1.1.5 Company A company or corporation is a separate legal entity formed under the Corporations Act 2001 (Cth), hereafter referred to as the ‘Corporations Act’. In the most common company structure, the owners of the company are called shareholders and their ownership interests are represented by the number of shares they own in the company. There are other types of company as well, which we will discuss later in the text. As a separate legal entity, a company can enter into contracts, sue and be sued in its own name. Furthermore, the owners of most companies have only limited liability for the company’s debts. Another advantage of the corporate form is that a company has an indefinite life. Once registered a company will exist until it is deregistered. Compared with other business structures, the owners of a company can more easily transfer their ownership interest — by selling their shares in the company to other investors. The decision to incorporate or to remain unincorporated has distinct legal and financial ramifi­ cations. Many businesses, though by no means all, start as sole traders or partnerships and eventually incorporate. The company is the most common business structure for organisations in Australia. It is the com­ pany structure that is the focus of this text.

Racing Parts activity

Looking back at the list of factors to consider when choosing an appropriate business structure, which do you think are relevant to David’s decision? For each, note why it is relevant to his situation. Based on your notes about the relevant factors, along with the brief descriptions of the business structures given in this section of the module, which structures do you think might be appropriate for Racing Parts? Briefly explain why.

1.1.6 Incorporated association Many people in society form organisations for reasons other than business. Sports clubs and community groups are typical examples of not‐for‐profit organisations. Depending on the size and objectives of the organisation, its members might choose to form an incorporated association. An incorporated association is a separate legal entity and its members have limited liability. Module 1.1 provided an overview of the key administrative and legal aspects of the sole trader, partner­ ship, joint venture, trust, company and incorporated association structures. The remaining modules in this text will then investigate the company structure, which is the focus of this text.

1.2 Sole traders

learning objective 1.2 Discuss the characteristics, regulatory processes, advantages and disadvantages of a sole trader structure. At the most basic level, becoming a sole trader simply involves accepting money in exchange for pro­ viding goods or services. Generally other steps must follow, such as advertising, opening a bank account, and keeping records of payments and receipts.

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c01BusinessOrganisations 7 2 May 2016 1:45 PM Businesses that commonly use the sole trade business structure include newsagents, electricians, hair­ dressers and personal trainers. The sole trader structure is the second‐most common form of business structure in Australia, with 26.4 per cent of businesses operating as sole proprietorships.

1.2.1 What is a sole trader? A sole trader (or sole proprietor) is a person who trades alone in their own right — that is, not using a company, partnership or trust structure — and who bears sole responsibility for their busi­ ness. A sole trader receives all the profits from the business, but they must also bear all of the losses. A sole trader has unlimited liability — they are personally responsible for the debts of the business and if they are either unwilling or unable to meet the business’s liabilities, they can be made bankrupt. Many small businesses, retail stores and professional practices are operated as sole proprietorships. Sole traders are typically self‐employed. The owner of the business is usually also the manager. Some sole traders employ other people to help them run and operate the business. From a legal perspective, a sole trader is indistinguishable from its owner (figure 1.3), in the sense that creditors claim against not only the assets of the business, but also the owner’s personal assets (including that person’s share of assets that are owned jointly; e.g. with a spouse). However, from an accounting point of view, a sole trader is distinct from its owner in the sense that a sole trader’s accounts do not normally include a record of that person’s personal affairs.

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c01BusinessOrganisations 8 2 May 2016 1:45 PM The business

Figure 1.3 The sole trader business structure

Whether being a sole trader is appropriate for a person going into business depends on, among other things: •• the type of business activity, •• how much risk and liability they are willing to bear, •• the extent to which they wish to be independent or control the management of the business, •• their taxation position, •• how much capital they have, and •• whether they are willing to be solely responsible and accountable for what the business does and does not do. 1.2.2 Advantages of being a sole trader The main advantages of the sole trader business structure are as follows. •• A self‐employed sole trader has full management authority, and thus greater flexibility than an employee or a manager who has to share decision making when deciding what to do or not do, and how and when to do it. •• Sole traders are subject to fewer regulatory and reporting obligations, and can use simpler record‐ keeping and other documentation than other business structures. •• Sole traders can keep their business affairs relatively private. •• There are minimal costs involved in establishing and operating a sole trader business compared with other business structures. •• A sole trader is normally free to close or wind up the business whenever desired, simply by ceasing to trade, paying any creditors (including employees) and keeping any surplus assets or funds remaining. In addition, some employees might be attracted to becoming a sole trader; for example, to work for multiple customers and clients rather than a single employer, or to access certain tax advantages. 1.2.3 Disadvantages of being a sole trader The main disadvantages of the sole trader business structure are as follows. •• A sole trader has unlimited liability. They are solely responsible for all liabilities of the business. As a result, if the business fails and some of its debts remain unpaid, creditors can not only sue the owner to recover the debt from their business assets, but also from their personal assets. •• Because the sole trader operates on their own, they may find it more difficult to raise financial capital than if they operated the business with others (e.g. as a partnership or with other investors in a com­ pany). For example, a sole trader cannot generally invite the public at large to invest money with it.

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c01BusinessOrganisations 9 2 May 2016 1:45 PM •• The life of the business is limited by the working life of the sole trader, so the business will not nor­ mally continue after they cease to work. However, a sole trader can sell the business to a new owner or can bequeath it to their heirs. Table 1.2 summarises the key advantages and disadvantage of the sole proprietorship business structure.

Table 1.2 Key advantages and disadvantages of the sole proprietorship business structure

Advantages Disadvantages

• Full management authority • Unlimited liability • Fewer regulatory and reporting obligations • More difficult to raise financial capital • Business affairs are relatively private • Life of the business is limited to when the sole trader • Minimal costs to establish and operate ceases to work (although the business can be sold) • Free to close or wind up the business whenever desired

Racing Parts activity

David Douglas established Racing Parts as a sole trader business. Five years later he is still using that structure, but has been advised to consider other business structures. Using the advantages and disadvantages mentioned above, along with the information provided about David’s circumstances at the start of the module, briefly assess the suitability of a sole trader structure for David’s business. Make a recommendation as to whether a sole trader is an appropriate business structure for David.

1.3 Partnerships

learning objective 1.3 Discuss the characteristics, regulatory processes, advantages and disadvantages of a partnership structure. The concept and nature of a partnership is set out in each State’s and Territory’s partnership legislation, listed in figure 1.4. We will refer to these collectively as ‘the Partnership Acts’. The Partnership Acts expressly exclude companies and other incorporated associations. Generally, associations of more than 20 people must be incorporated. Exceptions are made for certain professions (discussed later).

Australian Capital Territory Partnership Act 1963 (ACT) New South Wales Partnership Act 1892 (NSW) Northern Territory Partnership Act 1997 (NT) Queensland Partnership Act 1891 (Qld) South Australia Partnership Act 1891 (SA) Tasmania Partnership Act 1891 (Tas) Victoria Partnership Act 1958 (Vic) Partnership (Limited Partnerships) Act 1992 (Vic) Western Australia Partnership Act 1895 (WA)

Figure 1.4 The State and Territory Partnerships Acts

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c01BusinessOrganisations 10 2 May 2016 1:45 PM 1.3.1 What is a partnership? A partnership is a firm made up of its various partners; it is not a separate legal entity. A partnership exists when four elements are present (figure 1.5). In essence, a partnership is: 1. a group of people, 2. carrying on business, 3. in common, and 4. with a view to a profit.

