When starting a business, one of the first decisions you’ll make is which type of business structure you should trade in. Each has it’s pros and cons, so let’s take a quick look at your options.
Your business structure is the vehicle your business operates through. Choosing the right structure is critical, as it determines your legal obligations, reporting requirements to the Tax Office, level of bookkeeping and accounting complexity, and how you draw profits from your business.
Many people choose a more simple structure when starting out, and upgrade to a more complex structure once the business has proven itself and the expense is justified. However keep in mind that changing legal structure once you’re already trading can be a little messy. If you have solid expectations for the scale and profits of your business and are willing to spend a little extra, you may wish to establish a more future-proof structure from day one.
We’ve provided some broad general information here, but it is not intended to be personalised advice. There is also information regarding structures on the ATO website. If you are still unsure about how this information applies to you, we recommend seeking professional guidance.
Being a sole trader is the simplest and lowest cost option. This is the primary choice for most small businesses with a single owner. The business is in your own name, although you can also nominate a trading name for your business. You’ll apply for an ABN in your name, and use your own existing Tax File Number.
Your business income and expenses are reported in a sub-section of your own tax return, and you will be taxed on the business net profit at your marginal tax rate. Your bookkeeping can be done through a simple spreadsheet or use more comprehensive software if you prefer. You can register for GST and employ staff as necessary.
You are the business, and thus you’re legally liable should anything go wrong. Creditors or claimants can go after personal assets such as your house and car. This means that business liability insurance is essential.
This structure is similar to a sole trader, except it allows for multiple owners. It has a low setup cost and is the simplest choice if you have business partners. The partnership has its own Tax File Number, and lodges its own tax return. The partnership can register for GST and employ staff. Bookkeeping can be done through a simple spreadsheet or use more comprehensive software if you prefer.
To pay tax, your accountant will calculate the partnership’s income minus its tax deductions, to work out it’s taxable profit. Each partner’s share of the profit is then entered in their personal tax return, and taxed at their own marginal tax rate. Note that profits are taxable whether the partners took money out of the business as drawings or not.
If legal issues arise, partners are joint and severally liable. This means that if the partnership is sued, courts or creditors can choose to pursue any one partner (usually the one with the most personal assets) for all of the damages, not just that partner’s share. Insurance is an absolute must. A written partnership agreement is also recommended to set out the rights and obligations or partners.
A company is a separate legal entity, with its own name, ABN and TFN. The company lodges its own tax return and pays tax at a flat 30%. Directors draw money from the business by paying themselves a wage (which also incurs superannuation and Workcover costs).
To set up a company, you must have a number of legal documents prepared, including a Company Constitution (contains the company’s rules), share certificates, resolutions and appointments of office holders. You must then register the company with ASIC to get an Australian Company Number (ACN) which costs $457. The company must then apply for a Tax File Number, ABN, and any other registrations, such as GST, that might apply.
Ongoing costs include an annual fee to ASIC ($243 for 2014-15) and the cost of having financial statements and a tax return prepared by an accountant (can vary greatly, $800 – $2,000, or more for larger businesses). It must also keep fully reconciled bookkeeping records.
You can choose to be the sole director (controller) and shareholder (owner), or share these roles with a spouse or business partner. We generally recommend keeping the a company in one spouse’s name to allow for future asset protection strategies such as placing family assets in the other spouse’s name.
A company provides legal protection to its owners, because in most situations creditors and claimants can only sue for the assets of the company. The assets of the shareholders or directors are generally protected. They’re a great choice for those who run a high risk business, will own lots of business assets or are concerned about protecting their assets.
Keep in mind that companies are not eligible for the 50% capital gains tax discount, so are not the best alternative for holding capital assets that may appreciate in value, such as property. In these cases consider a trust structure instead.
There are various other legal obligations and responsibilities, which directors of a company must make themselves aware of. More information can be found on the ATO website.
A trust is a complex legal entity that is controlled by Trustees, and operates on behalf of Beneficiaries. You and your family members will be the Beneficiaries, who will all be eligible to receive distributions of profits, to be taxed at their marginal tax rate. A key benefit of this type of trust is that it can do this in a discretionary manner, which means that you can distribute taxable profits to a lower income earning spouse, for example, to take advantage of their lower marginal tax rates. In some cases this can save significant amounts of tax.
A trust has its own name, ABN and TFN. It must keep fully reconciled bookkeeping records, and have full financial statements and a tax return prepared each financial year (accounting fees can vary greatly, $1,000 – $2,000, or more for larger businesses). To set up a full company+trust structure with SmallBizLaunchPad is $1,340, including ABN, TFN all other required registrations and a wealth of information to get you started.
Control and legal liability generally rests with the Trustees of the trust. For this reason, trusts are usually set up with a company as the trustee, and then you will be the director of the company. The company will not trade or own any assets, it simply acts as an asset protection vehicle. However there is an added cost in setting up the Company as well as the Trust.
There are various other legal obligations and responsibilities, which Trustees of a Trust must make themselves aware of. More information can be found on the ATO website.
There are a number of alternative business structures, but they are more complex than what we can offer online. If you have multiple business owners with varying ownership proportions, you expect to earn large profits within your first few years of trading, your business will own high value machinery or assets, or you have any other complexities you are concerned about, we recommend seeking personalised professional advice from your accountant.
Thinking of starting a business?
How To Start A Business is your plain English guide written especially for small businesses, by Jess Murray, CPA accountant and small business expert. Choosing the right structure, how to register your business, GST, employees, bookkeeping and much more.