When starting a business, one of the key decisions you’ll face is choosing the appropriate business structure. This choice is influenced by various factors including the business size, type, your personal circumstances and how much you plan to grow the business. The right structure affects critical aspects such as tax obligations, asset protection and setup costs. While you can change your structure later down the line, take the time initially to consider your options and choose the right structure. It’s worth noting that no one business structure is guaranteed to suit you for the entire life of the business or investment class asset. Circumstances change and what works for you at the beginning might not be the best fit as your business grows.

What is a Business Structure?

A business structure defines the legal framework of your organisation. While your structure may not greatly impact the day-to-day operations of running your business, it is important for defining ownership, limiting personal liability and managing taxes.

Whether you’re planning to work under your own name or build a separate entity, understanding the implications of each structure is essential for asset protection and tax management.

Types of Business Structures

A business structure defines the legal framework of your organisation. While your structure may not greatly impact the day-to-day operations of running your business, it is important for defining ownership, limiting personal liability and managing taxes.

Whether you’re planning to work under your own name or build a separate entity, understanding the implications of each structure is essential for asset protection and tax management.

There are four business structures that you can choose from when starting or expanding your business including:

  • Sole Trader: This is the simplest form, offering full control but also full personal liability.
  • Partnership: Consists of two or more people sharing income or losses, with shared liability.
  • Company: A separate legal entity that provides limited liability but involves more complexity and regulation.
  • Trust: Involves a trustee managing operations for beneficiaries, offering asset protection but at a higher complexity and cost.

How to Choose the Right Business Structure

When you decide on a structure for your business, choose the one that best suits your business needs.

What works for one business might not be the best for another. As there are key factors and rules to consider for each structure, it’s important to engage with an accountant early on your business journey.

Key Differences Between Business Structures

Sole Trader

Partnership

Company

Trust
Cost

Low

Medium

Medium to high

High
Complexity of setting up

Simple

Moderate

Complex

Highly complex
Tax obligations

Low

Low

Medium

High
Legal obligations

Low

Low to medium

High

Medium
Owner

You

You and your partners

Company shareholders

Trustee

Sole Trader: In-depth Review

A sole trader is an individual who owns and manages their business with their own ABN. It’s the simplest and cheapest business structure. However, as a sole trader, you’re personally responsible for all of the business’ debts and liabilities.

Advantages of Being a Sole Trader:

  • Simplicity and Control: Easy to set up and operate, offering complete control over assets and business decisions.
  • Tax Benefits: Pays tax at personal income rates with eligibility for a 50% capital gains tax discount on business or capital asset sales, such as goodwill and trademarks.
  • Reduced Reporting and Flexibility: Fewer reporting requirements and the ability to use an individual tax file number (TFN) for tax returns, simplifying administrative processes.
  • Financial Integration: Ability to offset business losses against other personal income (under certain conditions) potentially reducing overall tax liability.
  • Independence: Not considered an employee of your own business and therefore can avoid payroll tax, superannuation or workers’ compensation on personal income drawn from the business.
  • Adaptability: Ease in changing the business structure to accommodate growth or winding up the business.

Disadvantages of Being a Sole Trader:

  • Unlimited Liability: Personal assets are at risk if the business incurs debt or legal issues, presenting a significant financial risk.
  • Tax Limitations: Limited tax planning opportunities, as profits or losses cannot be split with family members, and the sole trader is liable for tax on all business income.
  • GST Obligations: Requirement to register for and pay GST if annual business turnover exceeds $75,000, adding to tax responsibilities.
  • Employee Responsibilities: If employing others, responsible for withholding income tax from wages through PAYG instalments, adding to administrative tasks.
  • Limited Business Growth: Growth potential can be limited by the sole trader’s personal financial resources and borrowing capacity, making it extremely difficult to raise capital beyond personal sources.

Partnership: In-depth Review

A partnership is a group of people carrying on a business together and sharing the business’ income and losses. Like sole traders, partnerships are cheap and simple to set up. They also need their own TFN and ABN. You can form a partnership with a verbal agreement or a written partnership agreement. However, it is recommended that you have a written partnership agreement in place.

Advantages of a Partnership:

  • Simplicity and Shared Control: Easy to set up with minimal reporting requirements, offering shared control and management among partners.
  • Capital Gains Tax Discount: Eligibility for a 50% capital gains tax discount on the sale of the business or certain assets, similar to sole traders.
  • Financial Synergy: Ability to offset a partner’s share of business tax losses against other personal income, under certain conditions, and easier access to finance due to multiple financial profiles.