The business

Figure 1.5 The partnership business structure

A partner is simply a member of the partnership; that is, someone who carries on business in common with one or more other people with a view to a profit. The rights and obligations of partners and the way the partnership will operate as a whole are governed by the partnership legislation in each State and Territory. In addition, there is a substantial body of case law that establishes principles for the operation of partnerships. Most partnerships will also have a partnership agreement, which is a contract that regulates how the partnership will operate. The provisions of the partnership agreement supplement the legislation, and in some cases override the default rules provided by the legislation. It is important to note that partners are not necessarily equal. It is prudent not only to obtain legal advice when drafting the partnership deed, but to ensure that proper partnership accounts are drawn up, which reflect each partner’s debt and equity contributions to the partnership. A person may take on the role of a ‘silent’, ‘dormant’ or ‘sleeping’ partner. Such a person has the rights of a partner and contri­ butes property to the partnership, but does not actively participate in its management. They may, how­ ever, still be liable for the debts of the partnership and wrongful acts done on its behalf. Determining whether a partnership exists The Partnership Acts provide a number of rules that can be used to determine whether a partnership exists. No single factor or rule is conclusive within itself and, in determining whether a partnership exists in law, the courts must consider all the facts and relevant circumstances of the relationship between the parties. Therefore it is important that a written partnership agreement exists. As described earlier, for a partnership to exist there must be a group of people carrying on business in common with a view to a profit. A group At least two people must be involved in order for a partnership to exist. For most partnerships, there is a maximum of 20 partners, but certain professional partnerships are allowed more (see table 1.3).

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c01BusinessOrganisations 11 2 May 2016 1:45 PM The existence of the group alone is not sufficient to prove a partnership exists. The group must also have the necessary relationship, which is determined by the other tests.

Table 1.3 Partnership member limits2

Type of partnership Maximum number of partners

Actuaries 50

Medical practitioners 50

Patent attorneys 50

Sharebrokers 50

Stockbrokers 50

Trade mark attorneys 50

Architects 100

Pharmacists 100

Veterinary surgeons 100

Legal practitioners 400

Accountants 1000

All others 20

Carrying on a business The tests that determine whether someone is carrying on a business are known as the ‘badges of busi­ ness’, and their application to the facts of a particular case are a matter of judgement. The tests include, for example, assessing whether the parties’ activities have some significant commercial purpose or char­ acter of an ongoing or continuous nature. The factors to consider include whether: •• the parties maintain systems and keep appropriate books of account concerning their activities, •• the parties’ activities involve the use of substantial assets and funds, and •• the parties aim to operate at a profit. In common Crucially, there must be evidence that the parties intend to come into a business relationship that is mutual, shared or reciprocated as to its rights and obligations as pertains to some specified business activity. In other words, each partner is both a principal and an agent for all other partners. By way of contrast, two people co‐owning property (e.g. as tenants‐in‐common) does not of itself create a partnership because co‐ownership of property is not by itself a business or carrying on business activity. Note that for income tax purposes where income is derived from property and shared jointly it is recognised as a partnership for tax purposes. With a view to a profit The phrase ‘with a view to a profit’ essentially means that people come together in common with the aim or purpose of making a profit. While there is an expectation of making a profit, there is of course no guarantee, and some partnerships in fact make losses. Partners are not entitled to remuneration simply because they have entered into a partnership and con­ tributed equity to a business. While employees may be able to sue for ‘unpaid wages’, partners are more analogous to investors in a business; they hope to earn a profit if the business performs well, but they do bear the risk of the business failing.

2 Adapted from Nickolas James, Business Law (Wiley, 3rd ed., 2014).

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c01BusinessOrganisations 12 2 May 2016 1:45 PM 1.3.2 Advantages of a partnership The advantages of a partnership are as follows. •• Partnerships enable individuals to combine capital in order to undertake projects that a partner might not be able to undertake individually. •• The partnership is not taxed separately for income tax purposes (unlike a company). This follows from the fact that a partnership is not a separate legal entity distinct from the identities of its partners. (While a partnership files a separate tax return, in addition to the individual tax returns filed by each of its partners, this is just so that each of the partner’s individual tax returns can be reconciled with that of the overall partnership business.) •• Even though the law imposes duties on each partner to disclose relevant information to all other part­ ners, partnerships are not subject to onerous disclosure requirements. Accordingly, some people con­ sider that a partnership allows them to keep their business affairs relatively private. •• While more complex than establishing a sole proprietorship, it is still relatively straightforward and easy to establish a partnership.

1.3.3 Disadvantages of a partnership The disadvantages of partnerships are as follows. •• Each partner has joint and several liability for the acts and omissions of every other partner or part­ ner’s agents in the normal course of the partnership business. Partners are ‘jointly’ liable because they are assumed to be acting together, so that their liability is entered into mutually (jointly). Partners are also ‘severally’ liable, meaning that they are liable separately, so they can be sued separately and at different times. This has the advantage for plaintiffs that they can proceed against any or all partners for their claims. In other words, the partners are collectively responsible and each partner is individ­ ually responsible for any and all liabilities that arise from the actions of the partnership. This follows from the law that each partner is both a principal and an agent for every other partner.

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c01BusinessOrganisations 13 2 May 2016 1:45 PM •• Generally speaking, a partnership can have no more than 20 partners. If more than 20 people wish to combine to form a business, they must generally form a company, unless they fall within particular exceptions made for certain industries (see table 1.3). •• Partnership decisions must be unanimous in some matters, which can make decision‐making difficult. For example, the admission of a new partner or the sale of part of the business will usually need to be decided by unanimous vote. Table 1.4 summarises the key advantages and disadvantage of the partnership business structure.

Table 1.4 Key advantages and disadvantages of the partnership business structure

Advantages Disadvantages

• Individuals can combine capital • Each partner has joint and several liability • The partnership is not taxed separately • Can have no more than 20 partners (with some • Partners can keep their business affairs relatively exceptions for certain industries) private • Partnership decisions must be unanimous in some • Relatively straightforward and easy to establish matters

1.3.4 Partners’ dealings with each other The internal regulation of the firm is a matter for agreement between the partners. As noted earlier, the partnership agreement sets out: •• the rights and obligations of the partnership, •• the rights and obligations of particular partners, and •• the rules that determine the way in which the partnership is managed. The partnership agreement may be written or oral. In practice, it is always prudent that the agreement be formalised in writing by a competent solicitor. Partnership agreements can be varied by consent between the partners. Variations of the partnership agree­ ment need not be in writing unless that is itself a requirement in the partnership agreement. A partnership agreement is a contract and the laws of contract apply. A written partnership agreement may be varied by a verbal agreement between the partners and variations may be express or implied (i.e. where the partners con­ duct themselves in such a way that suggests they agree to a variation of the partnership agreement). If there is no agreement between the partners or if the partnership agreement is silent on a particular matter, then the Partnership Acts set out default rules that apply to management matters (see figure 1.6).

1. All partners share equally in the profits and capital of a partnership business, and bear losses equally. 2. Every partner is entitled to be indemnified (compensated) for payments made by that partner in the ordinary and proper course of the partnership business, and any expenses necessary to preserve the business or its property. 3. A partner who has lent money to the partnership business is entitled to interest on that loan of 6 per cent per annum. 4. If a partner has contributed equity capital to the partnership, that partner is not entitled to any interest on that capital (unless the capital provided by the partner is by way of preference shares). 5. Every partner is entitled to participate in the management of the partnership business. 6. A partner is not entitled to remuneration for simply acting in their role as a partner in the partnership business. 7. No person can be introduced as a new partner without the consent of all of the existing partners. 8. While ordinary day-to-day matters can be decided by a majority of the partners, any change to the fundamental nature of the partnership business, or any proposed such change (e.g. expulsion of one of the partners by the others), requires the consent of all the existing partners. 9. Every partner has access to the accounts of the partnership and is entitled to a copy of them. The accounts are to be kept at the principal place of business of the partnership.

