Business Structures: Choosing the Right Type

Four Most Common Business Structures in Australia

Each business in Australia has a different purpose, unique goals and specific ambitions. Therefore the most suitable business structure for your business will be determined by its specific circumstances. Below are the four most common business structures in Australia:

1. Sole Trader (Individual)

The Sole Trader business structure is best suited for small business owners, especially when the business centres around the owner’s personal skills and talents. Sole Traders frequently conduct business under the owner’s name (e.g. Jenny Lee), or they can register a business name (e.g. Jenny’s Automotive). The simplicity of the setup process, low costs, and complete control make this structure quite appealing to many new businesses.

Key Features of the Sole Trader Business Structure:

• Simple and low-cost setup process;
• Relatively easy to change the business structure as it grows, and easy to dissolve;
• Sole Traders are fully liable for any debts incurred (which may extend to the owner’s personal assets);
• Sole Traders pay tax on the net profit generated from their business activities. The income is included in their personal tax returns and taxed at marginal rates;
• The business owner has direct control over the business and reaps all the rewards of its success;
• Sole Traders cannot be employees of their own business, so they will not receive the minimum superannuation guarantee payments. However, they can make personal concessional (deductible) contributions to their nominated super fund, up to the annual limit.

Costs: The Sole Trader structure has low costs and minimal legal requirements to establish.

2. Partnerships 

A Partnership business structure is a formal arrangement between two or more parties to manage and operate a business. In this structure, risks and rewards are shared by each partner. A Partnership has its own Australian Business Number (ABN) and Tax File Number (TFN), and it is highly recommended for the owners to develop a Partnership Agreement to explicitly set out the terms and conditions of the Partnership for security purposes.

Key Features of the Partnership Business Structure:

• Different skills can be pooled together;
• Profits and losses of the business are shared amongst the partners;
• A 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 any tax itself;
• 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. Like a Sole Trader, the partners share of the income or loss is included in their personal tax returns, in which the partner pays tax at marginal rates;
• There is unlimited liability, meaning each partner bears the total responsibility of the business liability if other partners are unable to fund their shares;
• Partners cannot be employees of their own individual Partnership, so they do not receive a wage or the minimum superannuation guarantee. However, partners can make their own personal concessional (deductible) contributions up to the annual limit.

Cost: Setting up a Partnership is inexpensive. A Partnership Agreement is highly recommended.

3. Companies

A Company is a legal entity that can be formed by one or more individuals to operate a business. In Australia, there are two types of companies: Public and Private. Private companies are more common due to the increased regulation and reporting requirements for public companies. Company shareholders own the business, and directors are appointed to manage them.

Key Features of the Company Business Structure:

• Companies are separate legal entities, and the assets and liabilities owned by the Company are completely separate from the directors and shareholders;
• Company profits remain in the business until they are paid out to shareholders;
• The Company is required to lodge an annual tax return and pay tax. Profits are taxed at a flat rate, as opposed to marginal rates.
• There are increased regulations that must be complied with, and directors can face serious penalties for breaching these regulations.

Costs: Setting up and maintaining a Company is more expensive due to establishment and compliance costs.

4. Trusts

Trusts are a popular business structure in Australia due to their flexibility and tax benefits. With a Trust, the business is managed by a Trustee, who can be either a Company or an individual, on behalf of the beneficiaries. The Trust is required to have its own Tax File Number (TFN) and lodge its own tax return on an annual basis. The beneficiaries include their share of income in their personal tax returns and pay tax at their individual marginal rates.

There are different types of Trusts available, but the two most common ones are Discretionary and Fixed Trusts. Fixed Trusts provide beneficiaries with a fixed percentage of the income based on their ownership of the Trust, while Discretionary Trusts offer more flexibility in terms of distributing income. The Trust Deed outlines the powers of the Trustee and the operational procedures of the Trust.

While Trusts offer tax benefits, they also have higher compliance and establishment costs compared to other business structures such as Sole Traders or Partnerships. Corporate Trustees can provide greater asset protection that individual Trustees, but the costs associated with establishing a Trust can be significant. Overall, Trusts can be a useful business structure for those looking for flexibility in distributing income and managing tax obligations.

Key Features of the Trust Business Structure:

• The Trustee manages and holds the business assets on behalf of the beneficiaries. The Trustee can be either a Company or one or more individuals.
• Corporate Trustees offer a high level of asset protection compared to Individual Trustees.
• Fixed Trusts are required to pay a set percentage of income to their beneficiaries each financial year, based on their proportional ownership of the Trust.
• Discretionary Trusts allow for more flexibility in terms of income distribution to beneficiaries.
• Trusts are required to fil an annual tax return.
• Beneficiaries must include their share of income from the Trust in their personal tax return and pay tax based on their individual marginal rate.

