Introduction
Many business owners or investors may not understand how important choosing the right structure is when it comes to investing or commencing a business. Others may assume they can always change the structure in the future, without realising the costs and administrative hassle that may be involved when restructuring.
Ideally, there would be an optimal, ‘one-size-fits-all’ structure for different types of ventures to suit all taxpayers. Unfortunately, this is not the case, as each structure has its pros and cons. Ultimately, the best choice for a particular client will depend on specific circumstances and for what purpose they need the structure.
What is asset protection?
Asset Protection involves implementing strategies to separate your assets from your business risks. Asset protection is an essential part of any business structure to be considered before a business is commenced or a significant asset is to be purchased.
The Importance of Asset Protection
Do I need asset protection?
It is important to remember that it is not just business taxpayers that are at risk of becoming bankrupt. Anyone may find themselves in a situation where they cannot pay their creditors, and consider, or be forced into, bankruptcy (for example, a person may make comments online which result in a defamation lawsuit, which may force them into bankruptcy if they lose).
Individuals and businesses have been hard hit by the shocks that began in 2020 and are continuing into 2021. Consequently, it is expected that bankruptcies and insolvencies will rise to unprecedented levels in the coming months and years.
When releasing the ‘Insolvency Practices Inquiry’ final report in July 2020, the Australian Small Business and Family Enterprise Ombudsman predicted there is a ‘tsunami’ of insolvencies to come, saying “the COVID-19 pandemic – which has come on the back of devastating natural disasters – will likely trigger a wave of insolvencies in the coming months”.
Therefore, it is important for all, regardless of how ‘at risk’ they consider themselves to be, to consider how best to protect their assets or, for businesses at risk of not being paid, how best to recover their debts.
Examples of Basic Asset Protection Strategies
WARNING – Asset protection must start early
Asset protection strategies are most effective if implemented before acquiring significant assets, therefore, when thinking about how to build wealth, thought should also be given to implementing strategies that will best protect future wealth.
The ‘art’ of asset protection involves several different areas of law that are highly complex and technical. Ultimately, if protecting their assets is a top priority for high-risk clients, it is strongly recommended they seek specialist legal advice about additional safeguards.
The following general ‘blueprint’ effectively sets out ‘three layers of asset protection
- The first layer – minimise exposure to risk
Where possible, steps should be taken to minimise exposure to successful court action. For example, a significant risk faced by professionals is that of being sued for professional negligence by a client who is aggrieved at the outcome or financial result of the service. Therefore, such professionals should ensure that advice is only provided where it is in their area of expertise (and, if not, appropriate external advice should be sought).
- The second layer – insuring against risk
Regardless of any attempts to reduce risk exposure, it is often impossible to reduce that risk to nil. Therefore, steps should also be taken to ensure appropriate insurance cover is taken out to reduce any remaining risk.
- The third layer – avoid owning assets in your name
Despite the best efforts to minimise risk exposure, you may end up facing a significant payout that is not covered by insurance. You can therefore limit the ‘damage’ in this regard by not owning any assets in your name. Rather, wealth should be accumulated in another entity that is ‘low-risk’ from an asset protection perspective, whether that be, for example, a (‘low-risk) spouse (or entity controlled by the spouse) or even a superannuation fund (where possible).
TAX TIP – Other basic strategies to consider
In addition to ensuring that assets of ‘high-risk’ spouses and entities are separated (or transferred) to ‘low-risk’ spouses and/or entities, some other basic but important asset protection strategies that should be considered by all clients include:
-
- Separating operating (e.g., trading) entities from asset holding (passive) entities.
-
- Separating different businesses from each other (and quarantining the trading risks of any one business to the confines of a ‘high-risk’ entity).
-
- Separating personal wealth and private assets from business assets and
-
- Utilising single-purpose corporate trustees, rather than individual trustees, for trusts.
Using Trusts to protect your assets
A discretionary trust has long been the ‘go-to’ structure for asset protection for many years. Where the objective is to quarantine risk to the trust (e.g., where the trust carries on a business that carries risk), a discretionary trust with a corporate trustee provides very effective asset protection. To maximise asset protection, it is important the corporate trustee only acts in its capacity as trustee of the trust (and does not, for example, carry on business or own assets in its own right).
More commonly, however, the objective of a client will be to shield the trust assets from third-party attacks, such as from a trustee in bankruptcy where a beneficiary of the trust goes bankrupt and/or from an ex-spouse or ex-partner in the event of a relationship breakdown.
Unfortunately, the effectiveness of using a discretionary trust to protect trust assets from a third-party attack has been diluted in recent times, particularly in the context of divorce.
Therefore, specialist advice is essential when considering trusts for asset protection.
Key Takeaways
- Obtain specialist advice before acquiring significant assets or starting a business.
- There is no ‘optimal’ protection strategy. Each person’s circumstances are different, and so your assets will need to be protected in a manner that suits those circumstances.
- It’s also an important aspect of making sure your family is protected in any event that may unexpectedly put your assets at risk.
Submit the form to contact our team at Prosperity Accountants and get started with an asset protection strategy.
Disclaimer: The information provided is general in nature and does not take into account your situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice.