Disadvantages of a Partnership:

  • Joint & Several Liability: Each partner is personally liable for the business’ debts and liabilities as well as the actions and debts of other partners, offering no asset protection.
  • Conflict Potential: Increased risk of disputes over profit sharing, administrative control and the direction of the business due to shared management.
  • Complexity in Ownership Changes: Altering the ownership structure or dissolving the partnership can be complex, often necessitating the establishment of a new partnership agreement.
  • GST Obligations: Requirement to register for and pay GST if the partnership’s annual turnover exceeds $75,000, adding to the administrative burden.

Company: In-depth Review

A company is a separate legal entity. Shareholders own shares in the company and directors make the management decisions. A company itself owns the business’ income. You cannot take the business’s income unless you receive it as wages (as an employee) or as dividends (as a shareholder).

Advantages of a Company:

  • Limited Liability: Shareholders have limited liability, protecting personal assets from the company’s debts and liabilities.
  • Capital and Growth: Well-recognised structure that enables significant capital raising opportunities and supports business expansion.
  • Tax Efficiency: Profits are taxed at the company rate, which can be lower than personal tax rates, offering advantages for reinvestment. This system prevents double taxation of dividends.
  • Operational Continuity: Ability to carry forward losses indefinitely to offset against future profits, enhancing financial flexibility.
  • Transferability: Ownership can be easily transferred, making it simpler to sell the business or change its ownership structure.
  • Dividend Distribution: Profits can be distributed to shareholders as dividends, potentially with franking credits that reduce shareholders’ personal tax liability.
  • R&D Tax Incentive: Companies are the only structure that can access R&D tax concessions, providing a significant advantage for businesses engaged in research and development activities.

Disadvantages of a Company:

  • Cost and Complexity: Higher setup and ongoing maintenance costs, coupled with complex regulatory and reporting requirements. Additional legal costs can often be necessary for shareholder agreements and buy/sell insurances and agreements.
  • Control: Shareholders may not retain complete control over business operations, as decisions are often made by directors or a board.
  • Loss Utilisation: Inability to distribute losses to shareholders, which can limit financial flexibility in challenging times.
  • Tax Responsibilities: Responsible for withholding income tax from employees’ wages and managing PAYG instalments, adding to administrative duties.
  • Limit to SB CGT Concessions: Some access to the Small Business CGT Concessions can be restricted. Active Asset 50% reduction can be trapped in company.
  • Complex Division 7A Rules: Navigating Division 7A rules can be challenging, as they govern the payments and loans made by the company to shareholders and their associates, adding another layer of complexity to tax management.
  • Winding Up: The process of winding up a company can be highly complex and regulated, requiring compliance with numerous legal obligations and potentially involving substantial costs.

GST Obligations: Like sole traders and partnerships, companies must register for and pay GST if the annual turnover is over $75,000, increasing compliance obligations.

Trust: In-depth Review

A trust is a relationship between a trustee and beneficiaries. The trustee legally owns assets for the benefit of beneficiaries. Trustees and beneficiaries can be either people or companies. Many businesses operate through discretionary (family) trusts. The trustee manages the business and distributes business profits to the beneficiaries through the trust.

Advantages of a Trust:

  • Asset Protection and Liability: Offers reduced liability (especially with a corporate trustee) and protects assets from personal liabilities.
  • Full use of SB CGT Concessions: Trusts can fully access the Small Business CGT Concessions, providing significant tax advantages during asset disposal or business sale, in contrast to some limitations faced by companies.
  • Tax Flexibility: Enables the distribution of income to beneficiaries, potentially at lower personal tax rates, allowing for tax-efficient income distribution.
  • Distribution Control: Provides flexibility in how assets and income are distributed among beneficiaries, which can be tailored to meet the specific needs and objectives of the trust.

Disadvantages of a Trust:

  • Complexity and Administrative Burden: Setting up and managing a trust is both complex and costly, requiring expert legal and financial advice. The restrictive nature of Trust Deeds, coupled with intricate year-end distribution calculations, adds to the administrative challenges.
  • Rigidity: Once established, trusts can be difficult to dissolve or modify, especially in arrangements involving minors or where specific conditions are set for beneficiaries.
  • Taxation of Undistributed Profit: Profits not distributed to the beneficiaries are taxed at the highest marginal tax rate, which can be disadvantageous compared to other structures.
  • Loss Limitations: Trusts cannot distribute losses to beneficiaries; they can only distribute profits, limiting financial flexibility in challenging times.

