Steve often talks about his 'Three Pillars Of Wealth' Strategy, a concept that involves building sustainable wealth through:

• Developing sound money habits
• Investing in positively geared investment properties, and
• Owning several small cashflow generous businesses.

If you follow Steve's advice, it won't be long before you start to see the results in the form of a mini-empire.

My job as an accountant is to help you build your empire in a manner that will minimise your tax, while also protecting your personal assets. In accounting circles, this is better known as structuring.

In this month's Hot Topic, I will outline various structuring options within the context of a fictional case study. While this isn't a substitute for specific accounting advice, it's my hope you'll pick up some ideas or increase your understanding about alternatives that you may not be familiar with.

I'd like to remind you to always discuss your options with your accountant or adviser before doing anything.

The reason I've chosen structuring to be this month's topic is not just for its accounting appeal :)

No, structuring has been very much in the press lately, particularly with the collapse of HIH Insurance and also One Tel.

It seems that although the now defunct HIH group may have debts as high as $4billion, Mr. Williams can still live a life of luxury in his $7 million waterside mansion.

The mental picture of the stories which the media have been running are not hard to imagine. Headlines like "Millionaire Relaxes In Mansion While Creditors And Policy Holder's Suffer" have filled the newspapers recently.

So, should Mr. Williams be worried? Well, not if he hasn't done anything wrong... and even more importantly if he is correctly structured. The later certainly seems to be the case since the $7 million waterside mansion is owned in his wife's name, so it generally can't be touched.

Protection in some form or another is necessary as without it, the risk of running a business may be too great and could cause some entrepreneurs to take their businesses offshore. This would adversely impact employment and also trade, which are two sensitive issues for State and Federal governments.

Exceptions to this rule are when directors act is a deceptive manner, for example - Corporations Law makes it an offence for a company to trade while insolvent. If this occurs then the directors can be sued either personally through a civil action and/or also charged with a criminal offence.

You don't just have to be a millionaire to benefit from effective structuring. All you need is a clever accountant and something that needs protecting, which we all have if we own any valuable personal assets.

Using structuring to protect your assets comes by setting up the right sort of entity where the assets of the entity are separated from the assets of the individual.

The second benefit of effective structuring is:

At a parliamentary inquiry in 1991, Australia's richest man Kerry Packer said two spectacular quotes:

The idea behind using structuring to minimise your taxation bill comes from adopting the policy of using the lowest tax rate possible. Different entities have different tax rates. For example, the top marginal tax rate for individuals is 48.5%, yet for companies it is just 34%.

If you're confused about the various types of entities and how they are taxed, then please review the April 2001 Hot Topic titled 'Taxing Times'.

The point I'm trying to get across is that almost anyone can benefit from an effective structure, so long as you have something to protect or you'd like to potentially legally reduce your annual taxation bill.

Every type of structure has advantages and disadvantages. I've outlined some of these in the table below (you may like to read this in conjunction with the April 2001 Hot Topic titled 'Taxing Times'):

As you can see, there are a lot of different structuring options available. To try to further illustrate the difference between each type of entity, let's look at the fictional case study of Dave, a guy who wants to set up his own furniture store where he makes replicate antique furniture and sells retail to the public.

Dave estimates that in the early years of his business he'll earn a small profit in addition to a regular market equivalent wage. Over the longer term, Dave is confident that he'll make a success of the venture and will generate significant profits.

Because Dave doesn't have many assets at the moment, the concept of protecting them isn't a high priority. But he does expect that as the business grows, he'll be investing the profits in other assets.

He has subscribed to wealthtipsonline.com.au and has decided to take Steve up on his advice about developing good personal money habits. In doing so, he's invested in blue chip shares as his regular investment savings plan via an online trading account.

Before long the business surpasses all of Dave's dreams and is very successful. He makes quite a lot of money ($150,000 per year in profit) and he now has a large amount of money tied up in his bank account, debtors and inventory. His business name (goodwill) is also growing and is quite recognisable. His wife doesn't work as she looks after their 3 children.

Then one day a tragedy occurs... one of his employees trips over and breaks her neck. Despite the issues of dealing with an injured employee, the business is being sued for unspecified damages for negligence.

What would be the outcome for each type of structure that Dave could possibly have used?

Dave will personally own the business and all of its assets (debtors, stock, goodwill, equipment). If Dave loses the case then all the business assets will be lost to the value of the awarded damages. If the business assets aren't enough, then any of Dave's personal assets such as his house, car or other items of value may be seized to pay for the shortfall.

There is no difference in suing Dave or the business, as they are really the same entity. If you sued the business you can get access to Dave's wealth and if you sued Dave you can get access to the business.

