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Businesses in Australia are usually structured in one of four ways: as sole traders, partnerships, trading trusts or companies. Depending on the nature of the business, each has advantages and disadvantages. Before choosing a legal structure, thought must be given to the future, as it is not always easy to implement a new structure once a business is up and running.
Let’s briefly consider the options and associated issues for a typical SME.
Sole Trader
If you operate your business as a sole trader you personally trade, control and manage ALL aspects of your business.
Factors to consider:
- There are very few legal and tax formalities involved setting up the business.
- This structure is inexpensive to set up.
- You have full control of the business.
- You receive the full benefit of profits made by the business and are taxed personally.
- You keep all the after-tax gains if the business is sold.
- You are legally responsible for ALL aspects of the business.
- Your access to finances is usually limited to your own resources.
- Debts and losses cannot be shared.
- You place your private assets at risk if the business cannot pay its debts.
Partnerships
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.
Factors to consider:
- Partnerships are inexpensive to set up.
- You have greater access to finances from the resources of all partners.
- There are more people to share losses and legal responsibilities.
- You share the profits with the other partners.
- You need to lodge an annual partnership income tax return on behalf of the business and pay tax on your share of the partnership profit.
- You and your partners are jointly responsible for the debts of the partnership, even if you do not directly incur or cause the debt.
- You place your private assets at risk if the partnership cannot pay its debts.
Companies
A company is a legal entity that is regulated by the Australian Securities and Investment Commission (ASIC) and is generally the preferred structure via which to run a business.
Factors to consider:
- A company pays tax on its own profits at the corporate rate of tax currently 30%.
- Shareholders are not liable for the debts of the business and hence a company offers increased asset protection to the individual.
- A company is more expensive to establish.
- The tax reporting requirements for companies are far greater than for sole traders and partnerships.
- The profits of the company remain with the company unless they are paid to the shareholders as dividends and/or as wages to the proprietors. Both have income tax implications for all the interested parties.
Trusts
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 most common variety of trust is the discretionary trust. If you’re the trustee of a discretionary trust, you have the power to decide how the profit will be distributed among the beneficiaries.
Factors to consider:
- 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.
- A trust offers increased asset protection.
- Like a company, a trust is more expensive and potentially complicated to establish.
- It may be more expensive to complete the required tax and administrative paperwork each year
- In the normal course a discretionary trust does not have to pay tax. Instead, the trust beneficiaries pay tax on their share of the trust’s net income.
- It is considered the most flexible income tax structure and offers efficient estate planning opportunities.
The reality is that often a combination of the above structures provides the best structuring opportunities and depends on each particular set of circumstances. Finally, business becomes more complex as soon as there are other people involved. Partnership or shareholder agreements are important documents that outline how people work together in business. It’s very easy to get into business with people – it’s much harder to get out.