Figure 1.6 Default partnership rules under the Partnership Acts

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c01BusinessOrganisations 14 2 May 2016 1:45 PM The rules set out by the Partnership Acts must be interpreted with reference to case law. Under case law, the relations between the partners themselves revolve around the fiduciary duties that each partner owes every other partner. This idea is based not only on the law of agency, but on an assumption of mutual confidence and trust between the partners, with the result that each partner owes every other partner a duty of the utmost good faith and utmost fairness. In other words, each partner is bound to exercise their rights and powers in good faith for the benefit of the others. 1.3.5 Partners’ fiduciary and statutory duties Partners are subject to fiduciary and statutory duties in their conduct. Fiduciary duties are equitable duties to act in good faith for the benefit of the partnership, and include a partner’s duty not to profit personally from their position (other than where expressly permitted, preferably in writing), or to put themselves in a situation where their partnership duties and self‐interest come into conflict. In addition, the following statutory duties are imposed on each and every partner by the Partnership Acts. •• A duty to account, or make full disclosure to one another of all matters relating to the partnership business. This simply reflects the fiduciary duty in equity. •• A duty to account for any private profits or benefits derived from any transaction concerning the partnership, or any use of partnership property (including goodwill), without the consent of the other partners. This reflects the usual duty of an agent towards the principal. •• A duty not to compete with the firm without the consent of the partners, and to account to the firm for any profit made without that consent. This refers to business activities of the same type as those carried on by the partnership. 1.3.6 Property of a partnership Under the Partnership Acts, property bought with money belonging to the firm is deemed to have been bought on account of the firm. Whether particular assets or property become partnership property or whether ownership is retained by individual partners is a question that can only be determined by: •• the express terms of a partnership agreement, or •• inferences drawn from the manner in which the partners have dealt with that property during the course of the partnership. Two key indicators of the latter are whether the asset has been bought out of partnership funds and whether the asset has been recorded in the partnership accounts. Almost any type of property, from the most tangible to the least tangible, can become property of a partnership (as in the following examples). •• Real estate — the partners will hold any land bought by the partnership as part of the partnership’s property, and the certificate of title to the land will record the partners as the owners of the property, which will be held in trust. •• Rights to information — a particular partner may contribute the rights to information to a partnership, which could then become partnership property. 1.3.7 Changes to partners Expulsion of a partner relates to the right or power of the rest of the partners to expel a partner from the firm. Retirement of a partner relates to a partner retiring from the firm; for example, because they wish to exit the business. Expulsion Because the expulsion of one of the partners would amount to a fundamental change in the partner­ ship, such an expulsion cannot be made by a majority decision only, unless the partnership agreement expressly stated that a majority of the partners is entitled to expel a partner. Even where an express

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c01BusinessOrganisations 15 2 May 2016 1:45 PM power of expulsion is included in the partnership agreement, the fiduciary relationship between the part­ ners requires that the power must be exercised: •• in good faith, and •• strictly in accordance with any conditions imposed by the partnership agreement. Retirement Any partner is generally free to make the decision to leave the partnership. This is referred to as ‘retire­ ment’. The terms that apply when a partner retires are usually set out in the partnership agreement, and generally relate to the period of notice the partners agree to give each other prior to leaving. The decision of one partner to leave the business (retire) has major consequences for the partnership — it operates as an automatic dissolution. It may well be that the remaining partners choose to carry on the business and it may appear that the transition is seamless, but technically, the partnership is now dissolved even though it may reconvene as a new partnership. The retiring partner will want to claim their right to retire from the business by withdrawing their share of capital, and the retiring partner will need to give notice to creditors of their retirement, or else they will continue to be liable to their pre‐retirement creditors. 1.3.8 Dissolving a partnership A partnership may be dissolved with or without a court order. The partnership may be dissolved without a court order if: •• a partner retires (if it is a partnership of no fixed duration, i.e. ‘at will’, the retiring partner is simply required to give notice of his retirement), •• the term of the partnership expires, or a partner gives notice of their intention to dissolve the partnership, •• the business venture for which the partnership was formed has been completed, •• one of the partners dies, or •• it is (or becomes) illegal for the partnership to carry on business (e.g. the maximum of 20 partners is breached), or for one of the partners to continue carrying on the business (e.g. a partner becomes bankrupt). The Partnership Acts, by default, mean that a partnership will be dissolved if a partner retires, dies or becomes bankrupt, the partnerships often override these provisions by writing alternative arrangements into their partnership agreements. A court order is required to dissolve the partnership if: •• one of the partners is found to be of permanently unsound mind, •• one of the partners becomes incapable of acting in their capacity as partner, and therefore unable to perform their duties in that role, •• one of the partners has engaged in conduct prejudicial to the partnership, •• there have been wilful and persistent breaches of the partnership agreement, or one of the partners behaves in a way which makes it practically impossible to continue the partnership, •• the partnership can only be carried on at a loss, or •• it is just and equitable for the court to wind up the partnership (e.g. because any mutual trust and con­ fidence that once existed between the partners has since dissipated and, in the court’s view, continuing business relations between the partners have become impossible). 1.3.9 Alternative forms of partnership Limited partnerships and incorporated limited partnerships are regulated by the Partnership Acts. Limited partnerships A limited partnership consists of: 1. limited partners who, although they contribute capital to the firm and share in the profits, have only limited liability (i.e. they are not liable for partnership debts or liabilities beyond their agreed con­ tribution of capital). In exchange for this limited liability, they take no active part in the operations

16 Company Law

c01BusinessOrganisations 16 2 May 2016 1:45 PM of the partnership. They cannot bind the firm or withdraw any part of their capital, although they can inspect the firm’s accounts. A limited partner may lose their limited liability status if: –– there are defects in the formation of the partnership, or –– if they participate in the management, withdraw their capital, or fail to disclose on documents that it is a limited partnership; and 2. at least one general partner who manages the venture and has unlimited liability. In Australia this general partner may be a proprietary limited company. The responsibilities and liabilities of the general partner or partners in a limited partnership are similar to those of partners in a normal partnership. The number of limited and general partners in a limited partnership is regulated by the Partnership Acts. Under that legislation, limited partnerships are required to register their agreement and names of the partners, and the firm name must be followed by the words ‘(A limited partnership)’ on all business documents of the limited partnership. The obvious advantage of using limited partnerships is that the limited partners have limited lia­ bility, and that the general liability may be confined to a limited liability company. So why don’t more businesses use limited partnerships? For most businesses, there are generally no more advantages to be gained from using a limited partnership than from using a company structure. For this reason, most businesses prefer a company structure, possibly with some asset protection for the directors (e.g. a dis­ cretionary family trust). For many professional practices, there is a further reason why they are not struc­ tured as limited partnerships — they are specifically prohibited from doing so. Like an ordinary partnership, a limited partnership may be wound up: •• by the partners agreeing not to continue carrying on business as a limited partnership, •• by the general partner or general partners, or •• by the court. However, in other respects, unless the partnership deed states otherwise, there are some constraints on how a limited partnership may be legally dissolved: •• a limited partner cannot dissolve the firm by notice, and •• the firm does not dissolve simply because a limited partner resigns or leaves the limited partnership, or becomes permanently of unsound mind.

Incorporated limited partnerships A derivative structure called the incorporated limited partnership is common in the venture capital industry. Venture capital is a type of private equity capital used to fund — generally with institutional backing — new, potentially high‐growth businesses and existing businesses that are substantially restructuring. Indeed, in an effort to encourage the venture capital industry in Australia, the Federal government has created substantial tax advantages for venture capitalists who structure themselves as incorporated limited partnerships. Incorporated limited partnerships are separate legal entities comprised of at least one general partner (but no more than 20), and at least one limited partner (there is no limit on the number of limited part­ ners). General and limited partners may be individuals, partnerships or companies.

Racing Parts activity

Using your knowledge of the partnership business structure from the description above, along with the information provided about David’s circumstances at the start of the module, briefly assess the suitability of a partnership structure for David’s business. Make a recommendation as to whether a partnership is an appropriate business structure for David. If David were to consider a partnership, who should he consider as potential partners? Why/why not?

module 1 Business organisations 17

c01BusinessOrganisations 17 2 May 2016 1:45 PM 1.4 Joint ventures

learning objective 1.4 Discuss the characteristics, regulatory processes, advantages and disadvantages of a joint venture structure. Although joint ventures have ancient roots in law, the law in relation to them is imprecise and always developing. A joint venture is somewhat of a hybrid structure of the law as it applies to partnerships, contracts and fiduciary obligations. 1.4.1 What is a joint venture? A joint venture is difficult to define with precision, and even the High Court has indicated that it does not have a technical legal meaning, at least at common law.3 In general terms, a business undertaking is said to be a joint venture where people come together in business (figure 1.7), with each of them seeking to earn an individual (not shared) profit or output from the business.