Even if he is successful in defending his lawsuit, he still has the tax problem to deal with. The business profits will all be taxed in Dave's name at individual rates. As the business is now making $150,000 per year in profits, Dave will have a tax liability each year of $60,130. He can't remunerate his wife as she does not "work" in the business.

Let's assume Dave is in partnership with his wife. Partnership law stipulates that all partners are joint and severally liable for any business debts.

If someone sues the business, then the total business assets to the value of the damages are at risk. If there is a shortfall, then both partners' personal assets are up for grabs too. Note that the debt won't necessarily be allocated evenly or fairly to a particular partner. Instead, the debt will be recovered from the partner who has the most assets or the partner whose assets are easiest to liquidate.

If somebody sues Dave, one of his assets is his interest in the partnership. The business may need to be sold to access this wealth to allow him to pay the debt. Alternatively, he may be able to borrow money against the business to allow him to pay the debt. If someone decided to sue his wife the risk is still the same, as the business is still potentially "on the line".

Examining the income tax consequences, both Dave and his wife will pay tax on their share of the profit (assuming their partnership agreement has the profits are shared 50:50, so each partner receives $75,000).

The tax will be $23,755 each or $47,510 in total, a saving of $12,620 compared to a sole trader option because Dave can use two tax-free thresholds (his and his wife's).

He will still not be eligible for a tax deduction for his superannuation contributions (greater than $3,000), but he probably won't now be charged the superannuation surcharge since his income ($75,000) will probably be below the surcharge threshold.

Let's assume that both Dave and his wife are the shareholders in DaveCo Pty Ltd, a private company with one director. The company was set up when the business commenced and each shareholder owns one share.

If the business is sued, then the limit of what is on the line is the net assets of the company. The personal assets of the shareholders is generally not available to the creditors, so if Dave (or his wife) owns the family home, then it's protected as long as no one sues them personally.

If someone sues Dave personally though, one of his assets is his equity in the company. He may have to sell the business to liquidate his shareholding as well as some of his personal assets if there is a shortfall.

Companies pay income tax at a flat rate of 34% (30% from July 1, 2001). What will probably happen is that Dave and his wife (as officers of the company) will be each paid a salary of $50,000. The balance of the profit will be taxed in the company.

This will mean that both Dave and his wife will pay $12,130 each in tax and the company will pay $17,000. The total tax will be $41,260, or $6,250 less than the partnership option.

Let's assume that both Dave and his wife are directors of the trustee company. This means as individuals they effectively control the trust, but they don't own the trust or its assets.

As beneficiaries of the trust, all Dave and his wife are entitled to is a share of trust fund that are distributed at the discretion of the trustee.

If someone sued the business, then the business assets are potentially at risk but the personal assets of Dave and his wife will generally not be on the line, since they are not connected with the business. While technically incorrect, an analogy you might like to imagine here is that you wouldn't sue the shareholders of HIH because it's insolvent since they are not a part of management.

Similarly, if someone sued Dave personally, they will not be able to access the assets of the business (again, if a shareholder is sued personally, the assets of the business that they own shares in is not at risk).

It is though there is an imaginary wall between (1) the trust and (2) Dave and his wife. Creditors will find it almost impossible to get over the wall and get the assets of the other side.

Trusts do not pay any tax provided the income is "distributed" to the beneficiaries. The directors of the trustee company (Dave and his wife) can use their discretion as to who gets the income (hence the term discretionary trust).

They will probably decide that their children get $643 each (for the reasoning behind this, see the April Hot Topic titled 'Taxing Times') and that both Dave and his wife will get $50,000 each. What should they do with the balance of $48,071? They will probably want to have a company as a corporate beneficiary that will receive this distribution so that the tax rate is capped at 34%.

This means that the total tax paid is $nil for the children, $12,130 for Dave and his wife and $16,344 by the company. The total tax is $40,604. This is $1,016 less than the company outcome described above.

By quickly looking at the four options, a trust will give the best tax result as well as give the higher degree of asset protection.

This may not always be the case though.

Just because a trust is the best alternative for Dave does not necessarily mean that it is always the best alternative for you. It may be, but you should always check with your accountant first.

To assist you with understanding when a particular structure may be useful, I've created the following list. Please note that it is only a guideline!

There is almost always a structuring solution to any asset protection or tax minimisation need.

My goal with this Hot Topic was to try and provide you with a practical context on which to base your understanding of the various structuring options available to you.

I strongly suggest you don't try to become an expert at which structure is best for you. However I do encourage you to develop a working knowledge of the basics of each possibility and then discuss your specific circumstance with your accountant or adviser.

The correct structure is just one piece of a larger 'total wealth' puzzle. Don't let it become a major hurdle and stop you from getting started.

If you have any questions or comments, please post them on the Inner Circle forum board.

Sincerely,

David Bradley