For QBCC licence holders, the benefits of trusts carry a burden when it comes to assessing the Minimum Financial Requirements (MFR).
This article was originally published 18 November 2019.
Trusts have long been a preferred structure for small- and medium-sized business, and for good reason. Whether it is their flexibility in distributing income to beneficiaries or their robustness with regard to asset protection, trusts are key to the structuring toolkit of business advisers and a common feature in most business structures.
However, for QBCC licence holders, the benefits of trusts carry a burden when it comes to assessing the Minimum Financial Requirements (MFR).
In a trust structure, the QBCC licensee is the ‘trustee’. This is usually a ‘two dollar company’ where the business asset is the $2 of paid-up capital required for its incorporation.
Furthermore, any assets of the trust are held by the trustee only for the benefit of the beneficiaries and are specifically excluded in the MFR regulations in calculating the trustee’s Net Tangible Assets. This means a company trustee usually relies on a Deed of Covenant and Assurance from a beneficiary, a director, or a related company in order to have sufficient Net Tangible Assets to support its Maximum Revenue.
In contrast, but less frequently, the trustee of the trust can be an individual, in which case all of the individual’s assets and liabilities need to be considered in calculating the trustee’s Net Tangible Assets.
On the flip side, all of the liabilities of the trust need to be included in calculating the trustee’s Net Tangible Assets. The value of the liabilities to be included is reduced where the trustee has a right of indemnity against the assets of the trust. However, any indemnity is dependent on the trust deed provisions, which makes it important to read your deed.
Given that most trusts are established with only $10 of settlement capital, any intangible or disallowed assets in the trust, or even a small trading loss for a particular year, could easily result in an amount of trust liabilities to be included in the trustee’s Net Tangible Assets. When subtracted from the trustee’s own assets of $2 of paid-up capital, any deficit would easily result in the QBCC licence holder’s Net Tangible Asset position being less than $0.
Importantly, this outcome is an immediate failure of QBCC requirements and is unsalvageable even by a Deed of Covenant and Assurance.
The Current Ratio calculation takes a simpler approach and includes the eligible current assets and current liabilities of the trust to the trustee’s current assets and current liabilities.
What of the Unpaid Present Entitlements (UPE’s) of the beneficiaries? Advisers often view these as the equity of the trust, the profits left behind by the beneficiaries to help the trust earn more profits in the future.
For many years, the ATO has asserted that UPE’s are ‘financial accommodation’ akin to providing a loan. The QBCC is more black and white on the issue.
The QBCC directs that these unpaid amounts owing to beneficiaries are to be included in the trust’s liabilities. Whether these amounts are current liabilities or non-current liabilities is less clear and is a question to be determined by the provisions of the trust deed, the accounting standards, and the expected timing of payment.
Given the difficulty for trustees to meet the requirements of the Minimum Financial Requirements, special consideration must be given when trading using a trust. As for all QBCC licensees, those currently trading though a trust structure should monitor their QBCC specific financial position closely.
The question should be continually asked; is a trust the right vehicle for me to operate a QBCC licensed business?
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Further insights on the QBCC reporting changes from our BDO specialists are available here.