Costs: Establishing and maintaining a Trust involves higher compliance and establishment costs.

Comparing Australian Business Structures

Why is Business Structuring Essential?

Choosing the appropriate business structure can significantly impact various aspects of your business, such as tax payments, asset protection, ongoing expenses, and compliance obligations. It is important to know how your structure will support your business and daily operations. Let’s look into some considerations in further detail.

 1. Tax Implications

Every business structure has distinct tax implications, and the nature and extent of your business operations can heavily influence the most effective structure to adopt.

For instance, in the 2023 and 2024 financial years, profits generated in a Company are taxed at a fixed rate of either 25% or 30% (dependent on their base rate entity status). Sole Traders who earn the same amount of income are taxed at their marginal rates, which can be as high as 47% (including the Medicare Levy)! For the same profit, each entity pays a vastly different amount of tax, all determined by the legal structure the business operates under.

Although changing your business structure can now be done almost immediately, tax implications may arise when making changes. Tax concessions are available to help with these transitions, but they come with certain eligibility requirements.

2. Asset Protection

The most effective way to safeguard your assets is through a Company or Trust structure. This is primarily due to the fact that these business structures are distinct legal entities from their owners, and are responsible for their own liabilities.

When a Company runs a business, there is a clear distinction between business and personal assets. In the unfortunate event of Company liquidation or litigation, personal assets should be protected.

It is important to note that Trusts can provide the same level of protection, provided that you have a corporate trustee rather than an individual trustee.

 3. Costs of Maintaining the Structure

Companies and Trusts as business structure have ongoing annual costs that must be paid to remain compliant. Every year, the entity must prepare financial accounts and file a tax return, which can lead to costly accounting fees. In addition, Companies are required to pay ASIC an annual review fee to keep their registration active.

Sole traders and Partnerships do not have these ongoing costs to keep the business active.

4. Ensuring Compliance in Your Industry

The appropriate business structure can vary depending on your industry. For example, if you run a basic hairdressing salon or a small handyman service, you may benefit from a low-cost structure like a Sole Trader. In contrast, professionals like doctors, lawyers, and builders who deal with numerous clients and may be exposed to liability or litigation issues require a secure structure that protects their assets.

The business structure can be subject to minimum requirements depending on your industry. Businesses that contract with government organisations are frequently required to operate their business through a Company.

The advantages of a sound business structure are significant. Keep in mind that the structure that is suitable for your business today may not be the best option five years from now.

How to Set Up Your Business Structure

The process of setting up your business depends on the structure you choose. Here are some essential steps to follow:

For Sole Traders:

• Apply for an ABN in your name (if you have a TFN)
• Determine if you need to register for GST
• Optional: Register a business name with ASIC
• Obtain the necessary insurance coverage
• Prepare employee contracts (if you are hiring)
• Register for PAYG Withholding and Single Touch Payroll (if employing staff)
• Subscribe to online accounting software to simplify administration and to comply with Single Touch Payroll requirements
• Open a separate bank account for your business and personal finances

For Partnerships/Companies/Trusts:

• Choose a name for your entity
• Apply for an ABN and TFN for your entity
• Determine if you need to register for GST
• Optional: Register a business name with ASIC
• Obtain the necessary insurance coverage
• Prepare employee contracts (if you are hiring)
• Register for PAYG Withholding and Single Touch Payroll (if employing staff)
• Subscribe to online accounting software to simplify administration and to comply with Single Touch Payroll requirements
• Open a bank account in your entity’s name
• Obtain necessary legal documents, such as partnership agreement, company constitution, or trust deed

Note that Partnership, Company, or Trust structures are complex and may require additional processes. It is recommended to consult an accountant or business adviser and possibly a solicitor for legal advice.

Helping You Decide on Your Business Structure

You’re not forever tied to the business structure you initially choose, however making the right decision based on your current situation and goals can save you time, money, and hassle. It is crucial to seek input from stakeholders when choosing a structure so you are 100% aware of what your responsibilities will be. This includes partners, family members, business owners, solicitors, and business advisers.

Gain the assistance of an experienced accountant or business adviser when choosing the right business structure, ensuring they take into consideration your unique circumstances. Our team at BLG Business Advisers are happy to help, as Wollongong Accountants who service right around Australia. Talk with us today to gain clarity and create a positive future for your business.