The right business structure for a business will be dependent upon a number of factors which can change or evolve over time. The right business structure is therefore right for the stated circumstances and should be reviewed regularly to ensure it remains optimal. The structure selected will impact the tax you are liable to pay, the level of asset protection afforded, ongoing costs and potentially the size of client who will buy from you.
Generally speaking, the characteristics of a good business structure are:
- Flexibility, accommodating changing circumstances with minimum consequences
- Provision of adequate asset protection for the owners of the business
- Minimisation of costs, in particular tax
- Facilitates efficient distribution of profits.
There are 4 primary structures that can be utilised by businesses in Australia. Let’s consider each of these and the associated advantages and disadvantages.
As a sole trader, all the assets and liabilities of the business belong to you, the owner. There is no dividing line between your business assets and your personal assets so you are personally liable in all aspects of the business.
- Simple set up and operation
- You retain effective control
- Minimal reporting requirements
- Income tax rate for the business is the same as your personal tax rate, which allows for the tax advantage of tax losses being offset against any other income you might have (for example, negative gearing)
- For capital gains purposes, you obtain the benefit of 12 month ownership discounts
- You are not an employee of your business, which means that there no compulsory superannuation contributions to be made
- You also don't have to pay payroll tax or workers' compensation
- Inability to split income to family members and hence limited opportunity for tax planning
- Unlimited liability which means all your personal assets are at risk in the event the business goes bad
A partnership is an association of individuals or entities for the purpose of carrying on a business venture or activity with a view to profit. A partnership is not a separate legal entity so all assets of the partnership are owned by the partners jointly.
- Income splitting between family members is less restricted than that of a sole trader
- A partner's share of any income tax losses of the partnership can be offset against other income of the partner
- Subject to any partnership agreement, the capital of each partner can be increased or withdrawn from the partnership without restriction
- Minimal reporting requirements
- Relatively easy to dissolve the partnership or to resign and recover your share
- Partners are not employees. Superannuation contributions and workers’ compensation insurance are not payable for partners
- Joint and several liability of partners. This means that each partner is fully liable to third parties despite any agreement amongst the partners
- No continuity of business where there is a change in partners, unless there is an alteration of the partnership agreement
- Potential for disputes over profit sharing, administrative control and business direction
- Changes of ownership can be difficult and generally requires a new partnership to be established
A company is a separate legal entity and can incur debt, sue and be sued. The company’s shareholders (the owners) can limit their personal liability and are generally not responsible for company debts.
A company is a complex business structure and has high set-up and reporting costs relative to other structures. You can form a company as either a private (also known as proprietary) or public entity.
A registered company must have at least one director (and a company secretary unless it is a private company). A director is responsible for managing the company’s business activities.
The tax requirements for a company are different to those of other business structures. A company pays income tax on its income (or profits) at the company tax rate. There is no tax-free threshold for companies and tax is paid on every dollar earned.
Company officers and directors have legal obligations that specify how they perform their duties and manage the company’s affairs. These obligations are outlined in the Corporations Act 2001.
- Limited liability for shareholders
- Company structure is commercially well understood and accepted
- Ability to raise significant capital
- Company tax imputation system means that distributed company profits are franked, which means tax is paid to the level of the company tax rate in the hands of the recipient shareholder
- Contributions made by the company for employee superannuation may be claimed as a tax deduction
- Profits can be reinvested in the company or paid to the shareholders as dividends
- Significant set up costs and maintenance costs, generally driven by greater reporting and accountability obligations
- Control rests with the appointed directors
- Company losses cannot be distributed to shareholders
- Significant regulation by multiple Government bodies
A trust is a structure where a trustee carries out the business on behalf of the trust’s members (or beneficiaries). A trust is not a separate legal entity.
A trustee may be an individual or a company. The trustee is legally liable for the debts of the trust and may use its assets to meet those debts. However, if there is a shortfall the trustee is responsible for the difference. A trustee must apply for a tax file number (TFN) and lodge an annual trust return. The trust is not liable to pay tax. Instead tax is assessed to the trustee or the beneficiaries that are entitled to receive the trust net income.
A trust is set up through a trust deed and there are two main types: discretionary or unit trusts.
In a discretionary trust, the trustee has discretion in the distribution of funds to each beneficiary. In a unit trust, the interest in the trust is divided into units with their distribution determined by the number of units held by each member.
- Reduced liability especially if corporate trustee
- Assets are protected
- Flexibility of asset and income distribution
- Can be expensive and complex to establish and administer
- Difficult to dissolve, dismantle, or make changes once established particularly where children are involved
- Any profits retained to reinvest into the business will incur penalty tax rates
- Can’t distribute losses, only profits
Hanrick Curran has over 30 years of business advisory experience across a broad range of industries to draw upon when providing structuring advice to business owners to ensure they benefit from the most suitable structures for their industry, growth objectives and succession considerations. To discuss your business structure considerations speak with your usual Hanrick Curran adviser, request a Complimentary Tax Structure Review or ask for one of our specialists Jamie Towers, Matthew Beasley, Tim Taylor, John Kotzur or Tony Hunt on 07 3218 3900.
Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.