Are you starting a business? Which is the right business structure for you?
Start up businesses need to make one important decision from the outset – what type of business set-up will suit your enterprise best? There is ‘no one size fits all’ structure, and which structure is right for you will depend on your specific circumstances. The business structure you choose to operate under will determine the amount of tax you’re liable to pay, your personal liability/asset protection, set up and ongoing costs, your control over the operations of the business and your growth potential.
The four most common business structures are – sole trader, partnership, company or trust, with each of them having their advantages and disadvantages.
|Sole Trader||Partnership||Company||Discretionary Trust (Corp Trustee)|
|Tax Rate||Marginal rates (Upto 47%)||Marginal rate of partners||30% (26% for base rate entities)||Marginal rate of beneficiaries|
To be a sole trader is the simplest business structure, and as the name implies you will be operating the business in your own name, and will control and manage all aspects of your business. For tax purposes, your personal financial affairs and your business’s affairs are one and the same – there is no separation.
The sole trader structure is cheap and easy to set up and there are few legal formalities, but you will need an ABN (Australian Business Number). You receive the full benefit of any profit.
Access to finances is limited to your own resources, and you are legally responsible for everything the business does. You also put private assets at risk, such as your house or car, if the business goes into serious debt and these private assets are targeted in any debt collection efforts.
As a sole trader:
- Simple to set up and operate
- you use your individual tax file number when lodging your tax return
- Don’t require a separate business bank account, however, this is recommended to make it easier to track your business income and expenses
- Has unlimited liability, meaning your personal assets are at risk if things go wrong
- the income of the business is treated as your own income
- your business income is taxed at your personal income tax rates along with your income from other sources (which can be as high as 47%). This is not ideal if your expecting to make high levels of income.
This arrangement sees you carrying on business with one or more other people, and receiving income jointly. There are more shoulders to bear the burden, but also more people to share profits, losses and responsibilities. A greater chance of legal dispute between the business partners themselves also exists (when compared to a sole trader).
Partnerships are simple and cost-effective to set up, and there will likely be greater financial resources than if you operated on your own as a sole trader. On the flip side however, you and your partners are responsible for any debts the partnership owes, even if you personally did not directly cause the debt. Therefore, it is important to carefully consider who you are entering into a partnership with, as all partners are equally liable for the actions of their partners.
This means that where one partner refuses to pay a debt of the business, the other partner is still liable for the whole amount of that debt. Each partner’s private assets may still be fair game to settle serious partnership debt. This is known as “joint and several liability”.
A written partnership agreement may not be legally required in every state and territory, but these agreements are usually inexpensive and will clearly set out the terms of the partnership (which reduces the risk of a future dispute).
As a partnership:
- Relatively easy and inexpensive to set up
- Share control and management of the business
- The business itself doesn’t pay income tax. Instead, you and your partners will each need to pay tax on your own share of the partnership income (after deductions and allowable costs)
- The business still needs to lodge a tax return (require a separate TFN) to show total income earned and deductions claimed by the business. This will show each partner’s share of net partnership income, on which each is personally liable for tax
- If the business makes a loss for the year, the partners may be able to offset their share of the partnership loss against their other income.
Operating your business as an incorporated company will transform your enterprise into a separate legal entity. This business structure is usually more costly to set up and administer, and will also come under the regulations of the Australian Securities and Investments Commission (ASIC). It is owned by the shareholders and managed by the directors that are appointed by the shareholders.
A company will have far greater access to capital as shares can be issued to potential shareholders in exchange for funding, the ability to issue shares and raise capital makes the company structure suitable for those businesses looking to grow and scale. Shareholders and directors are not generally liable for the debts of the business beyond the amount of capital they have contributed, therefore asset protection is one of the main advantage’s of this structure because creditors cannot, in most cases, go after a shareholder’s or director’s personal assets, only the company’s assets, therefore, this limited liability makes the company structure suitable for higher risk businesses.
The company will pay its own tax on its own profits at the applicable company tax rate and tax reporting requirements are more onerous than those for a sole trader or partnership.
As outlined above, ordinarily a director is not liable for the debts of a company. However, there are circumstances where a director of the company can be held personally liable for the debts of the company, which will potentially expose the directors personal assets. Examples include; when a company is shown to have been trading whilst insolvent, when a directors penalty notice is issued in respect of unpaid employee entitlements such as superannuation guarantee, and when a director has provided personal guarantees for company debt.
As a company:
- Is a separate legal entity
- Business operations are controlled by the directors and it is owned by the shareholders
- Limited liability
- Money earned by the business belongs to the company
- The full company tax rate is 30% and the lower company tax rate is 26% for the 2020-21 income year. Your company is eligible for the lower rate if it is a base rate entity.
The way a trust operates can be described as an obligation or a promise, where a person or a company agrees to hold income-earning assets or property for the benefit of others. The one who legally holds the assets is the trustee, and the trustee can be either an individual or a company. A trust with a company as the trustee has been regarded as an effective structure for asset protection purposes. Those who benefit from the income are the beneficiaries.
One basic outcome of a trust is to separate legal ownership and control (which the trustee has) from beneficial ownership (which the beneficiaries hold). A natural result from this is increased asset protection, as the beneficiaries’ personal finances are not put at risk by the business, since the business assets are legally owned by the trustee and not by the beneficiaries.
The most common variety of trust is a discretionary trust – such trusts give the trustee flexibility as to who distributions of income and capital can be made to.
Setting up a trust can be more expensive, and administrative paperwork potentially more complicated. But there can be tax advantages, because:
- Tax is usually paid by the beneficiaries at their personal tax rates, which may be well below the top marginal rate
- As trustee of a discretionary trust, you can use your discretion each year to decide which beneficiaries receive income, and how much – as long as the outcomes are within the rules contained in the trust deed, which is the document governing how the trust operates
- The trust’s beneficiaries, via their individual returns, pay tax on their share of the trust’s net income “distributed”
- If all income is distributed, the trust itself would generally not be liable for any tax
- A trust will need its own tax file number, and ABN and GST obligations may apply.
Comparison – Speak to us for assistance
No one structure will suit all business types. Each individual business will have different requirements and growth plans. However, a consideration of what structure a business takes at the outset can minimise costs and risks to the business in the future.
This overview of basic structures is however general in nature, feel free to consult this office if you are considering a new business venture or changing an existing one. This will ensure that the right structure for your business is put in place.
Get in touch with us for more information tailored to your situation. Feel free to contact us on 03 7022 6838 or send us a message.