A Hybrid?

Many business owners choose a hybrid structure, often running their trade through a company, which is then owned by a discretionary trust. This provides both the asset protection and lower tax rate advantages of a company, combined with the ability to stream income (in the form of dividends) to beneficiaries of the trust. For those willing to navigate its complexities, this setup can offer a balanced blend of advantages for both trading and investment purposes.

Can I Change Business Structures?

Businesses evolve and so can their structures. Commonly, businesses start out as sole traderships and then, as they become bigger and more successful, they look to incorporate or to roll the business into a trust. Since 1 July 2015, the path to changing your business structure has been smoothed out, with many such changes now exempt from capital gains tax. This is especially helpful for sole traders moving their business into a company structure, allowing for the transfer of assets without the tax hit.

Keep in mind that restructuring your business is no small task. It’s complex and needs to be approached with caution to ensure that you’re eligible for those capital gains tax exemptions. Given the complexity, do your research and get expert advice to navigate this process successfully.

What Registrations Do I Need?

Tax File Number

  • If you’re operating as a sole trader, you will simply use your own TFN.
  • If you’re creating another entity such as a trust, partnership or company, that entity will need its own TFN. You can get one via the Australian Business Register (ABR) website.

Australian Business Number

  • An ABN is essential for any Australian business since it is used in numerous other business interactions, with customers, suppliers and other government agencies.
  • You’ll need an ABN for instance before you can register for GST.
  • You can get an ABN through the ABR website.

Australian Company Number

Goods and Services Tax (GST)

  • Your business will need to register for GST once your annual turnover is $75,000 or more.
  • Taxi drivers and ride-sharing drivers (such as Uber drivers) need to register for and charge GST no matter what their turnover is.

Grants and Incentives for Businesses

R&D Tax Incentive

The Research and Development (R&D) Tax Incentive provides businesses with a tax offset for costs incurred in eligible R&D activities. It’s designed to encourage companies, including start-ups, to engage in R&D that might not otherwise be conducted due to financial risks.

Eligible businesses can claim up to 48.5% back on eligible R&D activities. Read more about the R&D Tax Incentive here.

ESIC Tax Incentive

The Early-Stage Innovation Company (ESIC) Tax Incentive is aimed at investors who put funds into qualifying early-stage innovation companies. It provides eligible investors with a 20% non-refundable tax offset on investments in these companies, capped at $200,000 per investor, per year. Additionally, investors may benefit from a capital gains tax exemption for investments held between one and ten years. This incentive encourages investment in innovative start-ups by offering significant tax advantages to investors, thereby facilitating access to capital for young, innovative companies. Read more about the ESIC Tax Incentive here.

Tax Deductions For Advice on Business Structuring

New businesses are eligible for immediate tax deductions on various start-up expenses to ease the initial financial burden. Key deductible costs include:

  • Professional Advice: Immediate deductions for expenses related to obtaining professional advice on the optimal structure for the business, whether it’s a company, trust or partnership.
  • This includes guidance on financing, market research and setting up the legal framework of the business.
  • Business Viability and Planning: Costs for advice on the potential success of the proposed business including due diligence for acquiring existing businesses and formulating business plans.
  • Capital Raising: Expenses incurred in raising debt and equity to fund the business are also deductible.
  • Regulatory Costs: Deductions extend to fees paid to government agencies for regulatory compliance, including the cost of business registration and stamp duty on asset transfers.

Keep in mind that these deductions are available even if the business idea is eventually not pursued, ensuring entrepreneurs are not financially penalised for exploring business opportunities.

Need Help Deciding?

Before launching your business it’s important to carefully consider the choice of your business structure, as it significantly influences aspects like control, liability and the ability to adapt and grow in the future.

  • How do you see your business growing in the next 5-10 years and which structure best supports that vision?
  • What level of personal liability are you comfortable with?
  • How important is control versus the potential for raising capital to you?

Given the complexities and long-term implications of this decision, consulting with professionals who can offer tailored advice is invaluable. An accountant is particularly crucial for understanding the tax implications and financial management of your chosen structure.

If you’re seeking expert guidance on selecting the most suitable structure for your business, consider reaching out to Carbon for personalised support and advice. Our Accounting & Tax team can help ensure that your business is set up for success, taking into account your unique goals and risk tolerance.

Sources:

Choose your business structure, Business.gov.au

How Are Different Business Structures Taxed? Legal Vision

Business structures, Small Business Development Corporation

 

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