This is the first of many in our new blog series for business owners.
Our aim is to provide our business clients with a wealth of information to help the successful operation of your business into the future. We will bring you topics for start-ups to established businesses with real-time, relevant information such as our stream of recent COVID updates.
This month we start out with a topic for our new business owners who are looking at starting up their own small business and wondering where to start.
Choosing the right structure for your business
First things first.
Before you launch into marketing plans, sourcing stock or hiring staff, it is imperative to firstly establish the correct business structure.
There are 4 types of business structures and we will run through the features, pros and cons of each.
The type of structure you choose will also affect the tax you are liable to pay, costs, asset protection, liability and level of complexity to run. Your accountant will be able to guide you on which structure is best suited to your business.
The 4 types of business structures
A sole is trader a single individual operating a business. You are the sole owner of the business and are 100% responsible for its operation. This also means you are 100% liable for the business, meaning all the profits are yours, but so are the losses. They cannot be spread to others. 100% of the liability rests on a sole trader’s shoulders, meaning your assets are open to litigation in the event of a legal issue. Despite the name indicating your business is only one person, you can employ people as a sole trader – you just cannot employ yourself. You are also responsible for paying your employee’s super as well as your own.
As a sole trader you operate under your ABN, pay GST if your annual GST turnover is above $75,000, report your income in your individual tax return, pay tax at the standard individual tax payer rate and can claim a tax deduction for personal superannuation payments.
A partnership on the other hand is two or more people who operate a business and distribute the profit or losses amongst themselves. A partnership agreement between the parties will establish how the profit and losses are distributed and how the business will operate. Similar to a sole trader, partners are not employed by the business but it may employ others. Again, a partnership is liable to pay super to its employees and the partners can claim a deduction for any personal super contributions.
A partnership doesn’t pay tax on its profits. The profit is divided as per the agreement to the partners, who then pay tax on their portion of the profit in their individual tax return. Similar to a sole trader, partnership pay GST if the annual GST turnover is $75,000 or more and must apply for an ABN.
Things get more complex (and costly) when we start looking at companies and trusts. A company is its own legal entity, with its own individual reporting requirements and is regulated by the Australian Securities and Investments Commission (ASIC). It is owned by shareholders and run by its Directors. The main benefit of a company is that is shifts the liability from the owner to the company, giving directors an element of asset protection. In saying that, directors can still be legally liable for the actions of a company.
A key difference with a company is that the company owns the money the business earns. Whilst sole traders and partners can take money in and out of their business freely, the same does not go for a company. It must be allocated as a formal distribution of profits or as wages. Come tax time, a company lodges its own company tax return, pays tax via PAYG and pays tax at the company tax rate. Companies must also pay Super Guarantee Contributions to all employees, including the Directors.
Finally, we look at trusts. A trust is generally the more complex and costly of all business structures as you require a formal deed outlining how the trust will operate. There are also yearly administrative duties that go along with a trust, therefore increasing your yearly operation costs. The key features of a trust are that a trustee (usually an individual or a company) is legally responsible for the trust, and all profits go to the trust beneficiaries.
How a trust pays tax is dependent upon how the income is distributed between its beneficiaries. This is also dependent upon whether the beneficiaries are adults or non-residents or minors. A trust is not suitable for those who wish to retain profits to help the business grow, as all income must be distributed otherwise it will be taxed at the top 49% tax rate.
When it comes to choosing the right structure for your business, you need to consider the following 5 things to determine which structure is right for you:
- The nature of your business
- Future growth opportunities
- Its level of risk
- The involvement of others/outsiders
- The level of power you want over the business (when it comes to decision-making)
Knowing the answer to these questions will help guide your decision.
It is also worth noting that you can opt to change your business structure at any point in time. It is common to see business owners start out as sole traders, only to convert to a company or trust as their business grows.
For further information on business structures, check out the Australian Government ATO website.
If you’d like to discuss the right set-up for your business to ensure the best tax minimisation strategy and set-up that is right for you, contact us to arrange an appointment.