When it comes to choosing a structure for your business, it’s worth spending a little time learning about your options.
It may surprise you to hear that your accountant is the expert when it comes to business structures! Why? Because business structures are the building blocks for tax planning and also protect your key assets such as the family home.
All too often business owners jump into a new venture and don’t take the time to think through the options for their business structure. Whether you’re about to start a business or are already in business, this is a great time to review the options open to you.
Choosing the right business structure is all about weighing up your risks and advantages.
Ask yourself:
- What tax rate will I be paying with a different business structure?
- Are the tax benefits enough to offset the set-up costs?
- Will my assets like my family home be protected?
- What levels of ongoing compliance will I need to meet?
- How do my family circumstances affect my decision?
Why consider structure?
The structure of your business can help you to minimise the amount of tax you pay. And if that wasn’t enough, then it can also protect you personally from litigation and liability. So, it makes sense to choose the right business structure that balances the benefits of tax minimisation and asset protection with setup and compliance costs. Much will depend on the nature and size of the business and your individual or family circumstances.
5 Most Common Business Structures
The most common types of business structures used by small to medium businesses in Australia are:
- Sole Trader
- Partnership
- Private Company
- Trusts
- A combination of these
Let’s take a guided tour through each structure so you can make a choice that’s right for you.
SOLE TRADER
Sole Trader is the simplest business structure, just get an ABN and Tax File Number (TFN) and you’re set to go!
The key benefits:
- No setup costs
- Minimum compliance
- Offset any business loss against other income*
What are the risks?
When it comes to a Sole Trader, there is no distinction between you as the owner and the business. This means you are personally liable if the business goes belly up, or if there is litigation against the business. It’s a sobering thought when you consider that your assets (like your family home) could be at risk.
What about tax?
When it comes to tax, you pay at individual tax rates and your ability for tax planning and income streaming is minimal.
Who is this ideal for?
Sole Trader structures are generally suitable if you are just starting or have no personal assets to protect.
*subject to satisfying non-commercial loss rules.
PARTNERSHIP
In a partnership, two or more people can come together to run the business. Again, like a sole trader, there is no distinction between the partners and the business, which means you will remain personally liable.
Key benefits:
- Minimal setup costs
- Ability to raise more capital
- Minimum compliance
- Partnership does not pay tax but partners pay tax on their share of profit
What are the risks?
Be mindful that the liability of partners is joint and several i.e. each partner will still be 100% liable for business debts and such liability cannot be just restricted to your share of the partnership. For example, if you take a loan in name of the partnership, the bank can still recover 100% of the loan from you if your partner is not in a position to pay his share of the loan. If you are in partnership minimise risk by taking loans in name of individual partners rather than in name of the partnership, but bear in mind your assets are still at risk.
What about tax?
The Partnership does not pay tax but rather partners pay tax at individual tax rates on their share of profit from the partnership. This means your ability for tax planning and income streaming is minimal.
Who is this ideal for?
A Partnership is generally suitable if you are just starting or have no personal assets to protect and would like to join hands with someone to have the ability to raise more capital. It is advisable to have a formal partnership deed in place.
COMPANY
A company on the other hand is an entity in its own right and different to its promotors/owners.
Key benefits:
- Lower tax rate
- Ability to tax plan through dividends*
- Much higher level of protection for your assets like the family home.
What are the risks?
Although you’re not personally liable, if you are a director, you will have legal obligations like ensuring solvent trading. Another consideration is that your compliance costs are higher.
What about tax?
Companies pay tax at 27.5% which can be streamed back to you as franking credits with the dividends. Franking credits allow you to reduce the income tax paid on dividends.
A further benefit to establishing a company structure is you can claim deductions available to businesses.*. However, capital gains discounts that are available to individuals and trusts are not available to companies. Nevertheless, a company structure is essential for some specific tax concessions like research and development tax incentives.
Who is this ideal for?
Anyone where protection of personal assets is important and/or other tax planning consideration apply. It also helps give the business a more professional outlook due to its compliance structure.
*Subject to personal service income rules.
TRUST
A Trust is more of a relationship i.e. an obligation imposed by a “deed” upon a person as a “trustee” to hold assets or business for the benefit of someone else. Discretionary trusts can be especially useful for entrepreneurs with family and provide flexibility to stream income and protect personal assets.
Key benefits:
- Tax planning by streaming income to beneficiaries
- Minimise overall tax
- Asset protection
- Estate Planning
What are the risks?
Trustees can be personally liable unless a company is used as a trustee. Trusts do attract higher compliance costs.
What about tax?
Trusts have to lodge their tax returns but tax is usually paid by the beneficiaries at their tax rates. However, a discretionary trust can change the share of income or beneficiaries every year for the best tax planning outcome. But, losses cannot be distributed to the beneficiaries and therefore cannot be offset against their incomes.
Who is this ideal for?
A Trust is an ideal structure for a family business making profits, especially where your spouse is on a low tax rate and there are adult children to whom income can be distributed.
Key points
For sole traders and partnerships:
- You pay tax at individual tax rates
- Your ability for tax planning and income streaming is minimal
- Your assets (like family home) remain exposed to business risks,
- Setup and compliance costs are minimal.
For companies and Trusts:
- Offers better tax planning opportunities
- Cost is approx. $1,500 to $1,900 to set up
- Yearly compliance can vary between $1,000 to 2,500.
Can I change my business structure?
Don’t worry, you’re not locked into any structure forever! You can change the structure of your business it grows and changes, or as your situation changes. However, it helps to know your path and options to scale your structure from the outset. After all, you don’t want to make decisions that leave you or your assets vulnerable, while also missing out on valuable tax savings.
Disclaimer: Any advice on this site is general nature only and has not been tailored to your personal objectives, financial situation and needs. Please seek personal advice prior to acting on this information. Because of that, before acting on the advice, you should consider its appropriateness to you, having regard to your objectives, financial situation or needs. Content in partnership with Taxpayers Australia.
