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Business Structures: Choosing the Right Type for You

Written by Peter Ryan . November 10, 2020
15 min read

If you’re investigating business structures, you may find yourself in one of two situations:

  1. You’re starting a business and need guidance on the best way to structure it; or 
  2. Your business is undergoing a period of change, and you suspect that your current structure no longer suits your purposes.

A variety of issues influence decisions about business structure, from start-up costs to long-term security. Keep in mind that you’re not locked into one business structure forever; you can change it at any time. So whilst it is necessary to consider the future of your business when deciding your structure, it is also important to consider the structure that best suits your business today.

In this article, we’ll explore the four most common business structures in Australia, delve into how to set up your business structure, and outline how consulting with a trusted business adviser will bring perspective and expertise to your decision.

Contents

4 Common Business Structures in Australia

As you learn about the four common business structures in Australia, keep in mind that different businesses have their own unique plans and goals. Therefore, your unique circumstances will determine the most appropriate structure for you.

1. Sole Trader (Individual)

The Sole Trader structure works well for small businesses, especially those based on the owner’s skills and talents. They often trade on the owner’s name (e.g. Anna Watts), or they can register a business name (e.g. Anna’s Automotive). Many businesses begin their lives as Sole Traders because set-up costs are low and control is high.

Key Features of the Sole Trader Business Structure:

  • The business owner has direct control over the business and reaps all the rewards of its success
  • It’s relatively easy to change the business structure as it grows
  • It’s easy to dissolve
  • Sole Traders bear full responsibility for any liabilities (this may extend to the business owner’s personal assets)
  • Sole Traders must pay the tax on all business income, which is included in their annual Personal Income Tax Return and taxed at marginal rates
  • Sole traders cannot be employees of their own business, so they will not receive the minimum superannuation guarantee. Sole Traders can make personal concessional (deductible) contributions up to the annual limit

Costs: Low costs and minimal legal procedures to establish.

2. Partnerships 

Designed for a business conducted by two or more individuals who share control and management of the business, in this business structure the partners share the costs, profits and losses of the business. A Partnership has its own Australian Business Number (ABN) and Tax File Number. It’s recommended that the owners develop a Partnership Agreement to set out the terms and conditions of their partnership.

Key Features of the Partnership Business Structure:

  • The Partnership structure allows for a combination of different skills
  • The Partnership automatically dissolves on the death of one of the partners
  • A Partnership must lodge an Income Tax Return, but the Partnership does not pay tax
  • The taxable income or loss is distributed to the Partners according to the Partnership Agreement. If no agreement exists, income and losses are split equally among the partners. The partners individually pay income tax on their share of taxable income.
  • In a general Partnership the liability of the individual partners is unlimited; it extends to the partners’ private property
  • Each partner also bears total responsibility for the business liability if other partners are unable to fund their share
  • Partners cannot be employees of their own individual Partnership, so they will not receive the minimum Superannuation Guarantee. Partners can make personal concessional (deductible) contributions up to the annual limit

Costs: Inexpensive to set up. Partnership agreement highly recommended.

3. Companies

In Australia, there are two types of companies: Public and Private. Generally speaking, Private companies are more popular. Public companies can be (but don’t have to be) listed on the Stock Exchange. Companies’ shareholders own the business, and directors are appointed to manage them. 

Key Features of the Company Business Structure:

  • Companies are separate legal entities. The assets and liabilities of the company are separate to that of the shareholders and directors. The profits generated also belong to the company until they are paid to the shareholders
  • Liabilities are limited to the Company’s assets and will not extend to the shareholders in most cases
  • The company is required to lodge a tax return and pay tax. All profits are taxed at a flat rate of tax
  • Companies face additional legal and financial reporting requirements

Costs: More expensive to set up and maintain due to establishment and compliance costs.

4. Trusts

With a Trust business structure, the business is operated by a trustee, which is either a company or one or more individuals. The trustee operates the business on behalf of the beneficiaries. 

A Trust must have its own Tax File Number and lodge a tax return, but like a partnership the trust does not typically pay tax. The trustee distributes any taxable income generated by the business to the beneficiaries. The beneficiaries individually pay income tax on their share of taxable income.

There are two types of Trusts: Discretionary and Fixed. Beneficiaries of a Fixed Trust are entitled to a fixed percentage of the income based on their proportional ownership of the trust.  Beneficiaries of a Discretionary Trust have no fixed entitlement, their share of the income is determined by the trustee each year.

A formal Trust Deed is required, as this sets out the powers of the trustee and formalises the operational procedures of the Trust.

Key Features of the Trust Business Structure:

  • A Trustee holds and manages the business assets on behalf of the Beneficiaries
  • With a Discretionary Trust, there is flexibility of income distributions
  • A corporate (company) trustee offers a greater level of asset protection than an individual trustee
  • Trusts must lodge a separate Tax Return
  • Beneficiaries must pay Personal Income Tax on their income distributions received from the Trust.

Costs: A Trust is subject to higher compliance and establishment costs.

Comparing Australian Business Structures at a Glance

 

Sole Trader

Partnership

Company

Trust

Key Features

Easy to establish;

Complete control.

Two or more people with joint control.

Separate legal entity.  Assets and liabilities belong to company, not the shareholders.

Business assets held and managed by trustee on behalf of beneficiaries.

Taxes

Income included on Personal Income Tax.

Partnership lodges a Tax Return.  Individual partners pay tax on their share of the income.

Company lodges a Tax Return and pays tax on the Profits at a flat rate of tax.

