Five money traps

SME owners who escaped from the grips of the global financial crisis shouldn't become complacent. As lawyers and accountants will warn you, there are always plenty of traps that could damage a business and, in turn, the personal finances of its owners.

A principle in behaviourial finance is the tendency to place too much confidence in your own abilities. And that confidence may well be boosted if you have survived unscathed from the impact of the GFC.

Indeed, an accountant specialising in SMEs told SmartCompany in confidence that the firm's SME clients had thrived over the past couple of years.

This could be a particularly vulnerable time for an over-confident SME owner to fall into a money trap.

These traps not only involve making mistakes. They can involve neglecting to take adequate protection from financial setbacks that might occur and failing to take advantage of excellent opportunities.

Here are just five of the numerous money traps – with particular emphasis on the consequences for personal finances of SME owners:

1. Letting the halving of the concessional super caps handicap your asset-protection strategies

Few personal asset-protection strategies can rival simply making large, regular contributions to super. This has been a popular strategy for SME owners who are realistic enough to acknowledge that the possible failure of their businesses in the future may also ruin their personal finances.

In short, a fund member's entire superannuation balance is inaccessible to creditors under the Bankruptcy Act. This is provided the contributions were made for the primary purpose of saving for retirement, and not in an attempt to avoid creditors.

From 2009-10, the cap on annual concessional contributions – which include employer superannuation guarantee (SG) contributions, salary-sacrificed contributions and deductible contributions by the self-employed – have been slashed from $50,000 to an indexed cap $25,000 for most fund members. (And the concessional cap for those over 50 has been cut from $100,000 to $50,000. From 2012-13, this larger cap will be lowered again to come into line with that applying to other fund members.)

Philip de Haan, a partner of solicitors Thomson Playford Cutlers, suspects that the halving of the concessional contribution caps unfortunately will encourage many SME owners to reduce their use of super as a means to protect personal savings from possible future creditors.

De Haan points out that the same asset protection can be made by making large non-concessional (after-tax) contributions to super. However, these contributions do not provide any immediate tax benefits upon contribution – apart from entering a concessionally-taxed environment.

Non-concessional contributions have an annual cap of $150,000 cap. However, this cap can be averaged over three years – making a contribution of up to $450,000 in a single year possible without exceeding the limit.

This means a married couple in their 40s, for instance, could still contribute a total of up to $950,000 in concessional and non-concessional caps, if appropriate for their personal circumstances, without overshooting any cap.

Watch you don't exceed the contribution caps – perhaps after contributing a large inheritance into super.

Members who overshoot both the concessional and non-concessional contribution caps are taxed at an effective rate of 93% on some excess contributions.

2. Holding business premises in a DIY super fund – without first thinking about the possible consequences

Sydney tax and superannuation lawyer Robert Richards warns that small business owners commonly hold their premises in their self-managed funds without considering what might occur if a member dies or retires.

Depending upon the circumstances, this can be a disaster waiting to happen.

Richards gives the example of two business consultants whose separate self-managed super funds equally own the small office building containing their consultancy.

If one consultant retires and wants to be paid all of his super benefits as a lump sum, the building would have to be sold or the other consultant's super fund would somehow have to raise the money to buy the other fund's interest.

"It's a huge problem when you think about it," Richards says. "SME owners often have their business premises as the dominant asset in their self-managed funds."

Under the Superannuation Industry (Supervision) Act, self-managed funds are permitted to borrow to buy investments – using instalment warrants and other means – provided strict conditions are met.

And funds, Richards says, can borrow to acquire full ownership of an asset from another fund. But a fund's trustees may not wish to borrow – particularly if its members are nearing retirement.

Richards gives another example of two entrepreneurs who are both members of the same DIY fund that owns their business premises as its sole asset, apart from a little cash and a few listed shares.

If one of the entrepreneurs suddenly dies, the fund must legally pay the deceased's super death benefits within a reasonable time as a lump sum or superannuation pension. The benefits cannot remain in the fund.

In most instances, Richards says the fund in this example would face a forced sale of the business premises – unless enough money can be contributed into the fund within the annual contribution caps.

Under superannuation law, a fund cannot borrow in order to finance the payment of benefits.

3. Failing to employ your non-working spouse part-time in your business – depending upon your family circumstances

Business owners should think about giving their non-working spouses a part-time job and making extremely large salary-sacrificed super contributions on their behalf.

This strategy, a favourite of SmartCompany, can be one of the most tax-effective to split income and to save for retirement. But understand; the money will be locked in the super system until the spouse's retirement or a transition-to-retirement pension is taken from age 55.

In short, the size of salary-sacrificed contributions for employees, including spouses working part-time, can much exceed the market value of their work, Richards says.

The tax commissioner has given an assurance that he will not use his anti-avoidance powers against these arrangements – apart from in exceptional circumstances.

Richards says anyone contemplating the strategy should also always remain aware of the alienation of personal services income (PSI) rules.

As SG and salary-sacrificed contributions are subject to the standard 15% contributions tax upon entering the fund, it is essential to check whether the strategy of making extremely large, salary-sacrificed contributions is tax-effective given the spouse's personal circumstances. These circumstances include the size of the non-concessional contributions cap applying to them.

Significantly, the $6,000 tax-free threshold and the low-income tax offset can mean it is more tax-effective for people under 50 working part-time and whose maximum contributions are limited by the lower contributions cap to make personal, after-tax contributions.

Get specific tax advice for your family's circumstances. The advice is crucial.

4. Ignoring the possibility of divorce

The breakup of marriages and de facto relationships could destroy an SME owned by one or both estranged spouses. ABS statistics indicate that up to 40% of marriages will end in divorce.

There were 118,756 marriages and 47,209 divorces in 2008 (the latest figures available). And these figures don't include de facto relationships, which are now within the jurisdiction of the Family Court.

Just think of how the breakdown of your marital relationship could possibly destroy both your business and your personal finances.

In a near worst-case scenario, the Family Court in a dispute property case might order, for instance, that the value of the business be split between the spouses.

This could necessitate either its forced sale or the person who wants to retain the business deciding to take a large loan to meet the terms of a court-order property settlement.

The family law team with Argyle Lawyers emphasises that the Family Court is generally reluctant to order the sale of a family business. However, the court could consider such an order – depending upon what other marital assets exist.

Holding the business in a company or trust may not provide protection from a Family Court order. The court can make orders against third parties, including companies and trusts.

A way to possibly protect a family business from the impact of a marriage breakdown is to enter a so-called binding financial agreement with your partner that stipulates how marital assets will be divided if the relationship fails. These agreements can be entered into before a relationship begins (commonly known as a pre-nuptial), during a relationship or after a relationship ends.

And apart from in limited circumstances, the Family Court cannot override a properly prepared binding financial agreement.

It is a smart idea to talk to a good family lawyer about this strategy – even if your relationship is not experiencing difficulties.

5. Holding appreciating business and personal assets in a company

This is a fundamental and potentially costly mistake.

Unlike individuals, trusts and super funds, companies are ineligible for the 50% CGT concession upon the disposal of appreciating assets held for a minimum of 12 months.

"Always buy appreciating business assets in a trust," advises Robert Richards. "Business premises, for example, held in a trust can be leased to a business's operating company at commercial rates."

"Unit trusts could also own a business's intellectual property and goodwill," Richards adds.

Discretionary trusts may be appropriate for income-splitting purposes if a business is owned by one person or one family. Business partners generally do not favour discretionary trusts, wanting the certainty of distributions.

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