Business A Business B

The joint venture

Figure 1.7 The joint venture business structure

Joint ventures are used in many commercial settings including mining, property development, agricul­ ture, entertainment and industrial research agreements. Sometimes the parties assign their rights, title and interest in relevant assets to a joint venture vehicle, which may itself be structured as a company or a trust. A joint venture undertaking is frequently for a single venture of limited duration (e.g. a mining project).

3 United Dominions Corp Ltd v Brian Pty Ltd (1985) 157 CLR 1.

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c01BusinessOrganisations 18 2 May 2016 1:45 PM The differences between a joint venture and a partnership There are two key differences between joint ventures and partnerships. 1. While joint venturers may share some of the costs of the joint venture business, they do not generally share all of those costs, and certainly do not share profits or losses in the venture. Generally, joint ven­ turers will specifically set out in their agreement which party will be responsible for which expenses, and they will agree as to how to share production or output, not profit. In comparison, partners do share profits or losses in the business — either equally or unequally, depending on the terms of the partnership agreement. 2. Joint venturers are severally liable in respect of their commercial undertaking, while partners are jointly and severally liable.

1.4.2 Advantages of a joint venture The advantages of a joint venture structure of a business are as follows. •• A joint venture can be established for a specific one‐off project or for a defined period of time. •• The parties engaged in a joint venture remain legally separate, including in terms of assets and liabilities. •• Particular interests in the venture can be sold.

1.4.3 Disadvantages of a joint venture The disadvantages of a joint venture structure of a business are as follows. •• While the overall aim of a joint venture is shared between the participants, each will have their own priorities and objectives. •• The parties will usually need to appoint a separate manager to oversee the joint venture. •• The parties must manage their involvement to ensure they do not become a partnership. The advantages and disadvantages of the joint venture structure are summarised in table 1.5.

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c01BusinessOrganisations 19 2 May 2016 1:45 PM Table 1.5 Key advantages and disadvantages of the joint venture business structure

Advantages Disadvantages

• Can be established for a particular project or period • Priorities and specific objectives of participants may of time not entirely align • Participants remain legally separate • A separate manager may be necessary • Participants can sell their individual interests • Parties must take care to avoid becoming a partnership

1.4.4 The joint venture agreement A written charter, known as the ‘joint venture agreement’ is usually drawn up to regulate the relations between the joint venturers. Where no such agreement is reduced to writing, the terms of the joint ven­ ture depend on what was said or implied (e.g. by the conduct of the parties). The joint venture agreement frequently includes, as a minimum, the following terms: •• assets are owned by the joint venture parties as tenants‐in‐common, •• none of the co‐venturers is agent for the other, except insofar as one of them may act as the man­ ager of the joint venture, and is therefore responsible for overseeing the day‐to‐day operations of the business, •• each party’s obligations are several, not joint — thus the relations between the parties are not those of partners, •• each joint venture party shares in the rights to the product produced by the undertaking, but does not share in any profit generated, and •• fiduciary obligations may arise through express covenants in the joint venture agreement. (Having said this, the courts are increasingly implying fiduciary obligations into the agreements made by joint venturers; e.g. obligations to act in good faith, or even occasionally to share losses or divide gains equally.)

Racing Parts activity

Using your knowledge of joint ventures from the description above, along with the information provided about David’s circumstances at the start of the module, briefly assess whether it would be appropriate for David’s business to pursue a joint venture.

1.5 Trusts

learning objective 1.5 Discuss the characteristics, regulatory processes, advantages and disadvantages of a trust structure. Trusts are often recommended by accountants and corporate advisers to provide taxation benefits, pro­ tect assets and hold superannuation.

1.5.1 What is a trust? A trust is an equitable device by which one person (the trustee) holds property (the trust property) for the benefit of another person or persons (the beneficiary or beneficiaries). The basic relationship for the trusts that are most relevant to accountants and corporate advisers can be represented as shown in figure 1.8. A trust is not a separate legal entity.

20 Company Law

c01BusinessOrganisations 20 2 May 2016 1:45 PM Settlor Trustee $10 (Creates a trust (Holds trust with $10) property)

Trust property ($10 + any subsequent injections of capital)

Beneficiary Beneficiary Beneficiary (Receives $X) (Receives $Y) (Receives $Z)

Figure 1.8 Basic trust structure

The parties The settlor is the person who ‘creates’ the trust — by settling $10 or some other nominal sum on the trust. In practice this person will be the accountant. This $10 becomes the initial trust property, the value of which increases during the life of the trust as capital is injected. The capital of the trust may of course be reduced during the life of the trust, provided there is sufficient capital in the trust to cover any capital distributions to beneficiaries. After they have established the trust, the role of the settlor is effectively finished. The trustee is the legal owner of the trust property and has legal authority to administer that property. The trustee has been entrusted to deal with the trust property for the benefit of others (e.g. another person or class of persons) or for the advancement of certain private or chari­ table purposes. The trustee is subject to fiduciary and statutory duties. For example, the trustee must ensure that the terms of the trust are carried out, that they deal prudently with the trust prop­ erty, and that they make appropriate distributions to beneficiaries. The trustee’s rights, powers and obligations are typically set out in the trust deed, as well as in legislation, including each State’s and Territory’s Trustee or Trusts Act, listed in figure 1.9. We will refer to these collectively as ‘the Trustee Acts’.

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c01BusinessOrganisations 21 2 May 2016 1:45 PM Australian Capital Territory Trustee Act 1925 (ACT) New South Wales Trustee Act 1925 (NSW) Northern Territory Trustee Act 1893 (NT) Queensland Trusts Act 1973 (Qld) South Australia Trustee Act 1936 (SA) Tasmania Trustee Act 1898 (Tas) Victoria Trustee Act 1958 (Vic) Western Australia Trustees Act 1962 (WA)

Figure 1.9 The State and Territory Trustee Acts

The beneficiary is a person on whose behalf, and for whose benefit, the trust property is held. Benefi­ ciaries have a beneficial interest in the trust property. The amounts that each beneficiary receives by way of income or capital under the trust are determined by the terms of the trust, which are generally set out in the trust deed. 1.5.2 Advantages of a trust For accountants and corporate advisers, the main reasons for using trusts are for taxation purposes, asset protection, and superannuation. •• A trust may be used to minimise income tax in circumstances where one spouse earns a substantial income, but the other does not. The tax rates on individuals’ income in Australia proceed in a step‐ wise fashion as income increases. By using a trust to split the highest earner’s income more equally between both spouses, each spouse can take advantage of the nil tax rate income threshold and two sets of lower tax rates, so that the overall family tax bill is lower than if the main breadwinner paid income tax solely in his or her own name. •• A trust may also be used for asset protection, either from the risk of bankruptcy (assuming assets are not transferred to the trust in an attempt to defraud creditors) or from a spendthrift family member who is likely to squander a family’s wealth. For example, if family assets are held in a trust and the main breadwinner goes bankrupt, then, provided the breadwinner is a beneficiary, their share of the assets may pass to other family members, rather than to creditors. •• Trusts are often used for superannuation. The trustee holds retirement savings on behalf of the super­ annuated person (the beneficiary) who, assuming the superannuation fund is a pension fund, typically has a contingent interest in the trust income until he or she reaches retirement age (e.g. 67 years). If the superannuated person is, after retirement, entitled to draw down capital from his or her super­ annuation fund, then they are likely to have a contingent interest in the income and capital of the fund. In addition, a trust does not need to be registered in the way that a company does. Often though, trusts are operated in conjunction with a company. 1.5.3 Disadvantages of a trust The main disadvantages of a trust are: •• the costs of establishing and operating the trust, •• the costs and formalities involved in dismantling the trust, •• the compliance and disclosure requirements imposed on the trust (generally related to taxation compliance), •• the trustee’s powers are limited to those expressly conferred by legislation or by the trust deed, and •• a trust cannot retain profits for business purposes. Table 1.6 summarises the advantages and disadvantages of a trust.

