Rogerson Kenny Business Accountants Melbourne
Choosing the Right Business Structure
What type of business structure will you use? Will you be a sole trader, in a partnership, a company or a trust? There are advantages and disadvantages to consider for each. Choosing your business structure is an important decision, so you need to investigate each option carefully.
When making your decision, consider whether your activity is a business, or a hobby. Remember that to be able to claim business deductions you must be carrying on a business. Other factors to consider are the cost of set-up, the taxation implications, the expense of ongoing administration and your personal financial liabilities.
You may want to consult a professional business adviser, Rogerson Kenny Business Accountants or a solicitor for advice.
Your choice of business structure is a very important decision. Your choice of business structure (or lack of it) can affect:
- The safety of your personal assets
- Your tax position
- The continuity of the business upon change of ownership and;
- What registration process you will need to take
Your selection will depend on a number of factors including:
- The type of business you are setting up
- If and how many others are involved in the business
- How you want profits (or losses) to be shares and who is going to be legally liable for the debts of the business
- Other considerations include the anticipated profitability of the business and the relationship, financial and tax positions of all the people involved
Experience tells us that in most instances, your business structure will be some form of compromise. It may even involve multiple entities in an attempt to balance the objectives of asset protection, income tax, flexibility of income distribution or capital gains tax. You should be aware that under anti - avoidance provisions of the Income Tax Assessment Act, the Commissioner of Taxation can challenge your business structure where the arrangement was undertaken for the sole dominant purpose of obtaining a tax benefit. In such a case, the relevant tax benefit may be cancelled and penalty tax imposed.
Your choice of business structure can be of critical importance to the success or failure of the business. It can be expensive to switch structures and it could have significant tax implications.
Before you select a business structure, commence operating and prior to signing any legal contracts it is imperative that you consult with our office and possibly seek legal advice. Rogerson Kenny Business Accountants will make sure that adequate planning and consideration is given to your choice of business structure given your individual circumstances.
There are 5 main business structures (click to view):
Below we explain these structures and the taxation requirements for each.
Sole Trader
What is a sole trader?
A sole trader is a single person operating a business under their own name, e.g. James Smith, or with a registered business name, such as 'Smith Exporting'.
A sole trader is a simple business structure, giving the owner all the decision making flexibility as well as managing the financial and as your business develops, it is possible to register as a company with ease.
Often a small business will start out as a sole trader, and later, when the business develops, register as a company.
Advantages
The easiest method of starting a business is to operate as a sole trader. This way the proprietor makes all the decisions for the business and deals with all the financial matters. Other advantages include:
- establishment fees are low - contact Consumer Affairs Victoria for the current rate
- simple business structure and documentation
- the sole trader maintains full control over business decisions
- the sole trader enjoys all profits and capital
- it is easy to wind up this type of business
- taxation advantages exist when profits are low
- other than the Income Tax Assessment Act and contract law, no specific legislation applies
Disadvantages
Although operating a business as a sole trader provides greater freedom and autonomy, this business structure can also present risks to your personal finances. Operating as a sole trader has one important disadvantage and that is that the operator's liability is unlimited. If a problem arises, creditors of the business are able to make you totally responsible for all debts. This affects your personal assets and in a worst case scenario will send you bankrupt. Other disadvantages include:
- your capital will be limited by your personal assets
- the sole trader's expertise may be limited, and there is no one else to share the workload
- the sole trader is subject to unlimited legal liability
- it can be difficult for the sole trader to take time off
- responsibilities can cut into family and holiday time
- there is no one to operate the business when the sole trader is ill
- the sole trader is personally responsibility for all debts and liabilities
- it may be difficult to pass on ownership, making the business hard to sell if the proprietor dies or experiences a change in circumstances
- taxation disadvantages exist when profits are high
Business registration
In the example above, James Smith is not required to register his exact name as a business name, though he may choose to. If he is trading under any variation of his name, e.g. 'James Smith and Associates', or as 'Smith Exporting', legislation requires him to register the business name with Consumer Affairs Victoria.
Tax Obligations
As a sole trader, you are required to include a declaration of income earned from the business as a part of your personal tax return. Sole traders pay income tax at personal tax rates, though they may also be liable to pay provisional tax.
