Which of the following is not one of the considerations when selecting a business structure?

Every business that operates in Australia not only has a different purpose, they also have different goals and ambitions. Some business owners like to maintain a small, tight network and oversee every aspect of their business. Other business owners thrive on growth and working on a much larger scale. As a result, the unique circumstances that apply to your business will determine the most appropriate business structure.

1. Sole Trader (Individual)

The Sole Trader structure is most appropriate for small business owners, especially when the business’ operations are based on the owner’s personal skills and talents. They often trade with the owners name (e.g. Jenny Lee), or they can register a business name (e.g. Jenny’s Automotive). Many businesses begin their journey as Sole Traders due to the simplicity of set-up procedures, low costs and the owner maintaining all the control.

Key Features of the Sole Trader Business Structure:

• Simple to set up & with very little cost
  
• Relatively easy to change the business structure as it grows & easy to dissolve
  
• Sole Traders also bear the full responsibility for any liabilities (this may extend to the business owner’s personal assets)
  
• Sole Traders pay tax on the net profit generated from their business activities. This income is included in their personal tax returns and is 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. Sole Traders can make personal concessional (deductible) contributions to their nominated super fund, up to the annual limit

Costs: Low costs and minimal legal procedures to establish.

2. Partnerships 

Partnerships are a formal arrangement by two or more parties to manage and operate a business collectively. In this particular structure, both risks and rewards are shared by each of the partners. A partnership has its own Australian Business Number (ABN) and Tax File Number (TFN). For security purposes, it’s recommended that the owners develop a Partnership Agreement to explicitly set out the terms and conditions of the partnership.

Key Features of the Partnership Business Structure:

• The Partnership structures allows for different skills to be pooled together
  
• Profits and losses of the business are shared amongst the partners
  
• 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 tax on their share of taxable income and any other income they may have
• Unlimited liability – each partner bears the total responsibility of the business liability if other partners are unable to fund their share
• Like a Sole Trader structure, partners cannot be employees of their own individual partnership – so they don’t receive a wage or 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

Companies are legal entities that are formed by either individuals or a group of individuals to engage in and operate a business. In Australia, there are two types of companies: Public and Private. Private companies are more common in comparison to public companies – purely due to the increased regulation & reporting requirements that need to be fulfilled for public companies. Public companies can be (but don’t have to be) listed on the Stock Exchange. Company 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 owned by the company are completely separate to company directors and shareholders. This is a feature that attracts business owners to this structure
• 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
• Increased regulation that needs to be complied with. Directors can face serious penalties for breaching regulations

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

4. Trusts

Trusts are widely used for investment and business purposes in Australia. With this particular structure, the business is operated by a Trustee (which can either be a company or one or more individuals). The Trustee is responsible for managing the Trust’s tax affairs as well as operating the business on behalf of the beneficiaries.

A Trust is required to have its own Tax File Number and lodge its own tax return on an annual basis. Similar to a partnership – the trust does not physically pay any tax. The Trustee will determine the appropriate distribution of profit to the beneficiaries. The beneficiaries include this income in their personal tax return and pay tax at their individual marginal rates.

There is quite an extensive list on types of Trusts, however the two most commonly used are Discretionary and Fixed. Beneficiaries of a fixed trust are entitled to a fixed percentage of the income generated – based on their proportional ownership of the trust. On the other hand, discretionary trusts have no fixed entitlement. It is up to the discretion of the Trustee to pay out different distributions to the beneficiaries each financial year.

A formal Trust Deed is required. The Deed explicitly 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. The Trustee can be a company, or more than one individual
  
• Corporate (company) Trustees provide a greater level of asset protection in comparison to Individual Trustees
  
• Fixed Trusts must pay the same proportion of income to its beneficiaries each financial year (which is based on their ownership)
  
• Discretionary Trusts have more flexibility in terms of paying income to beneficiaries
  
• Trusts must lodge an annual tax return
  
• Beneficiaries must include their share of income from the Trust in their personal tax return and pay tax at their marginal rate

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

Comparing Australian Business Structures

Two or more people with joint control;Easy to establish;

Death of a partner dissolves entire partnership.

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

Business operations and assets are managed by Trustee on behalf of beneficiaries;
Trustee can be a company or individuals.

Taxes

Income included on Personal Income Tax.

Partnership lodges an annual 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?

The business structure you choose can have a large impact on multiple aspects of your business including: how much tax you pay, asset protection, ongoing costs & fulfilling compliance requirements. It’s important to understand how your structure will support your business and compliment the everyday operations that occur. Let’s look into these considerations in more detail.

 1. Tax Implications

Each business structure has different tax implications. Each type has its own advantages and disadvantages, however the nature and scale of business activities will heavily influence the most effective structure to implement.

For example, profits that are generated in a company are taxed at a flat rate of either 26% (reducing to 25% in 2022) or 30%. On the other hand, Sole Traders that earn the same amount of income will be taxed at their marginal rates which can be as high as 47% (including the Medicare Levy)! For the same amount of profit, each entity pays a completely different amount of tax – and this is all determined by the legal structure the business operates under.

Changing your business structure these days can be done almost instantaneously, however there can be tax implications involved when changing structures. To help assist with these transitions, there are tax concessions available – however there are requirements that need to be followed in order to be eligible for these concessions.

2. Asset Protection

To best protect your assets, a company or trust structure will be most effective. This is purely due to the concept that these specific business structures are separate legal entities to its owners. These entities are subject to pay their own liabilities. When a company operates a business, there is a clear line between business and personal assets. In the unfortunate event that your company is liquidated or litigated against, your personal assets should be protected.

It should be noted that Trusts can offer the same level of protection, provided that you have a corporate trustee as opposed to an individual trustee. 

 3. Costs of Maintaining the Structure

Using companies and trusts as your business structure involve ongoing annual costs that need to be paid in order to remain compliant. Each year the entity must prepare financial accounts and lodge a tax return which can lead to costly accounting fees. Companies are also subject to pay ASIC an annual company fee in order to keep their company registered.

Sole traders & partnerships generally have 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 hairdressing salon or a small handyman service, you would benefit with a low-cost structure like Sole Trader. On the other hand, doctors, lawyers and builders 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 multiple factors to consider when choosing the right structure, as each individual person and their respective business is different. As mentioned earlier, some business owners prefer to remain small to ensure they always have control over their business and all decision-making involved. On the other hand, other business owners thrive on growth and funding from external parties to build their business on the highest platform possible.

As a result, the following concepts need to be considered:

• Your future goals and objectives of the business.
• Is cost going to be an issue? Sole Traders and Partnerships have very low start-up costs in comparison to Companies and Trusts (due to all the additional documentation that needs to be prepared when commencing these entities). However, sole traders and partnerships get taxed at marginal rates, as opposed to companies that get taxed at flat rates.
• Think carefully about who you want to have control in the business.
• If you need limited liability and want a clear distinction between your business assets and personal assets, consider a Company or Trust.
• The taxation implications for your business – not only whilst you operate the business, but also considering the taxation implications if a restructure or an exit was to ever occur.
• Understand the ongoing costs. Due to the nature and complexity of Companies and Trusts, they face higher ongoing costs due to their compliance and reporting obligations.
• Pay close attention to the type of industry your business falls in. Some structures can provide more protection and security than other structures.

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.

Seeking the Assistance of an Adviser to Help You Choose a 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. 

Our team at BLG Business Advisers are Wollongong Accountants who 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.