Choosing Your Business Structure

April 16, 2013

When entering into a new business venture, it is common for business owners to consider the type of business structure to use. It is important to choose the structure best suited to your business needs as the type of structure may affect:

  • your asset protection;
  • your operating costs including taxes; and
  • how other businesses deal with you.

Whilst it is important to get the structure right from the beginning to prevent problems later, it is possible to change your business structure as your business grows.

The following things should be considered for the following most common types of business structures:

Sole Traders

  • Simple and inexpensive to set up.
  • You will need an ABN (Australian Business Number) and will need to register for GST if your turnover is more than $75,000.
  • Unlimited liability – you can lose private assets such as your house if your business is unable to repay its debts.
  • You are responsible for your own super arrangements and may be able to claim a deduction for your personal superannuation contributions. You must also pay super contributions for any eligible employees.
  • The profits from the business is treated as your own income and included in your personal tax return.

Partnership

  • Generally inexpensive to set up.
  • Liability is joint and several and unlimited – you and your partners are responsible for the debts of the partnership even if you did not directly incur the debt.
  • You will need to register the partnership for an ABN. You will also need to register the partnership for GST if the partnership’s turnover is more than $75,000.
  • Although the partnership business does not pay income tax in its own right, you still need to apply for its own tax file number and lodge an annual partnership tax return for the business. Your share of the net partnership income will then be included in your personal tax return and taxed at your marginal tax rate.
  • As a partner of the partnership, you are responsible for your own super contributions as you are not considered to be an employee of the business. You may be able to claim a deduction in your personal tax return for any personal super contributions you make. The partnership must make super contributions for any eligible employees.
  • A partnership does not account for any capital gains or losses. If a partnership CGT asset is sold, each partner includes his share of the capital gain or loss in his personal tax return.

Companies

  • A company is a separate legal entity to you.
  • It is a more complex structure compared to a sole trader or partnership and its set up costs are usually higher.
  • A company is regulated by the Australian Securities and Investments Commission.
  • Liability is limited to the company’s assets, which has the benefit of giving you greater asset protection. However, directors of companies may be personally liable for various unpaid tax and superannuation obligations.
  • A company will need an ABN and will need to register for GST if its turnover is more than $75,000;
  • A company needs to apply for its own tax file number. It must lodge an annual company tax return and pay tax on its own profit.
  • A flat tax rate of 30% applies, which may be advantageous for businesses with high income levels as the top marginal tax rate for individuals is 46.5% (including 1.5% Medicare Levy).
  • If you receive wages or a dividend from the company, you must include these in your personal tax return to be taxed at your marginal rate. Your wages are deductible to the company, but a dividend paid to you is not. However, a dividend may be franked if there are franking credits in the company.
  • A company must make super contributions for its eligible employees, including you if you are a company director or employee.

Trusts

  • Unlike a company, a trust is not a separate legal entity. It is an arrangement whereby the trustee of the trust agrees to hold property or income for the benefit of the beneficiaries of the trust.
  • It is a complex structure and its set up costs as well as its ongoing tax and administration costs is generally higher than the other structures listed above.
  • A trust will need to apply for its own tax file number.
  • A trust will need an ABN and will need to register for GST if its turnover is more than $75,000.
  • A company or individual can act as the trustee of the trust. Due to the personal liability imposed on trustees, it is generally advisable to appoint a corporate rather than individual trustee as companies have limited liability.
  • A discretionary trust is probably the most common type of trust used by families for tax planning and asset protection purposes. Under a discretionary trust, the beneficiaries do not have any fixed entitlement to any assets or distributions from the trust. This means that if the beneficiary gets sued, the trustee can choose not to distribute any income to that beneficiary. Also, as none of the beneficiaries have a claim to the assets of the trust, the assets are protected in the event a beneficiary becomes bankrupt.
  • Under a discretionary trust, the trustee has power to decide how the trust income is distributed among the beneficiaries. This means that if the beneficiaries’ income from other sources fluctuates between the years, the trustee can also vary the percentage of trust income that gets distributed to each beneficiary year on year.
  • A discretionary trust needs to lodge an annual tax return but it usually only pays tax in limited circumstances. Instead, the beneficiaries pay tax on their share of the trust’s net income.
  • The trust must make super contributions for its eligible employees, including yourself if you are employed by the trust. If you have any queries on the above or wish to discuss any of the above in further detail, please do not hesitate to contact us on (02) 9713 1199.