Liability
As a sole trader, you own the assets of your business and are responsible for its liabilities. Liability is unlimited and can extend to your personal assets, including your share of any assets that you jointly own with another person.
Partnership
A partnership is formed when two or more people (up to 20) go into business together with a view to making profit.
As with sole traders if the partners are operating under their own names there is no need to register but they must register a business name if they have one. A partnership has its own Tax File Number (TFN), and usually an Australian Business Number (ABN) and lodges its own, separate tax return. There is also no legal requirement for a written agreement, although it is better if there is a document that sets out the full extent of the relationship between the partners.
Advantages
- partnerships are not expensive to set up and you have access to more capital
- you have pooled knowledge, experience, skills and ability to take time off
- there are certain tax benefits where the partners are in the same family, such as husband and wife
Disadvantages
- as the business develops personalities may clash and there may be disputes over administration and profit sharing
- partners can be individually and collectively be liable to the defaults of other partner(s)
- if a partner decides to dissolve a business, it may effectively end the business
Limited partnerships
Limited partnerships differ from conventional partnerships in that they are made up of general partners, who manage the business, and limited partners, who are passive investors in the business and do not contribute to its management. Limited partners are liable for financial debts in proportion to their investment.
The benefit of a limited partnership is that the business can attract capital investment. Limited partnerships must be registered with Consumer Affairs Victoria (see External Links to the right for more details).
Partnership agreement
Although partnership agreements can be verbal; it is recommended that a written partnership agreement be prepared with the input of all partners and the advice of a solicitor.
Some of the matters it needs to cover include:
- the nature of the business
- the role and authority of each partner
- proportion of ownership of each partner
- each partner's liability to contribute funds
- the manner of dissolution
- the distribution of assets on dissolution
- the resolution of disputes
If you're planning to use a business name, register it with Consumer Affairs Victoria (CAV). Limited partnerships and incorporated limited partnerships must be registered separately from the business name with CAV. General partnerships, also referred to as 'partnerships', do not need separate registration.
Taxation
A partnership has its own Tax File Number (TFN), and usually an Australian Business Number (ABN) and lodges its own, separate tax return. However, once the Tax Office (ATO) assesses this, the partnership’s profits are divided among the partners as set out in the partnership agreement.
Each partner then adds their share of the profit (or loss) to their personal income tax for assessment by the ATO.
If operating as a business enterprise, the partnership registers to collect GST when annual turnover passes $75,000 (payable monthly, quarterly or annually). The ATO's 'personal services income' rules may apply if you are a consultant or contractor in a partnership.
Drawings
Partnerships cannot claim a deduction for money partners draw from their business. Amounts taken regularly from a partnership business, and regarded by some as their wages, are not wages for tax purposes and are not tax deductible.
GST
Partners may apply for GST registration for the partnership if t is carrying on an enterprise. This can be applied for on the ABN application form. A partnership is required to be registered for GST if its GST turnover is $75,000 or more
Personal Services Income
Income and deductions in relation to this income may be treated differently (please contact Rogerson Kenny Business Accountants for more information)
Superannuation
Partners in a partnership are responsible for their own super arrangements as they are not employees of the partnership. Partners may be able to separately claim a deduction for personal super contributions. The partnership must pay 9% superannuation guarantee contributions for any eligible workers they engage.
Company
A company is an independent legal entity able to do business in its own right. The shareholders own the company, and directors run the company. The directors of a company can be shareholders. Company employees can also be shareholders. The most popular entity for a small business is a private company. The private company need only have one director and shareholder. The company is a separate legal entity, which is not subject to a time requirement relative to being wound up, such as a Discretionary Trust (see below) which must be wound up after 80 years.
Advantages
- shareholders of the company are only liable for the money they owe on any shares they own and/or for any amount of money they guarantee to contribute upon winding up of the company
- a company can be owned and operated by one shareholder and director
- directors, managers and employees have no personal responsibility for debts unless they caused the debts recklessly, negligently or fraudulently
- limited liability can make it easier to attract investment
- a company can own property
Disadvantages
- a company can be expensive to establish - you must register with the Australian Securities and Investments Commission (ASIC). Additional costs may also apply when purchasing off-the-shelf companies or seeking professional advice
- establishment rules are complex
- companies code regulations are strict
- companies attract higher compliance costs than other business structures
- company tax is payable
- shareholders may have difficulty recovering their investment due to limitations on who can buy shares
Incorporation
An entity becomes a company when it is incorporated under the Corporations Act 2001 and is registered with the Australian Securities and Investments Commission (ASIC). The Corporations Act 2001 regulates the running of the company and sets out the duties of its officers. Usually a solicitor, lawyer or accountant will prepare the necessary documents and apply for incorporation. A company needs to register for an Australian Business Number (ABN) and its own tax file number (TFN).
