When starting a small business, choosing your business structure is one of the most important decisions you’ll need to make.
In Australia, the most common types of business structures are sole traders, partnerships, companies, and trusts. Unfortunately, the intricacies of each structure can be complex, making it hard for new business owners to make the right choice.
This article will break down the advantages and disadvantages of each structure, helping you understand the differences when making an informed decision for your business.
What is a business structure?
A business structure is the legal structure of a business that determines how it operates daily.
Each business structure comes with its own distinct duties and responsibilities, affecting key factors such as your tax, ongoing costs and personal liability.
If you’re starting a new enterprise, you’ll need to know your business structure before applying for an Australian Business Number (ABN).
The simplest business structure to start from is a sole trader.
The sole trader structure is appropriate for small-scale business operations, particularly those relying on the owner's own skills. Such businesses are often registered and managed under the founder’s name, as well as under a business name.
A sole trader business structure is a common first step for many small business owners embarking on their business journey.
Are sole traders subject to taxation?
Sole traders are subject to taxation on business income, which is reported on their yearly Personal Income Tax Return and taxed at marginal rates.
- The sole trader (owner) has total control of the business and can benefit from its profits
- Low start-up expenses and minimum legal requirements
- Sole traders can easily re-structure as the business expands
- Sole trader businesses are subject to fewer government regulations
- Offers greater business privacy, including limited reporting requirements and disclosure of business profits
- The structure is easy to dissolve or sell
- Sole traders bear complete responsibility for the business, including profits, losses and legal obligations
- The rigidity of a sole trader business structure makes it harder to scale up as your business grows
- Your personal assets may be used to pay for business debts
- Sole traders must pay tax on all profits the business makes
A business partnership is a structure where two or more people operate as a business together.
This typically means that the partners are themselves the owners and have full authority over the business partnership. Once the business is set-up, the partners share the costs, profits, and losses, meaning each partner is liable for the actions of the other partners.
This structure will usually involve an agreement between the partners, clearly outlining the roles and responsibilities of each partner, as well liability for income and losses.
Are partnerships subject to taxation?
A partnership must lodge a tax return at the end of each income year.
Partners are taxed on their share of the profits of the partnership or entitled to a deduction for their share of the incurred losses. Here, the partners need to disclose their income or losses on their individual tax returns.
- Partnerships allow for the combining of different skills and expertise
- Some tax benefits may be available
- Partnership agreements are easily to set up and administer
- Financial and legal responsibilities are shared between each partner
- Raising capital is easier through the combination of multiple business owners
- The partnership's taxable revenue or loss is dispersed under the Partnership Agreement. If there is no agreement, the partners will divide it evenly between the parties.
- The partners' liability is unlimited and extends to their personal property as well as partnership assets
- Partners are liable for the actions and mistakes of other partners
- Changing business structures can be complex and difficult
A company business structure has its own separate legal entity, separating the business from its owners and shareholders.
This structure can involve extensive paperwork to set up and incur expensive costs to maintain, however it does provide protection from personal liability for the owners. Companies are incorporated under the Corporations Act 2001 (Cth) and governed by the Australian Securities and Investments Commission (ASIC), which administers the Corporations Act 2001 (Cwlth) and other legislation.
Are companies subject to taxation in Australia?
All companies are subject to a federal tax rate of 30% on their taxable income.
However, base rate entities (small or medium business' companies) are subject to a reduced tax rate of 25% from the 2021–22 income year onwards.
A company must also have its own Tax File Number.
- As a company is a seperate legal entity, liabilities are restricted to the assets of the company. This means that an owner's personal assets will likely be protected from the business’s risk
- A company has a lower tax rate than the highest tax rate for individuals
- A company business structure can be easily scaled to meet the growing needs and size of your business
- Companies have greater access to capital compared to sole traders and partnerships
- Profits are taxed at a fixed rate
- Companies are sold or dissolved easily
- Due to compliance requirements, forming a company can be a complex and expensive structure to establish
- Companies can require extensive ongoing administration, including legal and financial reporting requirements
- Companies must conduct an annual review and pay a fee
- Changing business structures can be difficult
- A company business structure is often not appropriate for small or new start-up ventures
A trust is a less common type of business structure which essentially allows a company or individual to have their assets held and managed by a third party. Trusts then distribute income and/or capital to the beneficiaries.
A trustee can be either a company or an individual who has complete control and responsibility for the operation of the entity, including business performance and financial losses.
Are Trusts subject to taxation in Australia?
In general, a trust's net income is taxed in the hands of the beneficiaries, depending on their right to the income (whether they have received the amount). In some circumstances, the trustee may be taxed on the beneficiary’s behalf.
Trustees must pay tax at the highest marginal rate of 45% on this undistributed income. This provision is in place to ensure that the trust is used for its intended purpose (i.e., to distribute income to beneficiaries).
A trust must have its own Tax Identification Number.
- A trust offers flexibility in how income from the trust is distributed, including added opportunities to implement tax planning strategies
- A trust can hold property (capital) for the benefit of beneficiaries.
- Trusts provide the asset protection for companies and individuals
- The rules and regulations around trusts are complex, making them difficult to set up, manage and dissolve
- Trustees must perform formal administrative responsibilities on an annual basis
- A trust must file a separate tax return
- The operations of a trust are the legal responsibility of the trustee
- Beneficiaries must pay Personal Income Tax on trust income distributions
How do I choose the right business structure?
Choosing the right structure for your business requires extensive research and consideration. The rules and regulations surrounding business structures are complex and affect different kinds of businesses differently.
We strongly recommend that you first speak to an accountant to help you understand the requirements and responsibilities that come with each type of business structure.
Elephant Advisory’s accounting team provide business structure reviews, assessing your business’s individual needs and goals to help determine which structure will maximise your growth and profitability.
To book a free consultation with one of our accountants or read more about our services, you can visit our website here.