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c01BusinessOrganisations 22 2 May 2016 1:45 PM Table 1.6 Key advantages and disadvantages of a trust structure Advantages Disadvantages • Tax minimisation • Costs of establishment and operation • Asset protection • Costs of dismantling the trust • Superannuation • Compliance and disclosure obligations • Trustee has limited powers • Trust cannot retain profits

1.5.4 Types of trust There are three main types of trust: express trusts, resulting trusts and constructive trusts. Accountants and corporate advisers are mainly concerned with express trusts, which arise because of the settlor’s expressed intention of transferring property (e.g. $10) to a trustee, who will then hold it for the benefit of particular beneficiaries. The main types of express trusts relevant to company advisers and accountants are fixed trusts and discretionary trusts, each of which is discussed next. Fixed trusts A fixed trust is a trust in which beneficiaries’ interests in the trust property do not depend on the trus­ tee’s discretion, and in which the beneficiaries ‘take’ (i.e. receive income or capital) is fixed, though not necessarily equal, proportions. For example, figure 1.10 shows a fixed trust in which three beneficiaries are entitled to one‐third each of the income (or capital) from the trust property.

Settlor Trustee $10 (Creates a trust (Holds trust with $10) property)

Trust property ($10 + any subsequent injections of capital)

Beneficiary Beneficiary Beneficiary (Receives 1/3) (Receives 1/3) (Receives 1/3)

Figure 1.10 A fixed trust

module 1 Business organisations 23

c01BusinessOrganisations 23 2 May 2016 1:45 PM The precise proportions of trust income or trust property the beneficiaries receive depend on the terms of the trust deed. For example, one beneficiary might take two‐thirds of the trust income, with two remaining beneficiaries taking one‐sixth each. Unit trusts Unit trusts are a type of express fixed trust and are often used in commercial practice to pool the resources of large and small investors. In unit trusts, the beneficiaries’ interests are widely diversified into blocks of units (akin to shares in a company), which can be sold and resold. Each beneficiary’s equitable interest in the trust property depends on the number of units that he or she has purchased. For example, if the publicly listed unit trading trust had 5000 unit holders, each of which held one unit, then each beneficiary would be entitled to 1/5000th of the value of the trust prop­ erty. The trust property in such trusts is usually: •• cash, bank bills, promissory notes and similar securities, in which case the trust is typically known as a cash management trust, •• shares, preference shares or similar securities, in which case the trust is typically referred to as a share trust or an equity trust, •• real estate, in which case the trust is a property trust, or •• privately funded public infrastructure such as a toll road or bridge, in which case the trust is normally referred to as an infrastructure fund. The trust may be private or public. For example, a public trust may be used as part of a capital raising by offering units to the general public at a subscription price. These units may have varying rights, including rights to a fixed income, capital and voting. In addition, unit trusts may be managed or not managed. Publicly listed unit trading trusts are invari­ ably managed by professional fund managers, usually affiliated with a bank or large financial institution, whose task is to optimise returns (within prudent limits, given the risk profile) for the benefit of their unit holders. Private unit trusts may or may not be professionally managed, depending on the intention or purpose behind the establishment of the trust. Discretionary trusts A discretionary trust is a trust in which the trustee has discretion as to the distribution of capital or income from the trust. Figure 1.11 illustrates the structure of a typical discretionary trust. Apart from providing a means of asset protection, the main reasons for the popularity of discretionary trusts are that they: •• allow income streaming for taxation purposes — this enables taxpayers (e.g. where there is one bread­ winner in a family) to manage their taxation liabilities by spreading the income and capital gains across multiple taxpayer beneficiaries, and •• permit superannuants to manage the amount they contribute to superannuation, thereby enhancing their ability to manage their cash flow. It is important to be aware of the income tax rules relating to trusts and the tax treatment of minors. This topic will be covered in other units in your course. Other types of trust Other types of trust that accountants and corporate advisers encounter in practice include testamentary trusts and constructive trusts. Testamentary trusts are trusts created by a will, or a codicil to a will. Testamentary trusts normally take the form of discretionary trusts, with terms consistent with the terms of the client’s will. Constructive trusts are trusts arising by operation of law, typically because a court declares a trust to exist, rather than by the parties’ intention. Constructive trusts are commonly used by the courts as a remedy to bring about restitution of property, unwind the consequences of unjust enrichment, enable property to be traced through a number of hands, or enforce a trustee’s equitable duties.

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c01BusinessOrganisations 24 2 May 2016 1:45 PM $10 Discretionary Settlor Trustee

Trust property ($10 + any subsequent injections of capital)

Discretionary objects (Potential bene ciaries)

Beneficiary Beneficiary Beneficiary

Figure 1.11 A discretionary trust

1.5.5 Duties, rights, liabilities and powers of trustees The trustee is the legal owner of the trust property and as such has an array of rights and responsibilities.

The duties of trustees A trustee must be familiar with the terms of the trust and ensure the preservation of the trust property by, for example, organising insurance, maintaining control over the property, ensuring that it is used for the trust purpose and, where necessary, recovering the property from third parties.

module 1 Business organisations 25

c01BusinessOrganisations 25 2 May 2016 1:45 PM The trustee must also comply with a range of fiduciary duties and other rules of law and equity gov­ erning the management of trust property, including those to: •• observe the terms of the trust, including the obligation to pay the correct beneficiaries, •• act impartially, •• act exclusively for the beneficiaries’ benefit, •• invest the assets of the trust fund in investments authorised by the trust deed, by statute or court order, •• not make a personal profit from the trust (though the trustee can be paid in certain circumstances; e.g. if the trust deed allows; if the trustee and beneficiaries, all being of full age and capacity, agree; if the court orders it; or if legislation allows it), •• refrain from any activity that may conflict with their duties as trustee, or accept any position in which such a conflict of duty and interest may arise, •• keep and render separate accounts of the trust assets, and produce the accounts to the beneficiaries when required, together with all necessary information relating to the trust property, and •• personally discharge decision‐making and other responsibilities, rather than delegate these to someone else, though the trustee can engage and pay an agent (e.g. a solicitor, accountant, banker, or stock­ broker) to act in connection with the administration of the trust. If the trustee does appoint an agent, the trustee will generally not be responsible for any of the agent’s wrongful or negligent acts or omis­ sions, provided the agent was appointed in good faith. For trustees who are not professionally qual­ ified in administering trusts, it is often the most prudent course to appoint an agent with appropriate expertise to help manage the fund on their behalf. In addition, if all the beneficiaries are ‘of age’ (e.g. over 18 years, unless the trust deed specifies some other age such as 25) and all are entitled to the entire equitable interest in the trust property, the trustee must comply with any direction unanimously given by them.

The rights of trustees A trustee has certain rights, including rights to: •• indemnity and reimbursement from the trust fund for all expenses incurred in connection with the trust or in the exercise of powers as trustee. The court also has power to relieve the trustee of liability and make the beneficiaries of the trust liable if it considers this to be appropriate, •• approach the court for directions in the discharge of its duties if it considers this to be necessary, •• personal protection from suit for breach of trustee duties when acting in accordance with a court’s directions, and •• have the trust accounts examined or audited by a public accountant.

The liabilities of trustees Liabilities usually fall on a trustee personally because the trust is not a separate legal entity. A ben­ eficiary will not normally be liable. There may be exceptions though; for example, if the beneficiary has appointed the trustee as his or her agent, which would be unusual. There are at least three ways in which a trustee might escape liability. •• The trustee generally has a right to be compensated from the trust property for liabilities incurred in the proper exercise of their duties as trustee. •• A trustee and a third party may agree in contract that the trustee shall not be personally liable for trust debts to the third party. •• The court or the beneficiaries, acting together, can excuse a breach of trust. Many trading trusts attempt to protect the individuals managing the trust by making the trustee a corporation with limited assets (e.g. a $2 proprietary limited company). In such cases, the company as trustee is liable, rather than those individuals who control the company. In these situations, the trust property is often protected by including a term in the trust deed that prohibits indemnification of the trustee from the trust property.

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c01BusinessOrganisations 26 2 May 2016 1:45 PM The trustee’s powers concerning trust property Generally, the trustee can and must in good faith: •• exercise all lawful powers (including any discretion) set out in the trust deed for the purposes for which they were given, and •• do anything which is reasonable and proper for the protection and preservation of the trust property. The trustee’s usual powers in relation to the trust property are listed in figure 1.12.