Company Names and Registration
A company is subject to taxation in it's own right, and this is usually paid quarterly to the Australian Taxation Office. Shareholders receive a credit towards the tax on dividends equal to the relevant amount of tax paid by the company. A company pays income tax on it's profits, this general rate is 30%.
Liability
Due to limited liability, a company structure may be advantageous to a high risk business. However, major creditors may require directors to personally guarantee the company's liabilities. Personal liability of directors and employees can also arise if they commit an offence under the Corporations Act 2001, or are found to have negligently performed their duties. A company can sue and be sued in it's own right.
Proprietary and Limited Companies
A proprietary company must have no more than 50 non-employee shareholders and be either:
- limited by shares; or
- an unlimited company that has a share capital
A company limited by shares, limits the liability of shareholders to the value of their shares. This structure is suitable for most trading businesses. A company limited by guarantee is most often used by non-trading organisations, for example, sporting clubs.
Proprietary’ or ‘Pty’ must be included in a company name to indicate legal status and ‘Limited or ‘Ltd’ also needs to be included in a company name where liability is limited of its member.
Who pays income tax?
If a business is run as a company, the money earned by the business belongs to the company. Under the self assessment system, companies have to lodge an annual company tax return, which shows the income and deductions of the company and the company's income tax payable. Companies also usually pay PAYG instalments, which are credited against their annual income tax liability. A company pays income tax on its assessable income (profits) at the company tax rate, which is currently 30%. The amount of tax to be paid is reduced by any PAYG instalments reported during the year. There is no tax free threshold for companies.
GST
A company may apply for GST registration if it is carrying on an enterprise. This can be applied for on the ABN application form. A company is required to be registered for GST if its GST turnover is $75,000 or more. The registration threshold for non profit organisations is $150,000
Personal Services Income
Income and deductions in relation to this income may be treated differently (please contact Rogerson Kenny Business Accountants for more information)
Superannuation
Companies must pay 9% superannuation guarantee contributions for any eligible workers they engage, including company directors.
Discretionary Trust
Discretionary Trusts are a very popular way of conducting small business operations in Australia. There are a number of persons who participate in the formation and operation of the trust. These can be summarised as follows:
| "Settlor" | This is the person who establishes the trust and normally contributes a small amount of money to the Trustee for the benefit of the beneficiaries of the Trust. The Settlor should never be a beneficiary or a Trustee of a trust. |
| "Trustees" | The Trustees are responsible for all aspects of the day to day management, investment of monies etc., relating to the trust. The Trustees can either be a Company or at least two individuals. The Trustee has extremely wide legal and trust responsibilities for the administration of the Trust. |
Advantages
- tax minimisation in very limited cases
- ease of succession
Disadvantages
- trading trusts are a complex and expensive business structure
- subject to higher compliance costs
- can be very difficult to dismantle
Tax and income implications
Rather than shareholders, a trust has beneficiaries who are entitled to distributions of capital and/or income. These distributions are controlled by the trustee and form part of a beneficiary's personal income, subject to income tax and provisional tax.
Registration requirements
A trust must have its own Tax File Number (TFN) to use when lodging its annual income tax return. The trustee needs to apply for a tax file number in its capacity as trustee of the trust.
If the trust is carrying on an enterprise in Australia, the entity that is trustee may register for an ABN in its capacity as trustee of the trust.
Who pays income tax?
Whether or not a trust has a tax liability depends on the type of trust, the wording of its trust deed and whether the income earned by the trust is distributed (in whole or in part) to its beneficiaries. Where the whole of the net trust income is distributed to adult resident beneficiaries, the trust will have no liability. Where all or part of the net trust income is distributed to either non-residents or minors, the trustee will be assessed on that share on behalf of the beneficiary. In this case, the beneficiary is required to declare that share of net trust income on their individual income tax return, and also claim a credit for the amount of tax liability paid on their behalf by the trustee. Where the net trust income is accumulated by the trust, the trustee will be assessed on that accumulated income at the highest individual marginal rate.
