When starting a business, the first consideration should be what structure you plan to operate in. Options include sole trader, partnership, company or trust. This may seem like a simple matter but the structure of your business impacts on your tax, personal liabilities, asset protection and reporting obligations.
Your structure dictates how much tax you have to pay at the end of the year.
Your structure affects your ability to bring in investors or offer equity to key staff.
Your structure determines your level of personal liability if something goes wrong.
Obviously it is beneficial to choose the correct structure during the initial start-up phase. However, few small business owners realise they are able to change their structure at a later date to align with growth plans or an exit strategy.
An individual, as the exclusive owner of the business, trading on their own.
People, companies and/or trusts running a business together (not as a company).
A legal business entity owned by the Shareholders and run by the Directors.
Discretionary or Unit Trustees (people or companies) operating a business for beneficiaries.
A sole trader is a person trading as the individual legally responsible for all aspects of the business. This includes any debts and losses, which can't be shared with others.
This is the simplest and relatively inexpensive business structure to start a business. However, the downside is all your personal assets would be exposed if things go wrong, such as lawsuits, bankruptcy or relationship breakdown. There is no opportunity for income splitting.
A partnership involves two or more people who go into business together.
It's relatively easy and inexpensive to set up. However, be very careful with this structure as each partner is liable for their share of the partnership debt plus those of the other partners, even if the partner had no knowledge of and was not responsible for the debt. Many business owners are not aware of these “joint and several liabilities”.
A company is a separate legal entity which has the same rights as a natural person and can incur debt, sue and be sued.
Business operations are controlled by directors and owned by the shareholders. The shareholders can limit their personal liability and are generally not liable for company debts. The disadvantage of a company is higher set-up and administrative costs because of additional reporting requirements with ASIC. A company has fixed tax rate however no access to 50% general Capital Gains Discount.
A trust is a relationship where a person (the Trustee) is under an obligation to hold property for the benefit of other persons (the Beneficiaries).
A discretionary trust is a trust in which the beneficiaries’ entitlements to receive capitals and incomes are not fixed but at the discretion of the trustees. A discretionary trust with trustee company is a very popular business structure because it offers asset protection, flexibility in income splitting and access to 50% general Capital Gains Discount. A discretionary trust is not a suitable business structure if you plan to go into business with unrelated parties.
A unit trust is similar to discretionary trust however the beneficiaries have fixed entitlement to capitals and incomes.
A unit trust has less regulation than a company and is easier to wind up. It also has access to the 50% general Capital Gains Discount. Units in a unit trust can be easily transferred. This is a suitable structure for unrelated parties to go into business together. The downside is stamp duty is payable on the sale/transfer of units in many states. Unit trusts also offers less flexibility in income splitting and asset protection compared to a discretionary trust.
Operating as a Sole Trader or Partnership while holding substantial assets like the family home in the individual’s names.
Trading as a Company when the company shares are held in individual’s names (e.g. Husband and Wife).
Operating all of your businesses or owning all of your business or personal assets under one entity.
Operating as a Sole Trader or Partnership while there are other family members earning lower incomes than you.
Purchasing investment properties or other assets with high capital growth while operating under a Company structure.
Operating as a Sole Trader or Partnership and having no consideration for your succession or estate planning options.
Here is a simplified example to show the different tax outcomes for three common business structures – each one earning $80,000. We have made a few assumptions but the outcome is clear: the right structure can save thousands of dollars in tax. Getting your structure right is critical to business success.