• Sell and lease the trust property • Mortgage the trust property • Repair, improve and insure the trust property • Carry on business • Compromise, compound or settle any debts relating to the trust • Give receipts • Borrow • Engage valuers and auditors • Engage in legal action

Figure 1.12 The powers of a trustee in relation to the trust property

1.5.6 Other administrative issues for trustees Other administrative issues for trustees include matters associated with their appointment, and the appointment of new trustees; the removal and termination of trustees; and when, and how, trusts may be terminated and wound up.

Changes to trustees Appointment of original and new trustees The original trustee is usually appointed by the settlor and mentioned in the trust deed. The legal title to the trust property vests in the trustee. If there is more than one trustee, they typically hold the property as joint tenants. In most jurisdictions, a trust may have up to four trustees at any one time. Retirement of a trustee As a general rule, a trustee may retire: •• if the trust deed permits, •• in accordance with the relevant trusts legislation, •• if all beneficiaries of full age and capacity consent, or •• if the court consents (e.g. because of significant illness). Death of the sole trustee If there is only a sole trustee, then the trust deed should provide for what happens if that person dies. The trust deed should either indicate in whom the legal title to the trust property vests until a new trustee is appointed or contain a power of appointment (e.g. given to the settlor).

Removal of the trustee Trustees may be removed: •• if the trust deed contains an express power to this effect (sometimes the trust deed gives this power to the settlor), •• in accordance with the relevant trusts legislation (e.g. because the trustee has been convicted of crime, is insolvent or bankrupt, or otherwise undesirable), or •• if the court intervenes on the ground that the trustee’s removal is in the beneficiaries’ interests.

module 1 Business organisations 27

c01BusinessOrganisations 27 2 May 2016 1:45 PM Replacing trustees The trust legislation in each State and Territory makes provision for existing trustees’ appointments to be terminated, for the existing trustees to be removed, and for the appointment of new trustees. For example, this may occur in circumstances where the existing trustee: •• has died, •• is out of the State for at least a year, •• refuses to act, •• is incapable of discharging their duties, •• has sought release from their duties, •• is a minor (i.e. aged under 18), or •• is a deregistered corporation. A new trustee is then appointed by the person nominated as appointor in the trust deed or, if no such appointors are nominated, then by the remaining trustees (if the trust deed permits) or by the court.

Racing Parts activity

Using your knowledge of trusts from the description above, along with the information provided about David’s circumstances at the start of the module, briefly assess whether a trust could be used as part of David’s business arrangements. If a trust is potentially suitable, what type of trust would you recommend and why? Who would be the beneficiaries?

1.6 Companies

learning objective 1.6 Discuss the characteristics, regulatory processes, advantages and disadvantages of a company structure. Under law, there are two types of entities: 1. natural persons, and 2. artificial entities. A company created by registration is an example of an artificial entity. The only proof of its existence is the record of its registration with the Australian Securities and Investments Commission (ASIC). The company is artificial and has no tangible form. Therefore to operate and do things, it will need to have real people do things for it and enter into transactions on its behalf. Because a company is a separate legal entity, the owners of most types of companies have limited liability for the company’s debts. The precise liability depends on the type of company. Companies in Australia are regulated by ASIC under the Corporations Act. The Act extensively regu­ lates the internal management of the company in terms of members and officers and the external deal­ ings the company has with third parties. Just as the internal management of a partnership is governed by a partnership agreement and the operation of a trust is governed by a trust deed, the internal management of a company is governed by a set of rules. These rules may be adopted from the ‘replaceable rules’ contained in the Corporations Act, replaced by a company constitution written specifically for the company (but which must still comply with the requirements of the Corporations Act), or be a combination of both. Most of this text focuses on the company and its regulation under the Corporations Act. The following description will allow a comparison with the other business structures presented in this module. We will look at the company form in substantial detail in subsequent chapters.

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c01BusinessOrganisations 28 2 May 2016 1:45 PM 1.6.1 Key elements of a company In creating a company, there are three key elements, illustrated in figure 1.13. Two are internal to the company and the third is external: 1. members — the owners (shareholders/investors), 2. operators — the people who run and manage the activities of the company (directors and senior offi­ cers/employees), and 3. customers and suppliers of goods and services.

Operators Members

The business

Third parties

Figure 1.13 The key elements of a company

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c01BusinessOrganisations 29 2 May 2016 1:45 PM 1.6.2 Types of companies in Australia Companies are distinguished by being a separate legal entity. They can be classified into various types based on the liability of the members, whether they are proprietary or public, and their listing status. Categorised by liability, companies may be as follows. •• Companies limited by shares — such a company is formed on the basis that the liability of members is limited to any unpaid amount on the shares they hold. •• Companies limited by guarantee — a company limited by guarantee involves the members of the company undertaking to contribute specific amounts to the company in the event the company is wound up. This structure is often used for clubs and charities. •• Unlimited companies — a company in which members are liable for all debts of the company if it is wound up. In this way, the liability of members is similar to that of partners in a partnership. While not providing access to limited liability, the unlimited company form can still offer the other advan­ tages of the company structure. •• No liability (NL) companies — these companies only operate for mining purposes (s 112(3) of the Corporations Act). They are distinguished from companies limited by shares in that the company can not force shareholders to pay outstanding amounts of unpaid or partly paid shares (the shareholder will simply forfeit the shares). Companies may be proprietary or public. •• Proprietary companies — these are not public companies. They are limited to 50 members and have limits on their fundraising activities. •• Public companies — any company that is not a proprietary company is a public company. Public companies may be listed or unlisted: •• Listed companies — a listed company is a public company that has listed its securities for trading on a public securities exchange such as the Australian Securities Exchange (ASX). •• Unlisted companies — these are public companies that have not listed on a securities exchange. The focus of the following chapters in this text is on companies limited by shares. 1.6.3 Advantages of a company The advantages of structuring a business as a company are as follows. •• The members of a company have limited liability. The debts of a company, as a separate legal entity, are its own. Members have no personal liability for company debts. The extent of their liability is determined by the type of company (see s 112 of the Corporations Act). •• A company allows for perpetual succession. As a separate legal entity, the company continues indefi­ nitely, regardless of any changes in members or operators. •• The company form provides for transferability of ownership. An owner’s interest in the company can be relatively easily transferred to a new owner. In the case of a shareholder company, this is achieved simply by selling the shares. •• Most types of company can have unlimited investors. This provides potentially enormous access to funds. Proprietary companies, however, do not provide this access. •• As a legal entity, companies have contractual capacity under s 124 of the Corporations Act. This means they can enter into contracts in the same way as an individual can. •• A company has flexibility in establishing internal rules to provide guidelines as to how the company operates. •• In Australia, the company as a taxpayer pays tax at a rate of 30 per cent, which is lower than the highest rates of income tax levied on individual taxpayers. 1.6.4 Disadvantages of a company The disadvantages of structuring as a company are as follows. •• Compared to the other forms of business organisation, companies involve substantial compliance costs. These costs are incurred in the initial establishment of the company, the ongoing running of the company, compulsory auditing of the company and eventually the winding up of the company.

30 Company Law

c01BusinessOrganisations 30 2 May 2016 1:45 PM •• Companies, particularly public companies, are required to make extensive public disclosures as to their activities and financial status. Disclosures are required by law under ASIC. Public companies listed on the ASX must also make further disclosures under the ASX Listing Rules. •• ASIC, as the companies regulator, has extensive responsibilities and powers that require it to subject companies to regulation, scrutiny and potentially penalties. •• While the company is a separate legal entity and members generally enjoy limited liability, it is possible in certain circumstances to lift the corporate veil. This means that in particular situations the members or operators of a company can be held personally liable for the actions or debts of the company. The main advantages and disadvantages of the company structure are summarised in table 1.7.

Table 1.7 Key advantages and disadvantages of the company structure

Advantages Disadvantages

• Members have limited liability • Substantial compliance costs • Perpetual succession • Extensive public disclosure requirements • Ownership is transferrable • Significant regulation and oversight • Access to potentially unlimited numbers of investors • Limited liability of members can be lifted in certain • Can enter contracts circumstances • Flexibility in establishing internal rules • 30 per cent tax rate

Racing Parts activity

Based on the brief description of companies given above, along with the information provided about David’s circumstances at the start of the chapter, briefly assess whether a company could be a suitable structure for David’s business. What should David consider in deciding whether to use a company structure? If a company is a suitable structure, which type of company would you recommend, and why?