Trust lodges a Tax Return.  Individual beneficiaries pay tax on their share of the income.

Liability

Personally liable for business debts.

Liable for partner’s actions.

Liabilities limited to Company’s assets.

Liabilities limited if trustee is a company.

Cost

Minimal

Low

Higher

Higher

Why is Business Structuring Important?

Your business structure can affect several areas of your organisation, including tax, asset protection, ongoing costs and compliance. It’s important to understand how your structure will support your business and why it’s a suitable option for you. Let’s look into these considerations in more detail.

 1. Tax Implications

Each business structure has different tax implications. Each type has its advantages and disadvantages, but there isn’t a simple answer to the question of which structure is most tax effective. You’ll need to consider both current and future tax implications.

Different entities have different taxation obligations. For example, profits made within a company are taxed at a flat rate of either 27.5% (reducing to 26% in 2021) or 30%. In contrast, profits made within a sole trader arrangement are taxed at marginal income tax rates, which can be as high as 47% (including Medicare Levy). This difference can significantly impact the cash flow of your business. 

Even though you are not locked into the structure you choose today, there can be tax implications involved when changing your business structure.  There are tax concessions that make restructuring your business more straight forward, but there are important steps required to minimise the tax impacts. 

2. Asset Protection

To protect your assets, it’s best to establish either a company or a trust with a corporate trustee.

These structures are separate legal entities and, therefore, they’re liable to pay their own debts. When a company operates the business, there’s a clear delineation between business and personal assets. Hence, in the unfortunate event that your company is liquidated or litigated against, your personal assets should be protected.

Trusts can also offer the same protection, provided that you have a corporate trustee, as opposed to an individual trustee. 

 3. Costs of Maintaining the Structure

Using companies and trusts for your business structure involves higher ongoing costs because of additional reporting and legal obligations. These costs can include annual fees paid to ASIC and additional accounting fees to prepare financials statements and tax returns. A sole trader or partnership structure generally has lower ongoing costs. 

4. Ensuring Compliance in Your Industry

Different business structures can be beneficial depending on your industry. For example, if you are running a simple tutoring business or a small handyman service, you would benefit with a low-cost structure like Sole Trader. On the other hand, doctors and lawyers who deal with numerous clients and may be exposed to liability or litigation issues need a secure structure that protects their assets.  

There can be minimum expectations for your structure depending on your industry. For example, businesses contracting to government organisations are often required to operate their business through a company.

The benefits of a good business structure are substantial. And remember, the format that suits your business today may not be the best option five years from now. 

Choosing the Right Business Structure For You

There are several factors to consider when choosing the right structure. What might be viewed as an advantage to one person may be a disadvantage to another. Therefore, you must think carefully about how each structure applies to your particular business. Consider:

  • Your future goals and objectives of the business (e.g. succession planning) because the decision you make now can either assist or hinder those goals.  It’s wise to consider your succession planning as you make critical decisions about business structure.
  • If the initial cost is a primary concern, a Sole Trader or Partnership may work best. But it’s important to remember that these structures mean you pay tax at your marginal rates and are personally liable for debts in the business.
  • Thinking carefully about who you want to have control in the business.
  • If you need to limit liability, consider a Company or Trust.
  • The taxation implications for your business, whilst you are operating the business, but also considering your eventual exit strategy from the business.
  • Understanding the ongoing costs. Companies and Trusts face higher ongoing costs associated with compliance and reporting than Sole Traders or Partnerships.
  • Pay attention to the type of industry or business you are in, as some structures can be more beneficial than others for certain business types.

How to Set Up Your Business Structure

Setting up your business all depends on what structure you have chosen. We have listed some necessary steps below for your reference: 

Sole Trader

  • Apply for ABN in your name (you should already have a TFN)
  • Determine if you are required to be registered for GST
  • Register a business name with ASIC (optional)
  • Ensure you are covered with the right insurances 
  • Organise employee contracts if you are hiring
  • Register for PAYG withholding and single touch payroll if you are employing staff
  • Subscribe for online accounting software to make administration for your business significantly easier
  • It is recommended that you open a separate bank account for your business, to separate your business and personal financial affairs

Partnership/Company/Trust

  • Determine a name for your entity
  • Apply for an ABN and TFN for the entity
  • Determine if you are required to be registered for GST
  • Register a business name with ASIC (optional)
  • Ensure you are covered with the right insurances 
  • Organise employee contracts if you are hiring
  • Register for PAYG withholding and single touch payroll if you are employing staff
  • Subscribe for online accounting software to make administration for your business significantly easier
  • Open a bank account in the name of your partnership, company or trust
  • You will need assistance with the following documents that are essential to establishing your entity:
    • Partnership agreement
    • Company constitution
    • Trust deed

Note: We recommend speaking to an accountant or business adviser to set up a Partnership, Company or Trust structure to ensure everything is accounted for. These structures are much more complex and may require additional processes to be set up. You may also need to speak to a solicitor when establishing your entities or any legal agreements.

Let an Adviser Help You Choose Your Business Structure

Although you’re not forever tied to the business structure you initially choose, making the right decision for your current situation, while still taking into consideration your goals, can save you a lot of time, money and hassle.

It’s also important to speak with all stakeholders and receive their input. That way, you’re 100% aware of what your responsibilities will be. Be sure to include your partner, family members, other business owners in the industry, your solicitor and business adviser

Learn how our team at BLG Business Advisers can help you choose the right business structure for your unique circumstances. Make a move to create a better future for your business and talk with us today.

Written by Peter Ryan . November 10, 2020

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