If you’re a small business owner in Australia, there are 4 different options to choose from when it comes to your business structure. Your small business can be structured as a Sole Trader, Partnership, a Company, or a Trust.
You may already know that your chosen business structure determines your initial and ongoing costs, your reporting responsibilities, personal liability, asset protection, and – just as importantly – the amount of paperwork you have to do! Paperless office, anyone?
But did you know your business structure can also have an enormous impact on your tax position? That’s right; carefully choosing your business structure can save you thousands of dollars at tax time, playing a vital role in the success of your small business.
Below you will find a list of pros and cons for each business structure to give you some clarity around which one might be best for you.
Structuring your small business as a Sole Trader
Becoming a Sole Trader is definitely the easiest way to start your own business; but that doesn’t necessarily mean it’s the ideal structure for you and your business goals. As a Sole Trader, the business will be owned entirely by you, but you may employ other people to help your business grow.
- Quick, easy and cost-effective to set up; ideal for first time business owners!
- A simple structure that’s easy to manage and run day-to-day.
- The business owner remains in control of the business.
- The business owner is entitled to all profits after tax.
- Sole Traders record business income and expenses on their individual tax return, instead of lodging two separate returns.
- The ATO also allows Sole Traders to use their individual Tax File Number to lodge tax returns, so there’s no need to get a business TFN.
- Far fewer reporting requirements compared with other structures
- Pay the same income tax rates as individual taxpayers. (Note: this pro may eventually become a con – see number 1 below!)
- Minimising tax becomes problematic for Sole Traders once business starts booming. You have to pay income tax at the applicable marginal tax rate, so if you earn over $180,000 the tax rate could be up to 47%! Fortunately, you can switch to a Company as soon as it makes sense to do so.
- You have unlimited liability and are legally responsible for all aspects of the business, and your personal assets are not protected.
- Your debts and losses can’t be shared.
- Raising capital is difficult because you can’t offer shares in the business.
- Taking time off can be difficult and stressful when every aspect of the business is your responsibility. If you’re a contractor, freelancer or small business owner, ABA can obliterate your overwhelm.
Get in touch today so you can focus on what matters most.
Structuring your small business as a Partnership
It’s very rare for one person to have the complete set of skills to run a successful business. Going into business with someone whose skillset compliments yours can be a really smart move, as two (or more) heads are better than one.
A partnership is a business in which two or more individuals share ownership and day-to-day operations, along with full legal and financial responsibility. Owners of a Partnership are not separate legal entities to their business, so a partnership does not pay tax on its income. Instead, income is disbursed and each partner pays tax on their share of net income they receive.
- Simple and inexpensive to set up compared to a Company.
- Minimal reporting requirements.
- Share control, management and responsibility with your business partner(s).
- Your share of the business’s tax losses may be offset against your other personal income.
- More opportunities for tax planning than if you operate as a Sole Trader. For example, income splitting is allowed.
- Relatively easy to dissolve the partnership or to resign and have your share paid out.
- Partners are not employees, which means Super contributions and workers’ compensation insurance are not payable for partners.
- A Partnership is not a separate legal entity, so your personal assets are not protected.
- A lawyer must prepare a formal agreement because personal liability is unlimited for each partner. Without an agreement, each partner is deemed to own equal shares of each asset.
- Even if only one partner is at fault, all partners must take legal and financial responsibility. You will be held liable for any shortfall if the business fails and your partner can’t afford to pay their share of the debts.
- Potential for disputes over profit sharing, administrative control and business direction.
- You have to consider the visions and business goals of the other partner(s). Misaligned business objectives can lead to friction and dispute. Make sure your visions and values are aligned before entering into a Partnership.
- Change of ownership can be difficult and generally requires a new Partnership to be established.
- Amounts you take from a Partnership are not wages for tax purposes, so you can’t claim deductions for money drawn from the business.
Structuring your small business as a Company
Most entrepreneurs start with a Sole Trader structure but, as the business grows and evolves, see the benefit in registering as a Company. Eventually, lodging a separate tax return for your small business becomes very worthwhile! You will require a separate Tax File Number and ABN for your Company, as it is considered a separate legal entity.
A Company must have at least one Director who is responsible for the operations of the Company, as well as a Secretary and a Public Officer (can all be the same person). The Director (or Directors) are responsible to the shareholders (which can be Directors), so it’s important to know your legal rights and obligations.
- Under Australian law, a Company is considered a separate legal entity from the individuals involved. This means any debts of a Company are those of the Company itself, rather than the directors and shareholders.
- Shareholders have limited liability up to the amount the individual invests as share capital, and creditors can’t access their personal assets.
- Raising capital much easier because it’s a recognised structure for both debt and equity funding.
- The company tax rate has recently been lowered to 27.5% and will continue to decrease to 26% next year, and 25% the following year.
- Once a Company is paying tax on profits, the profits are distributed as franked dividends.
- This structure is designed for flexibility and business growth.
- Business ownership can be transferred easily through the transfer of shares.
- The shareholder agreement must clarify exit and dispute processes.
- The set-up costs are much higher. Just to register your business, it could cost as much as $950. There are also more ongoing costs like accounting fees and the annual ASIC fee (currently $267).
- As there is more accounting and reporting to do, there can be a lot more paperwork involved. Fortunately, there are cloud-based software solutions that can solve this problem!
- Your business will be somewhat regulated by ASIC and Corporations Act 2001.
- You will need a separate Tax File Number and ABN for your business.
- There may be tax implications for personal expenses or withdrawing a wage.
- Loans between Directors and the Company must be paid back by the end of that financial year (30 June) or Division 7A applies.
- Directors are at risk of severe personal penalties for insolvent trading.
Structuring your small business as a Trust
Running your business as a Trust generally means you are the Trustee. You own and operate the business’ assets, distribute income to the beneficiaries, and comply with the obligations set out in your Trust deed.
Although a Trust can be a good option for family businesses, there are some tax implications that could make it difficult for your business to grow within this structure.
- A family member can be made a beneficiary without having any direct involvement in the business, making a Trust the ideal structure for a family business.
- There are asset protection advantages for beneficiaries.
- Reduced liability compared to other structures, particularly for corporate Trustees.
- The Trust does not pay tax. Instead, the Trust’s beneficiaries pay tax on income they receive at their own marginal rate.
- Flexible asset and income distribution to minimise tax.
- Trust deed generally permit Corporate Beneficiaries, meaning companies owned by the group can receive profits and pay applicable company tax rates.
- The Trust model provides a small business with a lot more privacy than the Company structure.
- Can be the most expensive and complex business structure to establish and maintain depending upon the number of people and entities involved.
- Unlike profits, tax losses can’t be distributed to beneficiares. Losses remain in the Trust and are applied to future income.
- Profits accumulated to reinvest into the business are taxed at the highest marginal rate. A Trust must distribute its profit to beneficiaries each financial year to minimise tax. This is not ideal if your business requires any working capital!
- It’s not easy to dissolve or alter an established Trust. Changing the terms or objects can lead to resettlement and liability for Capital Gains Tax and Stamp Duty.
- Loan structures can make it very difficult to borrow funds.
- Investors generally prefer to invest in a Company structure.
Whichever business structure you choose, there are two crucial boxes to tick:
- Fully understanding your tax obligations; and
- Having a plan in place to seamlessly manage your bookkeeping and accounting.