Importance of business structureThe legal business structure that you choose should be based on a important considerations such as:
- Who will own the business
- Who can make important decisions
- Tax obligations
- Protecting your personal assets
- How profits and losses are taken out of the business
- Setup costs and ongoing fees
Types of business structuresIn Australia there are four main legal types of business entities to choose from, each with their own pros and cons.
- Sole traders
- A combination of any of the above!
Sole traderThe sole trader business structure is the simplest and easiest to set up and manage. It’s generally considered the best structure for a small business where there is only one owner, such as a tradie or health professional. As a sole trader you own the business, control it and make all the decisions. All the business profits belong to you but at the same time so too do all the liabilities of the business. You, personally, must cover all losses, taxes and debt obligations, even if your business made no profit or has no cash in the bank. You may hire employees under a sole trader business structure but you can’t employ yourself. You can’t pay yourself a wage or salary and any money taken out of the business can’t be accounted for as such. It will be seen as drawings. You’ll be responsible for paying super for your employees as well as yourself. You don’t need to have a separate bank account as a sole trader, but it is strongly advised for better cash flow and business management.
Tax considerations for a sole trader structure
- Sole traders don’t submit a separate business tax return. You reflect your business’ income and expenses on your own personal income tax return under the appropriate section and use your individual TFN (tax file number).
- Therefore, the individual marginal tax rates are applied. If your business has over $180,001 in profit you will start paying income tax at 45 cents in the dollar for every dollar over! You may be eligible for the small business tax offset – chat to a registered tax agent to check.
- You don’t need to apply for an ABN to act as a sole trader (unless your turnover exceeds $75,000) but there are many benefits to having one if you intend to operate a business. These include appearing legitimate, registering a domain name, issuing formal tax invoices, etc. The major con to not registering an ABN is that other businesses must withhold 47% from payments they make to you for tax purposes.
- Once your annual GST turnover reaches $75,000 you need to register for GST which means you’ll need to lodge a monthly/quarterly/annual Business Activity Statement (BAS)
- You’ll be required to pay your income tax at the end of the financial year. To ensure that you’ve set aside money for that, the ATO will require you to submit your PAYG quarterly.
PartnershipsA partnership business structure has between two and twenty people that enter into business together. Partnerships are increasingly uncommon these days but can be used in a variety of ways e.g. a partnership between two trusts or companies The benefits of a partnership structure are that you share the losses, taxes, risks and liabilities of the business, but on the other hand you also have to share the profits and control. How this share is determined in a partnership is usually clarified in a partnership agreement. You don’t have to have one, but it’s strongly recommended that you have something to refer to when disputes or misunderstandings occur down the line. This form of business structure is also fairly inexpensive to set up and maintain. Partnerships are required to have a separate bank account.
Tax considerations for a partnership structure
- The partnership will have its own TFN and must lodge an annual return.
- Partnerships are not taxed on their profits. Instead, each partner will show their own portion of the profits on their tax return under the appropriate section.
- Each partner pays tax at their own individual tax return rate and may be eligible for the small business tax offset.
- A partnership has to apply for an ABN and use it.
- A partnership must register for GST if the annual GST turnover reaches $75,000.
Company business structureUnlike sole traders and partnerships, a company business structure is slightly more complex. The investment to set up is higher and comes with additional ongoing reporting and administration costs. An important difference with company structure lies in the separation between ownership and management. A company is owned by the shareholders and managed by the directors. In smaller companies this is often the same person(s) whereas this is clearly separated in large companies such as the Coles Group or Woolworths. Companies are regulated by the Australian Securities & Investments Commission (ASIC). As with any setup, there are pros and cons to a company business structure. Unlike sole traders and partnerships, a company (pty ltd) offers limited liability to its owners. All assets, liabilities, taxes and debts are the responsibility of the business, meaning that shareholders are not held liable. So too are profits. Shareholders cannot draw money out of a company without formally ‘distributing’ them as profits (aka dividends) or paying themselves a salary. Companies must pay super guarantee contributions (SGC) to all employees and directors. Companies are required to have their own business bank account.
Tax considerations for a company structure
- A company will have its own TFN and must lodge an annual return.
- After registering your company you will receive an Australian Companies Number (ACN) from ASICs. Once you have that number you can apply for your ABN with the ATO.
- A company must register for GST if the annual GST turnover is $75,000 or more.
- Companies must submit their own annual tax return and pay tax on company profits at their relevant rate. This is usually managed via monthly or quarterly installments (depending on the turnover of your business).
- The shareholders of the company are liable for tax on the profits distributed to them personally, if their individual tax rate exceeds the company tax rate that those dividends have already incurred. For example, if the dividends were taxed at the company tax rate of 30%, and the shareholder’s tax rate is 32.5%, the shareholder will be liable for the difference only (2.5%). These are known as ‘franked’ dividends. In the case where the company tax rate exceeds the shareholder’s personal tax rate, the shareholder may be entitled to a rebate on their personal tax return.
- Companies may be eligible for small business tax concessions.
TrustsDepending on their purpose, trusts can sometimes be complex and costly structures to set up and run, but on the flip-side they can also be relatively cost effective in the right circumstances. Not only are trusts used to operate businesses they are also often used as investment vehicles for holding shares or property. Family trusts are a common structure used when a family wishes to protect their personal assets from business risk exposure. The biggest appeal to trusts is that they offer great tax planning flexibility. The trustee of a trust has absolute discretion when it comes to distributing the trust’s net income and capital gains to the beneficiaries of the trust. This means they can choose to distribute whatever they want to whomever they want. In a trust structure a formal trust deed is required to establish how the trust will operate and what the trustee is allowed to do. A trust running a business can have employees (including the trustees) and must pay superannuation for those employees. A trust must have a separate bank account.
Tax considerations for a business trust structure
- A trust running a business must have its own TFN and lodge an annual return.
- Trusts must have their own ABN.
- A trust must be registered for GST if its GST turnover reaches $75,000.
- Whether or not the trust actually pays income tax will depend on how the income is distributed. According to the ATO:
- A trust is not required to pay income tax if all of that income is distributed to adult or resident beneficiaries. Each beneficiary is required to declare the income on their individual tax return.
- In the case where income is distributed to minors or non-residents, it’s the trustee who is liable for tax.