The threat of losing the family home is the stuff of nightmares for the small business owner. So how do you protect it against creditors or litigants if business starts to go bad?
According to Chris Balalovski, head of strategic advice, private wealth for Perpetual, there are several ways a business owner can ring-fence the family home from his or her business activities. He also says there are some common misconceptions about the right way to protect this important asset.
‘Sometimes people think that establishing a business in a company or trust structure gives the business owner the protection of the corporate veil and that creditors only have access to the company’s or trust’s assets and this is generally true,’ says Balalovski.
‘But as a director or trustee, if the structure has a deficit of assets to pay the debt, the creditor can sometimes use the personal assets of the director or trustee to make up the difference.’
Balalovski says there are three main ways to protect the family home in these circumstances. The first is to give majority ownership of the home to a person who is not at risk from any bankruptcy or litigation procedures – typically a spouse.
‘This does not usually incur any stamp duty or capital gains tax liabilities, but the business owner should still retain some interest in the family home to ensure the asset can’t be dealt with without their authority,’ he says, adding that this strategy ‘still means the asset is held by the family, but the business owner is largely disassociated from it”.
Emma Woolley, special counsel with law firm Hall & Wilcox, says business owners have to be aware of the traps of taking this approach.
‘If the unexposed spouse has the house in their name it’s essential to make sure they haven’t guaranteed any loans in the business. If they have, it could mean they and the home are exposed in the event of litigation.’
She says there are also estate planning considerations to be made in the event the family home is in the name of the unexposed spouse and he or she dies.
‘If the unexposed spouse has left everything to the exposed spouse, if there is litigation the house would still be under threat. An alternative is to leave everything to the kids and give the exposed spouse the right to occupy the property for life in the will.’
Woolley says business owners who have signed over the family home to the unexposed partner shouldn’t worry about getting their fair share of the value of the asset if the relationship breaks down.
‘The Family Court doesn’t care whose name the house is in, so the business owner should still be entitled to any proceeds from the sale of the home in a property settlement,’ she says.
An alternate strategy to signing over the property to the unexposed partner is to undertake borrowings and to allow a related charge to be made over the main residence. This structure means very little equity in the home would be available to an external party.
‘But as the value of the asset rises and the business owner builds equity in it, there will be greater exposure to potential creditors, so there’s a need to periodically refresh the charge to ensure not much equity is available to someone who sues the business owner,’ Balalovski says.
A third option is to use a service entity, which delivers asset protection and tax advantages. Typically a business owner would create a service entity that owns assets to be used by the business such as premises and plant and equipment and provides labour to it as well.
‘Separating these assets into a service entity means someone who might have received faulty goods or services from the business owner and who subsequently launches a legal action has never had dealings with the service entity and can’t pursue the assets held by it,’ he explains.
‘But the Commissioner of Taxation is very concerned about the rates paid to service entities, so it’s very important that the rates paid are appropriate and not artificial.’
Interestingly, superannuation has statutory protection from creditors if you are a small business owner. ‘Unless the business owner makes an unusual contribution to defeat the creditors when they know litigation is on the cards, super is protected,’ says Balalovski.