If a trust is carrying on a business, each year all income earned by the trust and deductions claimed for expenses incurred in carrying on that business must be shown on a trust tax return. The tax return also shows the amount of income distributed to each beneficiary. Trusts are not liable to pay PAYG instalments. Instead the beneficiaries or trustees may be liable to pay instalments.
GST
If the trust is carrying on an enterprise, the entity that is trustee can register for GST in its capacity as trustee of the trust. A trust is required to be registered for GST if its GST turnover is $75,000 or more. The registration threshold for non profit organisations is $150,000
Superannuation
Trusts must pay 9% superannuation guarantee contributions for any eligible workers they engage. This may include the Trustee if they are also employed by the Trust. Trusts may need to pay super contributions for trustees if they are also employed by the trust. A trust also needs to pay super contributions for other employees of the trust.
Winding up a trust
A trust can be wound up and the assets distributed, but only where there is consent of the beneficiaries. Where beneficiaries are specified as a class (which is usual), or are children, it can be difficult to obtain consent.
If you are considering using this structure, you will need to give careful consideration to the relevance of any tax savings and the potential difficulties involved in winding up.
Unit Trust
A Unit Trust is another popular way of conducting business operations. It is normally used as an alternative to a Partnership, especially where there are people involved on an "arms length' basis in the business entity.
Each member of the Unit Trust would have a set allocation of units in the Unit Trust, which is reflected in the control percentage of each unit holder in the trust. A Unit Trust also has Trustees and may have a Settlor.
Advantages
- Tax minimisation in very limited cases
- Ease of succession
Disadvantages
- Trading trusts are a complex and expensive business structure
- Subject to higher compliance costs
- Can be very difficult to dismantle
Tax and income implications
Rather than shareholders, a trust has beneficiaries who are entitled to distributions of capital and/or income. These distributions are controlled by the trustee and form part of a beneficiary's personal income, subject to income tax and provisional tax.
Registration requirements
A trust must have its own Tax File Number (TFN) to use when lodging its annual income tax return. The trustee needs to apply for a tax file number in its capacity as trustee of the trust.
If the trust is carrying on an enterprise in Australia, the entity that is trustee may register for an ABN in its capacity as trustee of the trust.
Who pays income tax?
Whether or not a trust has a tax liability depends on the type of trust, the wording of its trust deed and whether the income earned by the trust is distributed (in whole or in part) to its beneficiaries. Where the whole of the net trust income is distributed to adult resident beneficiaries, the trust will have no liability. Where all or part of the net trust income is distributed to either non-residents or minors, the trustee will be assessed on that share on behalf of the beneficiary. In this case, the beneficiary is required to declare that share of net trust income on their individual income tax return, and also claim a credit for the amount of tax liability paid on their behalf by the trustee. Where the net trust income is accumulated by the trust, the trustee will be assessed on that accumulated income at the highest individual marginal rate.
If a trust is carrying on a business, each year all income earned by the trust and deductions claimed for expenses incurred in carrying on that business must be shown on a trust tax return. The tax return also shows the amount of income distributed to each beneficiary. Trusts are not liable to pay PAYG instalments. Instead the beneficiaries or trustees may be liable to pay instalments.
GST
If the trust is carrying on an enterprise, the entity that is trustee can register for GST in its capacity as trustee of the trust. A trust is required to be registered for GST if its GST turnover is $75,000 or more. The registration threshold for non profit organisations is $150,000
Superannuation
Trusts must pay 9% superannuation guarantee contributions for any eligible workers they engage. This may include the Trustee if they are also employed by the Trust. Trusts may need to pay super contributions for trustees if they are also employed by the trust. A trust also needs to pay super contributions for other employees of the trust.
Winding up a trust
A trust can be wound up and the assets distributed, but only where there is consent of the beneficiaries. Where beneficiaries are specified as a class (which is usual), or are children, it can be difficult to obtain consent.
If you are considering using this structure, you will need to give careful consideration to the relevance of any tax savings and the potential difficulties involved in winding up.
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