Before making a decision about business structure, you need to consider the various factors that will determine the relative responsibilities, advantages and disadvantages of each structure: taxation requirements and liabilities, legal liabilities and costs, and capital and management requirements. The structure that you choose should take into account the possibility that your business structure may need to change over time, as well as providing for profit distribution, tax reduction and asset protection. There are four main business structures commonly used by small businesses: sole traders, companies, partnerships and trusts.
This is a simple structure where you operate a business under your own name, you are the business. It is a simple structure to set up and run. If you don’t want to use your own name you can register a business name through the Department Of Trade Fair Trading New South Wales and trade under that name. If you think you will turn over more than $70,000 you will need to get an Australian business number (ABN) and register GST.
If you operate your business as a sole trader, you trade, control and manage all aspects of your business, although you can decide to employ people to assist you.
The advantages of operating as a sole trader are:
- It is simple to set up since there are very few legal and tax formalities involved,
- It is simple to operate,
- It is a relatively inexpensive business structure and it requires fewer reporting requirements than most other structures,
- You have full control of the business,
- You are considered the business owner and not an employee of the business, which means that your pay is a distribution of profit and not a “wage” for tax purposes,
- You receive the full benefit of profits made by the business,
- You keep all the after-tax gains if you decide to sell the business,
- You can register your Tax File Number (“TFN”) to lodge tax returns,
- You do not have to pay payroll tax, superannuation contributions or compensation insurance if you do not have any employees but you can make superannuation contributions to yourself,
- As a sole trader you do not need to open a separate bank account for the business but you have to keep financial records for at least 5 years,
- It is quite simple to wind up the business if needed, and if the business grows it is relatively simple to change business structure.
The disadvantages of operating as a sole trader are:
- You have an unlimited responsibility for all debts and losses incurred by the business, which means that all of your personal assets may be seized to recover a debt,
- Losses incurred by the business may be offset against other income earned,
- Business profits and losses cannot be split with family members,
- You need to pay tax on all income derived from the business.
If you operate your business as a partnership, you’re carrying on your business with one or more other people as partners and receiving your income jointly. There can be maximum 20 people jointly operating a partnership.
There are two different types of partnership: general partnerships and limited partnerships. The main difference between the two is that each partner in a general partnership assumes unlimited liability for the partnership’s debts and can incur obligations on behalf of the partnership. In limited partnership’s there must be at least one general partner who is responsible for the day-to-day operations of the business and who has unlimited liability for the partnership’s debts. The limited partners make initial capital investments in exchange for sharing the profits made by the business, however, they do not take part of the day-to-day operations and they cannot incur any obligations on behalf of the partnership. The only risk you take as a limited partner is to lose your initial investment.
The advantages of operating a partnership is the following:
- It is inexpensive and relatively simple to set up,
- It does not require a lot of bureaucracy,
- Greater access to finances from the resources of all partners,
- There are more people to share the work load,
- There are more people to share losses and legal responsibilities,
- As a limited partner you only risk losing your initial investment.
The disadvantages of running a partnership are:
- The partnership is not a separate entity, which means that you are liable for all debts incurred by the business (if you are a general partner), all partners own the business and its assets jointly and are equally responsible for debts. So even if you only own 10% of the partnership, you’re personally responsible for 100% of its debts (as are the other partners).The Partnership Act together with your partnership agreement governs your rights.
- The management of the business is shared between more people,
- Since the partners are not employees of the business, each partner needs to arrange for his or her superannuation,
- Changes of ownership can be difficult depending on the partnership agreement and financial resources,
- About taxes, a partnership is not a legal “person” of its own and does not pay tax, but it does need to have a tax file number and lodge a return and business profits are distributed among the partners, who pay income tax on them.
A partnership is not a separate legal entity and does not have to pay tax but it requires a separate TFN and you need to lodge a return. There is a possibility to apply for an Australian Business Number (“ABN”) and if you have an annual income that equals $70,000 or more, you need to register for GST.
If you operate your business as an incorporated company, the business is a distinct legal entity that is regulated by the Australian Securities and Investment Commission; a company is a more complex business structure. Usually, the set-up and administrative costs for a company are higher than for other business structures. That gives you an extra level of flexibility in managing your business affairs. It also reduces your personal responsibility for business debts and other liabilities. In theory, your exposure is limited to the “paid up capital” of the company. This is the amount you and other shareholders have paid to own shares in it. But lawmakers are increasingly “tearing the corporate veil” to make company directors personally liable to a range of legal actions, while lenders will often ask you for a personal guarantee.
The advantages of operating as a company are:
- The fact that the company is a separate legal entity gives an extra level of flexibility in managing the business,
- Your liability for debts incurred by the business is limited to the amount of your initial investment in the business, the amount you paid to own shares in the company,
- It is possible to distribute profits to other shareholders, such as family members,
- If you would want to sell the business or make changes in ownership it is relatively simple,
- A company has far greater access to capital for the running of the business,
- A company pays tax on its own profits,
- Shareholders are not liable for the debts of the business,
- Increased asset protection.
The disadvantages in operating a company are:
- It involves more paperwork and bureaucracy,
- The need for compliance is higher running a company,
- The cost related to setting up the business is higher.
The company needs to pay taxes at a flat rate of 30% and the shareholders can choose between reinvesting profits in the company or to paying out the profit as dividends. Since the company already pays taxes for the profits made, dividends can come with “franking credits” which are credits for the tax already paid by the company. A company can also claim tax deduction for directors’ wages and other salary costs.
Setting up: you need to:
- Create a new company or buy a “shelf” company and register it with ASIC.
- Register for an Australian Company Number (ACN), an ABN on the Australian Business Register, and a tax file number.
- Register your business name and register for GST.
Total set up costs are around $1,500–$2,000.
If you operate your business as a trust, you’re a trustee responsible for holding property or income for the benefit of others (the beneficiaries). The beneficiaries and trust rules are set out in the “trust deed”. In a discretionary trust, the trustee has enormous flexibility in distributing each year’s income among the beneficiaries. The most common variety of trust is the discretionary trust. So, although the trust usually pays no tax itself, it can give you significant tax planning opportunities. And because the trustee is personally liable for the trust’s debts, it can limit your liability — especially if the trustee is a company.
The advantages of operating as a trust are:
- A trust has a limited liability if the trust is a company,
- A trust has perpetual existence and does not cease with the death of a beneficiary,
- Increased asset protection,
- Flexibility in distributing profits to beneficiaries,
- The process of selling or making changes to ownership is easy.
The disadvantages of operating a trust are:
- There is more paperwork involved,
- The cost for setting up a trust is higher,
- The need for compliance is higher,
- The trust has a lifetime limited to usually 99 years.
Taxes are paid by the beneficiaries, to whom the profits are divided. A trust generally does not pay tax.
- You need to register your business name, register an ABN on the Australian Business Register, and a tax file number, and register for GST if you turn over more than $70,000 a year.
- You should generally also ask a lawyer to draw up a trust deed (which costs around $1,000).
Total costs: around $1,400, plus trustee set up costs (if a company).
As this advice has been prepared without considering your objectives, financial situation or needs, you should, before acting on the advice, consider its appropriateness to your circumstances.
How can Citilawyers help you?
Citilawyers assists individuals and businesses with all legal issues relating to setting up new business structures by providing professional and tailored legal advice. Call us today on (02) 9233 7776 or send us a message.