Racing Parts activity

Should David stay as a sole trader or choose one of the other business structures? This activity requires you to consider the advantages and disadvantages of: • David’s existing structure, and • the other structures —a partnership, joint venture, trust or company. In looking at the different structures, you need to consider and ask David what the key or most important issues are for him. While it is easy to list the advantages and disadvantages of each structure, you always need to consider which advantages and disadvantages are the most important to the client. This will help you come to the best conclusion. Also remember that as circumstances change for David, a structure that may be appropriate for now may not be appropriate in the future. The key issues in relation to choosing the most appropriate structure are generally: • asset protection (consider David’s half share of the share portfolio), • limited liability (David does not want to lose his house), • tax optimisation (David does not want to pay more tax than necessary), • costs (keep it cheap), • flexibility (what if David wants to add others or a different structure appears more suitable in the future), and • control (David says it is my business). Can David achieve all of his goals or will he have to compromise? The key point to note from this case study activity is that a decision on a business structure involves consideration of a range of issues (e.g. protection of assets and taxation). Always remember that other academic subjects you are studying or have studied will need to be considered in answering the basic question of what business structure David should choose.

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c01BusinessOrganisations 31 2 May 2016 1:45 PM 1.7 Incorporated association

learning objective 1.7 Discuss the characteristics, regulatory processes, advantages and disadvantages of an incorporated association structure. Many groups exist in society for purposes other than business. For example: •• community groups, •• education groups, •• sports clubs, •• religious groups, and •• advocacy groups.

These groups form organisations, whether formally or informally, to go about their activities. Many of these organisations exist as unincorporated associations. An unincorporated association has no legal standing. Depending on the purpose, size and complexity of the organisation, its members may choose to become an incorporated association. An incorporated association is a separate legal entity registered under the relevant State or Territory legislation (see figure 1.14) and is subject to a degree of regulation. One of the main reasons for a not‐for‐profit organisation to become an incorporated association is to limit the liability of its members. An incorporated association can act beyond its own State or Territory if it is registered with ASIC under the Corporations Act.

ACT Associations Incorporation Act 1991 (ACT) NSW Associations Incorporation Act 2009 (NSW) NT Associations Act 2003 (NT) Qld Associations Incorporation Act 1981 (Qld) SA Associations Incorporation Act 1985 (SA) Tas Associations Incorporation Act 1964 (Tas) Vic Associations Incorporation Reform Act 2012 (Vic) WA Association Incorporation Act 1987 (WA)

Figure 1.14 The State and Territory Association Incorporation Acts

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c01BusinessOrganisations 32 2 May 2016 1:45 PM Note that a not‐for‐profit organisation can alternatively form a cooperative or certain of the corporate forms, including a public company limited by guarantee or a proprietary company limited by shares. 1.7.1 Key features of an incorporated association An incorporated association is required to have a constitution that sets out how the association will operate and what the obligations are between the association and its members. The association is required to have a management committee (generally a president, secretary and treasurer) that is responsible for managing the affairs of the association and ensuring it complies with its constitution and legal requirements. Once registered, an incorporated association is a separate legal entity that can enter contracts and own property in its own name. Provided it complies with its legal obligations, the members and officers of an incorporated association will have limited liability.

Management Members committee

The incorporated association

Third parties

Figure 1.15 The incorporated association

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c01BusinessOrganisations 33 2 May 2016 1:45 PM 1.7.2 Advantages of an incorporated association The main advantages of an incorporated association are as follows. •• Incorporated associations are cheap and straightforward to establish compared to a company. •• The ongoing costs to comply with disclosure and other regulatory obligations are minimal compared with the company form. •• Incorporating an association enables it to enter into contracts and own property. •• Incorporating an association provides its members with limited liability. 1.7.3 Disadvantages of an incorporated association The main disadvantage of an incorporated association are as follows. •• Incorporated associations are regulated and involve more disclosure obligations than an unincor­ porated association. •• Incorporated associations have more administrative obligations, including the need to maintain a register of members, conduct regular meetings and have formal minutes. Table 1.8 summarises the key advantages and disadvantage of the incorporated association structure.

Table 1.8 Key advantages and disadvantages of the incorporated association structure

Advantages Disadvantages • Cheap and easy to establish • More disclosure obligations than an unincorporated • Minimal costs compared to other corporate forms association • Can enter into contracts and own property in its • More administrative and record-keeping obligations own right than an unincorporated association • Members have limited liability 1.8 Business names

learning objective 1.8 Outline business name registration requirements. The philosophy underlying the regulation of business names is fairly simple. Every adult person in ­Australia is entitled to trade under their own name, provided: •• the person does not have some legal incapacity that precludes them from managing their own affairs (e.g. being an undischarged bankrupt or being of unsound mind), and •• the business name does not mislead the public into believing that the business is actually someone else’s. Sole traders often choose to operate under their own name. To do so, the name must simply be their full name, being first name and last name (as in the following examples). •• Sally Miller has a jewellery business named ‘Sally Miller’. As her business is trading under her own name, she does not need to register for a business name. •• Jodie Hart has a floral business named ‘Hart Flowers’. As her business is not trading under her own name, she needs to register ‘Hart Flowers’ as her business name. Partnerships can also choose to operate under their own names by simply listing the name of every partner. However, if a sole trader or partnership wishes to operate under a name other than their own, such as ‘Bill’s Shoe Repairs’ or ‘Nguyen and Tran Engineering’, they must, under the Business Names Regis­ tration Act 2011 (Cth), register the name and their details with ASIC. Trusts, joint ventures and companies must register their names with ASIC. 1.8.1 Registration Business name registration involves recording the business name, and the details of the people trading under that name, on ASIC’s Business Names Register (www.business.gov.au/registration‐and‐licences/ Pages/register‐your‐business‐name.aspx). ASIC charges a nominal registration fee to help cover the administration costs of maintaining the register. The Business Names Register is available for public viewing and includes the details of every business name that has been registered in Australia.

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c01BusinessOrganisations 34 2 May 2016 1:45 PM A key purpose of this public register is to protect the public and other businesses by enabling them to identify those people who trade under names other than their own. Anyone can search for any particular business name on the Business Names Register and so see the identity of the person or people trading under that business name. In this way, the public register promotes transparency, and people are pre­ vented from ‘hiding’ behind a business name that may have little or no association with their own name. Banks and other credit providers will usually need to sight a registration certificate or proof of regis­ tration before opening an account or providing a loan in the name of the business. The registration process Prior to 28 May 2012, business names were registered with the authorities in each State or Territory. Since then, a national system of business name registration has been in place. The process to register a business name is relatively straightforward and is performed online at ASIC’s web site (www.asic.gov.au). A fee is payable to ASIC and the registration of the business name lasts for either one or three years, depending on which period the business chooses. The process is summarised in figure 1.16.

Was your business name Yes registered in a State or Territory before 28 May 2012?

No

You do not have to register your business Are you exempt from registering your business name your business name was automatically name under one of the exemptions in — transferred to the Business Names Register on the Business Names Registration Act? 28 May 2012. No Yes

Are you ‘carrying on a business’ You do not need to register your business name. under your business name? No

Yes

You must lodge an application to register If your proposed business name is ‘available’, your business name at www.asic.gov.au. pay the registration fee.

To apply, you will need to create an ASIC Ensure your details on the Business Names Connect account and must provide certain Register remain correct and up-to-date. information, including: • the ABN of the proposed business name holder; • your proposed business name; • your preferred registration period If you wish to continue using the business name, (1 or 3 years); renew your registration before it expires, and • the ‘business name holder’ and their details; pay the registration renewal fee. • a street address for the principal place of business; and • a street address for service of documents from ASIC.

Figure 1.16 ASIC’s business name registration process4

4 Adapted from Australian Securities and Investments Commission, ‘Registering your Business Name’, Regulatory Guide 235 (ASIC, Canberra, 2013).

