Before opening the doors of any business, it is imperative to build a solid foundation to ensure the business will run smoothly and will be profitable. The first step in this process is to decide which type of business structure will be most supportive for your business. There are four main business structures to choose from: Company, Partnership, Sole Trader and Trust.
Each one of these structures has its specific advantages as well as its disadvantages. Your tax obligations will also depend on the type of structure you choose for your business. Before deciding upon the most suitable structure, it is important to consider your goals, any potential personal liabilities, and the level of control you want to have over the business. If you familiarise yourself with the main types of structures before you seek professional advice you will already have an understanding of the possibilities for your business.
The main types of structures are as follows.
Sole Trader
The Sole Trader structure consists of a single individual running a business and is considered to be the most cost-effective business option. The control and the management of the business is solely in the hands of the individual owner, but it is possible for the owner to employ staff. Before commencing business, Sole Traders are required to obtain an Australian Business Number (ABN). Under this structure the individual owner is personally liable for all debts, and costs accrued by the business and their personal assets may also be at risk if something goes wrong. They will technically own all the assets of the business and the profits from the business will be solely theirs.
The main advantage of operating as a Sole Trader, is that the initial set up and the running of the business is simple as it gives the individual full control of the decision making. Also, the start-up costs are generally low. The legal structure of this type of business structure can be easily changed in the future if it is needed and is relatively easy to wind up.
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Sole Traders are required to declare their business income (or loss) as part of their personal income tax return and are taxed at the same rate as an individual. For the individual, the tax-free threshold is $18,200 for the current 2020–21 financial year. The individual income tax rate is currently 19 cents for each $1 over $18,200 and up to $45,001, and rises in line with an increase in income. You will need to register your Sole Trader business for GST (Goods and Services Tax) if your annual turnover is expected to be more than $75,000.
Partnership
The type of structure known as a Partnership is formed by at least two individuals, trusts or companies joining together for the purpose of establishing a profitable business. There is generally a maximum limit of 20 individual entities in a Partnership. In this type of business relationship, it is considered that all the parties involved have a responsibility for the formation and management of the business and all ongoing business activities, with all income and/or losses distributed between them.
The Partnership model is similar to the Sole Trader as in the fact that all involved have personal liability for any debts that the business may accrue, so leaving their personal assets potentially vulnerable. If the structure of the Partnership needs to be altered, in the case of one individual wanting to exit for example, it is easier to dissolve the existing arrangement and create a new Partnership rather than to simply alter the current one.
There are several benefits of utilising a Partnership which include tax-free capital gains and tax incentives. A Partnership does not pay income tax on the profit it earns as each partner is individually responsible for reporting their share of the partnership income in their own tax return. As well, each partner is liable for the tax on their share of any profit. This is calculated at the individual tax rate and they may also be eligible for the small business tax offset.
GST (Goods and Services Tax) registration will be required if the annual income of the Partnership is, or is forecast to be, in excess of $75,000. Registration for an Australian Business Number (ABN) is also required for a Partnership.
Company
There are two types of companies, both of which are separate legal entities set up for the purpose of carrying out of a particular business activity. Each type of company has its own Tax File Number, and it is also required to have a registered ABN (Australian Business Number)
The two types are:
• A proprietary company. This type of company can have up to a maximum of 50 shareholders. It is limited by its number of shares and there must be at least one director appointed.
• A public company. This type of company has no limit as to the number of shareholders who own it. There must be at least 3 directors appointed. A public company can be either listed or unlisted on the Australian Stock Exchange (ASX).
In both types of company structures the liability of the shareholders is confined to the nominal amount of the shares they own, and therefore their personal assets are not liable. The Company Tax Rate in Australia is between 26% and 30% which is considerably lower than the 45% (plus 2% Medicare levy) rate which is the highest tax rate for an individual in Australia. For those individuals who reach this tax bracket a company structure can be a more applicable option.
As the structure of a company is more complex than all other types of business structures available there can be more work involved if it has to be wound down.
Trust
A Trust requires an official Trust Deed to be completed by a qualified accountant or business lawyer. Under this structure, an individual or a company is appointed to be responsible for the property or assets of the Trust for the benefit of others. The holder of the Trust is the Trustee and those who benefit are known as Beneficiaries. A trustee may be liable for any breach of its duties with the extent of that liability depending on the nature of the breach and terms of the Trust Deed. The Trustee is responsible for all the Trust’s business operations and will have administration duties that are required to be completed every year. As the Trustee is responsible for all transactions relating to the Trust, they have a personal obligation.
The establishment of a Trust is more expensive than for other business structures, but there are several advantages to working within this business model. Under the terms of the Trust, the Trustee is able to be employed by the Trust and the Trust can also have other relevant employees. Income Tax does not need to be paid for this type of business structure as whole, but the individual beneficiaries will be subject to tax requirements. GST (Goods and Services Tax) may be applicable. Depending on how the Trust is structured the beneficiaries many be able to claim tax-free capital gains and tax incentives.
There are two types of trusts.
- A Unit Trust. This is a fixed trust, and the beneficiaries have a similar status to company shareholders. They can be referred to as Unit Holders. In this model, the beneficiaries hold the beneficial assets in the trust assets.
- A Discretionary Trust. This type of Trust allows the Trustee to determine distributions for the Beneficiaries.
As with other types of business structures in Australia, a tax file number (TFN) must be obtained, and a tax return must be lodged annually. If the trust is carrying on an enterprise or any business activity in Australia an Australian Business Number (ABN) registration must be obtained as well.
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Other less common types of business structures include a Joint Venture which is a structure commonly used in property development.
To determine which of the above business structures is more suitable for your business venture consult your accountant or a trusted financial adviser. They will be able to offer you the advice and support you need while taking into consideration your personal circumstances as well as any long-term goals and plans. It is most important to seek this expert advice before you begin to put your business plans into action.
Taxopia has been working with many clients from a wide variety of businesses and industries over the last 20 years, so we are well equipped to guide you through the process of setting up your business so that from day one the business will be compliant with all Australian tax standards.
Disclaimer: the information contained in this article is for general information purposes only and in no event will Taxopia or its affiliated entities be held liable for any loss or damage caused through the use of this information. Independent advice is recommended for all individual circumstances. Data and specifications included correct as of May 2021.
Posted: 08-Sep-21
