With so many decisions to make when starting out in business, it’s sometimes hard to know which way to turn. One of the biggest decisions you’ll face relates to your business structure. But how do you know which business structure you should choose?
In Australia, there are four common business structures to choose from. And although it’s possible to change the structure of your business as it grows, it can get complex. Especially when it comes to legal obligations.
Thinking about it, and getting the right advice early, will set you up for your business to grow and thrive.
Let’s take a look at the options.
Simple and inexpensive to set up, operating as a sole trader means you manage and operate the business under your name. The most common business structure in Australia, it’s suitable for contractors, tradies, home businesses, service-based businesses, e-commerce stores, and most small businesses.
Sole traders pay tax at the individual tax rate. And the tax-free threshold is also the same. As a sole trader, you’ll need to lodge an individual tax return in the same way you would as an employee.
If, however, you’re projecting considerable growth and you need flexibility, you may want to consider other business structure options.
A partnership is an association of two or more people who undertake business as partners. Commonly used for professional service businesses, this business structure is also relatively inexpensive to set up.
When there’s more than one person involved though, things will always need a little more consideration. Some things you’ll need to think about include:
- personalities and if you have the same vision for the partnership
- how you’ll work together and what roles will each partner take on tax, insurance and superannuation requirements
- what will happen if one partner is injured, retires or passes away?
You’ll also need to keep in mind partners may be held personally liable for the debts of the business. And not just your share. If one partner does not pay, the other partner/s may be forced to pay their share.
But that doesn’t mean there aren’t benefits to a partnership model. It simply means taking the time to consider, discuss and get professional advice to put together a Partnership Agreement that’s right for all involved.
A company is its own legal entity and is ideal for businesses that want to grow and scale. You can be the sole shareholder or have multiple shareholders.
This structure limits liability to its shareholders, meaning if something goes wrong your personal assets are usually protected. Limited liability is particularly attractive for high-risk businesses.
Being structured as a company can have considerable tax benefits and concessions. It will however cost you more than other structures to set up. And there are ongoing administrative and reporting obligations. Companies are regulated by the Corporations Act and they must abide by their statutory obligations.
If your company has more than one shareholder, they’ll usually vote on any significant business decisions. It’s important to set out voting rights and management processes in the Company Constitution when establishing the business.
There is no tax-free threshold for companies. You’ll pay tax on every dollar the company earns at the full company tax rate at 30%. Some companies are eligible for the lower tax rate of 27.5%.
This is often a consideration when business owners switch from a sole trader structure to a company. Because their personal taxable income may have risen to the point where their tax is now more than 30%. So it can make financial sense to make the switch. Your business accountant can assist in helping you work out if it makes financial sense to make the change.
Company tax rates apply to:
- corporate unit trusts
- public trading trusts
A Trust is an arrangement where an overseer, known as a trustee, manages assets. This can be either an individual or corporate trustee. A trust distributes its income to beneficiaries (such as other family members) who are on lower tax rates.
The Trustee acts as the manager of the business making decisions and distributing profits to the beneficiaries of the trust.
An individual trustee could be personally liable for the trust’s debts. If a trust has a corporate trustee, the company’s shareholders receive protection from the company’s limited liability.
All income must be distributed, or otherwise, it will be taxed at the top marginal tax rate (currently 45%). The trust structure, therefore, isn’t suitable for businesses needing profits to be distributed back into the business for growth.
Generally, the beneficiaries of the trust declare the amount of their entitlement from the trust in their own tax return. Then they pay tax on it, even if they didn't actually receive the income.
Getting professional advice and help to set up a trust is essential.
Consider tax rates and concessions
Each business structure has different tax obligations:
- Sole trader profits are taxed as personal income
- A partnership is not a separate taxable entity. Each partner must declare their individual share of the partnership's net income or loss in their individual tax return
- Companies pay 30% on income. And there are requirements for keeping financial records and lodging tax returns are more stringent
- A trust structure provides avenues for distributing income to beneficiaries who are on lower tax rates.
Small business tax concessions may be available to you regardless of structure type.
Some of the concessions available include:
- income tax concessions
- goods and services tax (GST) and excise concessions
- pay as you go (PAYG) instalments concessions
- fringe benefits tax (FBT) concessions
The best plan is to get advice from professionals to determine if you’re eligible and what the requirements are.
What if I employ people?
As a sole trader or a company, you can employ people. If you do, you’ll likely have a payroll tax obligation. Payroll tax is a state and territory tax on the wages you pay as an employer. Each state and territory government has its own rules that you’ll need to become familiar with and follow.
Making the decision about what business structure is right for you
Think long term. If one option seems right now but you suspect it may not be in a year or two, it’s a good indication you should rethink the business structure you choose.
Tax implications and concessions will play a major role in your decision. But there are other key factors too:
- Is the structure realistic for your business type, size and growth?
- What are the tax advantages/disadvantages of each structure?
- Which structure best suits your situation regarding asset protection and personal liability?
- What documents will you need to set up each structure?
- Are you able to meet the requirements of the business structure?
This is where quality, professional advice helps.
Kelly Partners’ experienced business accountants work with you to give you the advice you need to determine the right business structure for your business and future.