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c01BusinessOrganisations 35 2 May 2016 1:45 PM Once a business name is registered, any changes of details (e.g. contact details) must be lodged with ASIC within 28 days. To maintain the registration of a business name, it must be renewed before it expires (i.e. before the end of either the one‐ or the three‐year period, depending on which was initially chosen), and the renewal fee paid to the department.

1.8.2 What names cannot be registered? There are some restrictions on what business names can and cannot be registered. An important first step for anyone considering a business name is to check whether that name has already been used by someone else. This can be done by searching for the name on ASIC’s Business Names Register. ASIC will not permit registration of a name that is identical or nearly identical to an existing registered business name. The Business Names Registration (Availability of Names) Determination 2012 describes what factors ASIC will consider when deciding whether or not to register a business name. In brief, ASIC will not register a name that is:5 •• identical or nearly identical to an existing name, or •• subject to an earlier application (i.e. it is not registered, but someone else’s application is being con­ sidered), or •• ‘undesirable’ (e.g. names that are offensive), or •• suggestive of a misleading association, or •• prohibited or protected by specific legislation — for example: –– occupational licensing regulations prevent people holding themselves out as chartered accountants, pharmacists or licensed electricians unless they hold the necessary qualifications to do so, –– the name ‘Olympic Games’ is protected by a special Act of Parliament passed around the time of the Sydney 2000 Olympic Games, –– the use of the word ‘Commonwealth’ is reserved for special purposes. Because it is possible for ASIC to refuse to register certain business names, it is important for busi­ ness operators to wait until ASIC issues the registration certificate before doing anything with the busi­ ness name, such as ordering stationery, advertising and signage. 1.8.3 Display and use of the business name Business names must be displayed prominently at the registered place of business. Commonly, especially for smaller businesses, this may be its business premises. Many companies, however, use their accountant’s or lawyer’s address as their registered address. This is why accounting and legal firms often have a large number of company names prominently displayed on the wall adjacent to the recep­ tion desk. If a business is operated from home, then a sign prominently displaying its business name should be located at the front of the house. Business names must also be properly used on stationery, invoices and so on. It is important to note that registering a business name does not provide the business with exclusive rights over that name. To protect its business name, a business can consider registering a trade mark (if the name qualifies).

Racing Parts activity

David Douglas has been operating as a sole trader under the name ‘Racing Parts’. If David chooses a new business structure, what implications (if any) would that structure have for his use of a business name?

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c01BusinessOrganisations 36 2 May 2016 1:45 PM

5 Business Names Registration Act 2011 (Cth); Business Names Registration (Availability of Names) Determination 2012. SUMMARY

1.1 Define the key business structures used in Australia and list some of the factors to consider when choosing an appropriate structure. The main forms of business structure in Australia are the sole trader, partnership, joint venture, trust and company. These vary in many fundamental ways and each offer certain advantages and dis­ advantages over the others. The most suitable business structure will always depend on the nature of the specific business in question and the specific aims and circumstances of the business owner(s). 1.2 Discuss the characteristics, regulatory processes, advantages and disadvantages of a sole trader structure. A sole trader is a business owned by one person. The business has no legal identity separate from the owner. A sole trader is the simplest form of business structure, and involves very few legal for­ malities. A sole trader receives all the profits, but also bears all the risks and losses of the business. They are personally responsible for all the debts of the business and, if they are either unwilling or unable to pay those debts, they can be made bankrupt. 1.3 Discuss the characteristics, regulatory processes, advantages and disadvantages of a partnership structure. A partnership is an association of 2 to 20 people (with some exceptions allowing for larger partner­ ships) coming together in business in common with a view to a profit. Each partner is both a prin­ cipal and an agent for every other partner in respect of acts and omissions in the normal course of the partnership business. Partners share profits and losses, and partners are jointly and severally liable. 1.4 Discuss the characteristics, regulatory processes, advantages and disadvantages of a joint venture structure. A joint venture is an association of people coming together in business, each of whom seeks to make an individual (though not shared) profit. Joint venturers are severally but not jointly liable for wrongful acts and omissions that occur during the normal course of the business. 1.5 Discuss the characteristics, regulatory processes, advantages and disadvantages of a trust structure. A trust is a special equitable (and fiduciary) relationship. It is not a separate legal entity. The main parties to a trust are the settlor, the trustee, and the beneficiaries. The settlor is only involved during the establishment of the trust. The trustee is legal owner of the trust property. Each beneficiary holds an equitable interest in the trust property. Trusts have a number of uses, including for taxation min­ imisation and asset protection. 1.6 Discuss the characteristics, regulatory processes, advantages and disadvantages of a company structure. A company is a separate legal entity in its own right and is regulated under the Corporations Act 2001 (Cth) by the Australian Securities and Investments Commission (ASIC). Internally, companies comprise members (owners or investors) and operators (directors and senior officers/employees). Externally, the company structure has customers and suppliers. A variety of company types exist, distinguished by the liability of their members and other considerations. Depending on the type of company, the advantages can include limited liability, perpetual succession, transferability of owner­ ship, unlimited investors and the ability to enter contracts. The disadvantages include the high costs, disclosure obligations and extent of regulation. 1.7 Discuss the characteristics, regulatory processes, advantages and disadvantages of an incorporated association structure. An organisation may register as an incorporated association under the respective State and Territory legislation. An incorporated association is a separate legal entity and the liability of its members is limited. Incorporated associations are subject to a degree of regulation, but much less so than companies.

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c01BusinessOrganisations 37 2 May 2016 1:45 PM 1.8 Outline business name registration requirements. Every person is entitled to conduct a business under their own name. A sole trader can operate under their own personal name and a partnership can operate under a complete list of its members names, provided the exact first and last names are used. To operate under any other business name, the business must apply to ASIC for registration of the business name under the Business Names Registration Act. ASIC will assess the application against a number of rules, including looking at whether the name or a very similar name is already registered.

KEY TERMS Beneficiary A person for whose benefit the trust property is held. Business name registration Recording the business name, and the details of the people trading under that name, on ASIC’s Business Names Register. Company A separate legal entity formed under the Corporations Act 2001 (Cth). Discretionary trust A trust in which the trustee is given discretion as to how the trust income and trust property is distributed to beneficiaries. Fiduciary duties Equitable duties to act in good faith for the benefit of another. Fixed trust A trust in which beneficiaries’ interests in the trust property do not depend on the trustee’s discretion. Incorporated association A not‐for‐profit organisation that is a separate legal entity and provides limited liability for its members. Incorporated limited partnership A partnership that is a separate legal entity and in which some of the partners have limited liability. Joint and several liability In a partnership, each individual partner is responsible for any and all liabilities that arise from the actions of the partnership. Joint venture Two or more parties engaged in a joint enterprise. Limited liability The liability of the members of an organisation for the debts of the organisation is limited to the amount owing on any partly paid shares or the amount the members have guaranteed to contribute. Limited partnership A partnership in which some partners have limited liability. Members The owners (shareholders) of the company. Operators The people that manage the activities of the company. Partner A member of the partnership. Partnership A relationship or association between two or more entities carrying on a business in common with a view to making a profit. Partnership agreement A contract between the partners in a partnership, regulating the operation of the partnership. Settlor The person who creates the trust (usually an accountant). Shareholders The owners of a company. Sole trader A business owned by one person and that has no separate legal existence from the owner. Statutory duties Duties imposed by legislation. Tenants-in-common Co‐owners of an asset where each has a defined, not necessarily equal, share of the asset. Trust A relationship or association whereby one party holds property for another. Trustee The person who administers the property of the trust. Unit trust A trust in which the trust property is divided into units which can be bought and sold on the open market. Unlimited liability The situation in which an owner of a business is personally liable for all the debts of the business.

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c01BusinessOrganisations 38 2 May 2016 1:45 PM Acknowledgements Photo: © Andrei Rahalski / Shutterstock.com. Photo: © Tyler Olson / Shutterstock.com. Photo: © Pressmaster / Shutterstock.com. Photo: © Kzenon / Shutterstock.com. Photo: © wavebreakmedia / Shutterstock.com. Figure 1.16: © Australian Securities & Investments Commission. Reproduced with permission.

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