You will probably have heard most of the common types of business structures, and there are some general considerations to think about, but everyone will have a different situation.
We advise that if you are trying to make a decision, give our accounting team a quick call on 1800 955 089. We are happy to help.
There are various types of business structure, and they include:
I’ll save tax because the company tax rate is 25%
Having a company structure does not guarantee you’ll save tax. If one associate of the company performs most of the work, or the company has only one or two clients, we may be required to allocate all profit to the individual that is generating the income. This is called the Attribution Rule for Income from Personal Services. The individual associate includes this profit allocation in the individual tax return and pays tax at their personal rate.
The result is exactly the same as if you use the sole trader structure.
With the top tax rate being 45% (excluding Medicare levy), the Australian Taxation Office is very much aware that individuals may change to a company structure for no other purpose than to reduce their tax bill. This could be considered tax avoidance.
My personal assets are protected
If you’re the size of a sole trader but operating as a company, and/or the company has few assets, lenders are likely to request a personal guarantee from the shareholder(s). By giving this personal guarantee, the shareholder(s) personal assets may be taken or liquidated to settle the debt.
The easiest option for a start up
A sole trader is a person trading on their own.
The sole trader:
- Controls, manages and owns the business
- Is personally entitled to all profits
- Is personally liable for all business taxes and debts.
As a sole trader you can usually begin the business without following any formal or legal processes to establish it. You may employ other people to help run the business.
Pros: Quick and cheap to get going, just start trading in your own name and ABN number. You will need to register for GST if you earn more than $75,000 in any 12 month period.
Cons: You can’t split your income for tax purposes which means that if you earn a reasonable amount, you’ll be exposed to the highest tax rates.
You also have no protection against creditors and other claims against you. If you also own your own home, then you place this at risk.
Often associated with professional practices, less common these days
In a partnership, two or more people run a business together.
- Shares responsibility for running the business
- Shares in any profit or loss equally, unless the partnership agreement states otherwise
- Is liable for any debt within the partnership.
Many partnerships are established with a formal partnership agreement.
Income tax – The partnership itself does not pay income tax. Instead it distributes the partnership income to the partners. The partners then pay tax on their own share.
Income, tax credits, rebates, gains, expenditure or losses allocated to a partner in an income year will generally be allocated in proportion to each partner’s share in the partnership’s income under the partnership agreement.
Limited partnerships – A limited partnership exists as a formal and legal entity in its own right. It is separate from its partners.
Limited partnerships need to be registered at a state level.
Pros: Partnerships give certainty about what happens to the business profits. Profits are taxed according to individual circumstances as all profit is paid out to the partners and they pay their own tax.
Cons: There is no flexibility about the division of profits and tax is paid at the individual’s rate which can expose the partners to the highest tax rate, if profit is high.
In addition, most standard partnerships mean that all partners are jointly responsible – so again people can place their personal assets at risk. The limited partnership is designed to reduce this risk.
The most ‘commercial’ entity
A company exists as a formal and legal entity in its own right. It is separate from its shareholder(s) or owner(s). The cost of registering a company is $512 and the annual return cost is $276.
Assets and liabilities
- Owns the assets and liabilities of the business
- Is responsible for any debts
The shareholders’ liability for losses is limited to their share of ownership of the company.
Pros: This is the most common trading entity so gives the business a more commercial look and feel, profits can be retained in the company or paid out to shareholders and therefore gives the tax flexibility, and liability is restricted. This provides business owners with some protection from creditors or other claims.
Cons: You have to pay to incorporate and there generally is a higher cost of compliance due to the increased complexity of the structure type.
Do you have any more questions about what business structure is right for you? Give us a call on 1800 955 089, and one of our expert accountants will answer your questions free of charge!