There are many considerations when it comes to choosing the right structure for your new business or re-structuring your existing business. There are several ways in which a business can be structured, and each has its own advantages and disadvantages as discussed below.
The most common structures include:
- Sole trader
In considering which business structure to choose, some of the other factors that may affect your choice include:
- Costs: One factor to consider is the costs in establishing the business structure and the ongoing costs of maintaining it.
- Taxation: There are taxation consequences that are different for each of the possible structures that ought to be considered and discussed further with your accountant.
- Liability: It is possible to limit your personal liability depending on your business structure.
- Management: Your ability to maintain administrative and management control over your business may depend on the structure you choose.
Different business structures – things to consider
A sole trader is the simplest business structure and consists of an individual trading on their own, managing and controlling their business. This suits individuals who want complete control over their business.
- A sole trader structure offers the simplest setup and operation.
- The sole trader retains effective control of the business.
- A sole trader has minimal reporting requirements.
- The sole trader is eligible to claim a 50% capital gains tax discount for individuals.
- Income tax for the business is the same as the sole trader’s personal tax rate (allowing a tax advantage of any tax losses being offset against other income the sole trader may have).
- Sole traders are not employees of the business meaning there is no compulsory superannuation to be paid and the sole trader does not need to pay payroll tax or workers’ compensation.
- The most significant disadvantage of a sole trader operating its business is that there is a lack of ability to split income to family members resulting in restricted opportunities for tax planning.
- When the sole trader ceases working on retirement or death, the business will end.
- The sole trader has unlimited liability, meaning the sole trader’s personal assets are at risk.
A partnership structure offers the flexibility and ease to run a business as individuals, without the need to create a company structure and avoiding rigid reporting obligations. A partnership is ideal for two or more individuals looking to operate a business together.
- Partnerships are easier and less expensive than companies to set up.
- No paperwork is required to set up a partnership, though a partnership agreement is recommended to govern how the partnership operates and to manage expectations for each partner.
- Partnerships combine the resources and expertise of its partners allowing each to bring different skills to the table and start with more capital.
- Partnerships are simple to administer. Profits and losses are shared between partners according to his/her share (as specified in the ‘partnership agreement’).
- All partners together are personally responsible for business debts such that each partner assumes unlimited liability. Each partner is individually liable for debts incurred by the other partners and can be sued personally for anything done in the name of the partnership.
- All partners have a right to participate in the management of the partnership (unless otherwise agreed).
- Tax is charged at the personal tax rate.
- Partners cannot transfer their ownership to someone outside the partnership unless the other partner(s) agree. Each time a new partner is introduced or a partner exists, the partnership needs to be dissolved and a new partnership formed.
- A partnership is required to lodge a partnership tax return though the partnership itself does not pay tax on its income (as tax is paid by each party in their personal capacity).
A company structure is where a separate legal entity capable of holding assets in its own name operates the business. The company is owned by shareholders and controlled by directors. There are proprietary limited companies and public companies. Companies are the most common structure for businesses looking to achieve high growth and protect their assets with limited liability.
- A company structure offers the flexibility to expand the business and bring on new partners via new shareholders, investors and co-owners.
- As a company is a separate legal entity, all liability is borne by the company and this offers limited liability and reduced personal risk. Shareholders of a company are only liable up to the amount of their investment.
- The structure ensures continuing of management and ownership in the event of the death or disability of key people (because the shares can be transferred).
- The tax rate for companies is less than the highest rate for individuals.
- There is no requirement to distribute profits meaning profits can be reinvested in the company or paid out to the shareholders as dividends. A company can also carry forward losses indefinitely to offset against future profits.
- A company has the ability to raise significant capital.
- A company structure makes it easy to sell and pass on ownership.
- A company structure has the ability to employ the directors and shareholders.
- There are significant set up costs and maintenance costs due to greater reporting obligations.
- Control of the company is in the hand of the board of directors (not necessarily the owners /shareholders of the company).
- A company cannot distribute losses to its shareholders.
- Often directors or shareholders are required to provide personal guarantees for landlords, suppliers and financiers to enter into leases, contracts or loans with them.
- Profits distributed by companies to shareholders are taxable.
A trust is an entity that holds property or income for the benefit of others. In a trust, a trustee (an individual or a company) operates the business on behalf of others (the beneficiaries). It is set up through a trust deed and comprises of discretionary trust (ordinarily a single family) or unit trust (ordinarily involving multiple families).
- A trust can offer limited liability if a corporate trustee is appointed.
- Trusts are very flexible for tax purposes. A discretionary trust provides flexibility in the distribution of income and capital gains among beneficiaries.
- Beneficiaries of a trust pay tax on income they receive from a trust at their own marginal rates.
- Unit trusts provide certainty to unitholders in respect of distributions.
- There are significant set up costs and maintenance costs. A trust must ordinarily be set up by a laywer or accountant.
- The powers of trustees are restricted by the trust deed.
- Losses derived in a trust are unable to be distributed to the beneficiaries and cannot be offset by beneficiaries against other income they may have.
- A trust cannot retain profits for expansions without being subject to penalty rates of tax.
- A trustee has a strict obligation to hold and manage property for the exclusive benefit of beneficiaries.
At Coulter Legal, we can help you understand the different structures that may be available and appropriate for your business and how each one can be adopted to your business.