When first thinking about how to start a business, not many people worry about structure. But your business structure can affect how you’re treated by the government and by the law. Here are some of the ins and outs.
The main types of business structure are sole trader, partnership, and company. Your choice will affect your admin burden, tax, legal status, and your ability to raise money by selling shares. The table below runs through some of the main differences between a company, a partnership, and a sole trader.
| Business Structures and their effects | ||||
| Structure | Easy Admin | Simple Tax | Legal Protection | Selling Shares |
| Sole Trader | Yes | Yes | Not necessarily | No |
| Partnership | Yes | Yes | Not necessarily | No |
| Company | Not necessarily | Not necessarily | Yes | Yes |
If you don’t choose a business structure
If you don’t choose a structure when starting a business, you’ll be assumed to be a sole trader. That’s how a lot of people start out. However, it’s worth understanding what it means to be a sole trader and getting your head around the other structures. Speak to an accountant before making any changes.
- Sole traders – Advantages and Disadvantages
A sole trader is a single-owner business. It doesn’t have to be a single-worker business, so you can hire staff. It’s easy to set up as a sole trader and tax is simple. You just declare income on your personal tax return. A sole trader doesn’t have any special legal status, which means the owner is personally responsible for what the business does. If the business gets into debt or legal trouble, so does the owner. Your choice of insurance becomes very important.
- Partnerships – Advantages and Disadvantages
A partnership is owned by two or more people. There are no rules about how it’s divided. One partner can own 99% of the business. It’s easy to set up as a partnership, though you may need an official letter that sets out the agreement between partners. Tax is simple too. You just declare your share of business income on your personal tax return. If the business gets into financial or legal strife, the partners do too. You could also get into difficulty if one of the other partners does something wrong. Your choice of insurance becomes very important.
What are Partnership Agreements
A simple business partnership agreement should include the following:
- state the legal name of the partnership and define what your business does
- name the owners and show how many shares each holds
- appoint a primary business officer
- say when and how income is distributed among the partners
- include a process for resolving disputes, bookkeeping and the management of finances
- outline how the partnership can be wrapped up (and how debts or profits would be distributed).
As you can imagine, even a simple business partnership agreement can get big and complicated. Do your research or ask an accountant or lawyer to help.
- Companies – Advantages and Disadvantages
A company is legally separate from its owner (or owners), which means you’re less exposed to legal or financial issues. A company can be owned by one person or many. You get some legal and financial protection if things go wrong – your accountant or a lawyer can give you the lowdown. Your business income may also get taxed at a lower rate. You can also sell shares in your company to raise money.
It will cost you more to operate as a company than as a sole trader or partnership. There’s also more admin. You’ll need to know how the company will operate before you get started, and you’ll have to regularly submit paperwork to the ATO or ASIC.
You’re not locked into one structure forever. A lot of businesses start out as sole trader or partnerships and grow into companies. You might change your business structure if you start getting bigger and doing more complex projects which carry a greater financial or legal risk for you.
Where do Franchises fit in?
If you buy into a franchise, you don’t automatically become part of their business. You form your own business and enter into a deal with the franchisor. You may be able to choose your own business structure, or the franchise agreement may require it to be set up in a specific way, such as a company.
What are the Tax Obligations for each Business Structure?
Sole Traders
As a sole trader, you:
- use your individual tax file number (TFN) when lodging your tax return
- report all your income in your individual tax return, using the section for business items to show your business income and expenses (there is no separate business tax return for sole traders)
- are entitled to an Australian business number (ABN) and use that ABN for all business activities
- must register for goods and services tax (GST) if
- your annual GST turnover is $75,000 or more
- you provide taxi, limousine or ride-sourcing services (regardless of your GST turnover)
- you want to claim fuel tax credits
- may be required to lodge business activity statements, for example if you are registered for GST, have employer obligations such as PAYG withholding, or have PAYG instalments
- pay tax on all your income, including income from your business, based on your individual tax rate
- may voluntarily use, or be required to make, PAYG instalments to prepay your income tax
- can claim a deduction for any personal super contributions you make after notifying your fund
- can hire workers and need to meet all employer and super obligations for them.
As a sole trader, you can claim a deduction for salary, wages and allowances you pay your workers on your tax return. You cannot claim a deduction for money or assets you take from the business for personal use.
Partnerships
A partnership:
- has its own TFN
- must lodge an annual partnership return showing all business income and deductions and how its income or losses are distributed to the partners
- must apply for an ABN and use it for all business activities
- must register for GST if it
- has annual GST turnover of $75,000 ($150,000 for not-for-profit organisations) or more
- provides taxi, limousine or ride-sourcing services (regardless of GST turnover)
- wants to claim fuel tax credits
- may be required to lodge business activity statements, for example if it is registered for GST, has employer obligations such as pay as you go withholding, or have pay as you go instalments
A partnership does not pay tax. Each partner reports their share of the net partnership income or loss in their own tax return and is personally liable for any tax that may be due on that income.
A partnership and its partners cannot claim a deduction for money they withdraw from the business. Amounts you take from a partnership are not wages for tax purposes and may affect what your share of the partnership income is that you have to pay tax on
You will need to be aware of the steps to take if you change the makeup of your partnership.
Companies
A company is a separate legal entity with its own tax and superannuation obligations, run by its directors and owned by its shareholders. A company’s income and assets belong to it, not its shareholders. There may be tax consequences if you are using your company’s money and assets for private purposes.
A company can distribute profits to its shareholders through dividends and may be able to attach franking credits to those dividends. This allows its shareholders to receive a credit for the tax already paid by the company on its profits.
A company:
- is responsible for its own tax and superannuation obligations
- must apply for its own TFN
- is entitled to an ABN, if it is registered under the Corporations Act 2001
- if the company is not registered under the Corporations Act 2001 it may still register for an ABN if it is running a business in Australia
- must register for GST if it
- has annual GST turnover of $75,000 ($150,000 for not-for-profit organisations) or more
- provides taxi, limousine or ride-sourcing services (regardless of GST turnover)
- wants to claim fuel tax credits
- may be required to lodge business activity statements, for example if it is registered for GST, has employer obligations such as PAYG withholding, or has PAYG instalments
- owns the money that the business earns (you may have to pay tax on any money taken out for personal use)
- must lodge an annual company tax return
- usually pays its income tax by instalments through the pay as you go instalments system
- pays tax at its applicable company tax rate
- must pay super guarantee for any eligible workers (this includes any company directors)
- must issue distribution statements to any shareholders it pays a dividend to
How can we help?
If you have any questions or would like further information or you are seeking property tax advice, please feel free to contact our office via email –info@investplusaccounting.com.au or phone 02 9299 7000 to either speak with someone or arrange a time for a meeting so we can discuss your requirements in more detail. You can arrange a free 15 minute no obligation chat to discuss your options. Please arrange an appointment with our office by clicking here
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