Being your own boss, making a living doing something you love, creating opportunities for other people. No matter why you might be looking to start your own business, it’s important that those aspirations are given the best chance of being fulfilled by starting off on the right foot. The often boring, but very necessary, process of laying a solid foundation for a business includes choosing the right structure, and understanding the differences between them, why it matters, and how it can change and evolve along with your business. So how do you know which is right for you?
Why is your business structure important?
Like many things in business, different things work for different situations and business owners. There’s generally no one-size-fits-all solution that can be applied across the board, so it is important to know how your structure will affect your business over time. Different structures can determine your personal liability for company debt and losses; your classification as an owner or an employee; how much control you have over the business; reporting requirements; your tax obligations (including future CGT obligations); and the licenses you require to run your business. Generally speaking, the optimum outcome for your business is to set up a structure that legally minimises tax, maximises profits and protects your assets adequately.
Different trading structures
In Australia, there are four common trading structures available to business owners. These are sole trader, partnership, company and trust. There are different advantages and disadvantages to each, so let’s have a look at a brief pros & cons/considerations list for each:
|Sole Trader||Low cost; simple structure; gives you full control; fewer reporting requirements; use your own tax file number (TFN) to lodge returns; ability to employ staff.||Legal responsibility for all aspects of the business (incl. debts & losses); requires you to keep financial records for 5 years minimum; unlimited liability, all personal assets are at risk; you are personally liable to pay tax on all income derived.|
|Partnership||Relatively easy and inexpensive to set up; minimal reporting requirements; share control and management of the business; you don’t pay tax on the net income earned, as each partner pays tax on the share of the net income they receive.||Must register for GST if turnover is $75,000 or more; requires separate TFNs; each partner is responsible for their own superannuation arrangements; partnership tax return to be lodged with the Australian Taxation Office (ATO).|
|Company||Limited liability; wider access to capital; greater personal asset protection (company is liable for debt).||Higher set-up costs; generally, more paperwork and higher ongoing costs; directors have legal responsibility to ensure the company meets its pay as you go (PAYG) withholding and superannuation guarantee charge (SGC) obligations.|
|Trust||Good asset protection; limits liability for trustees in relation to the business; beneficiaries of a trust are generally not liable for the trust debts; beneficiaries pay income tax on income they receive at their own marginal rates.||Can be expensive to set up and operate; requires a formal trust deed that outlines the operation of the trust; require the trustee to undertake formal yearly administrative tasks.|
Partnerships come in three different forms. A General Partnership is where all partners are equally responsible for the management of the business, and each has unlimited liability for the debts and obligations it may incur. Limited Partnerships have general partners, and their liability is limited to the amount of money they have contributed. Incorporated Limited Partnerships involve a minimum of one general partner with unlimited liability, who is responsible for any obligation shortfalls.
Changing structures in the future
As your business grows over time, your trading structure can change accordingly. What once worked for a business in its inception, may not be appropriate once it reaches a certain threshold of success and growth. The needs of those running the business may also change, as the requirements for asset protection can also shift. Conducting a structure review is a great way to periodically assess where your business is at, ensure that you are not paying more tax than you need to, and are maximising your potential profits. On the basis of these reviews, you can change your structure if necessary and build that into your overall business strategy.