What Business Structure should you choose?

Working out what business structure would be the most effective for you, can be a tricky decision. Remember though, that you are not locked into any structure and you can change the structure as your business changes or grows.

To make an informed decision it is best to understand what structures are available and what their key features are.

There are four commonly used business structures in Australia:

  • Sole trader

  • Partnership

  • Company

  • Trust

It's important to understand the responsibilities of each structure because the structure you choose may affect:

  • the tax you're liable to pay

  • asset protection

  • costs

SOLE TRADER

A sole trader is an individual running a business. It is the simplest and cheapest business structure.

If you operate your business as a sole trader, you are the only owner and you control and manage the business.

You are legally responsible for all aspects of the business. Debts and losses can't be shared with other individuals.

You can employ workers in your business, but you can’t employ yourself.

As a sole trader, you are responsible for paying your worker's super. You're also responsible for your own super and may choose to pay it into a fund for yourself to help save for your retirement.

Sole Trader - Key Features

As a sole trader, you:

  • use your individual tax file number when lodging your income tax return

  • report all your income in your individual tax return, using the section for business items to show your business income and expenses (there is no separate business tax return for sole traders)

  • apply for an ABN and use your ABN for all your business dealings

  • register for Goods and Services Tax (GST) if your annual GST turnover is $75,000 or more

  • pay tax at the same income tax rates as individual taxpayers and you may be eligible for the small business tax offset

  • put aside money to pay your income tax at the end of the financial year - usually, you will do this by paying quarterly Pay As You Go (PAYG) instalments

  • claim a deduction for any personal super contributions you make after notifying your fund.

As a sole trader you can't claim deductions for money 'drawn' from the business. Amounts taken from the business are not wages for tax purposes, even if you think of them as wages.

Personal Services Income (PSI) – Applicable for all Four Structures

If you're paid mostly for your personal efforts, skills or expertise, you might be receiving personal services income (PSI) and you may have to treat deductions in relation to this income differently regardless of your business structure

COMPANY (PTY LTD)

A company is a legal entity with higher set-up and administration costs. Companies also have additional reporting requirements.

A company is run by its directors and owned by its shareholders.

While a company provides some asset protection, its directors can be legally liable for their actions and, in some cases, the debts of the company.

Companies are regulated by the Australian Securities & Investments Commission (ASIC).

Company (Pty Ltd) - Key features

In this business structure, the company:

  • must apply for a tax file number (TFN) and use it when lodging its annual tax return

  • is entitled to an ABN if it is registered under the Corporations Act 2001. A company not registered under the Corporations law may register for an ABN if it is carrying on an enterprise in Australia

  • must be registered for GST if its annual GST turnover is $75,000 or more

  • owns the money that the business earns - the individuals who control the business cannot take money out of the business, except as a formal distribution of the profits or wages

  • must lodge an annual company tax return

  • usually pays its income tax by instalments through the Pay As You Go (PAYG) instalments system

  • pays tax at the company tax rate (27.5%) and may be eligible for small business concessional rates

  • must pay super guarantee contributions (SGC) for any eligible workers. This includes you, if you are a director of the company, and any other company directors.

PARTNERSHIP

A partnership is a group or association of people who carry on a business and distribute income or losses between themselves. For example, if you and a friend or family member decide to set up a business together, you might operate it as a partnership.

A partnership is relatively inexpensive to set up and operate. The partners share income, losses and control of the business.

A written partnership agreement is not essential for a partnership to exist, but it is a good idea. A partnership agreement should outline how income or losses will be distributed to the partners and how the business will be controlled.

A partnership agreement can help prevent misunderstandings and disputes about what each partner brings to the partnership, and what they are entitled to receive from the income of the business. This is particularly important for tax purposes if the profit or losses are not distributed equally among partners.

The partners in a partnership are not employees, but the partnership might also employ other workers.

Partners are responsible for their own superannuation arrangements. However, the partnership is required to pay superannuation for its employees.

Partnership - Key features

In a partnership business structure:

  • income, losses and control of the business are shared among the partners

  • the partnership has its own TFN and must lodge an annual partnership return showing all income and deductions of the business

  • the partnership doesn't pay income tax on the profit it earns – each partner reports their share of the partnership income in their own tax return

  • each partner pays tax on their share of the partnership profit at the individual tax rate and may be eligible for the small business tax offset

  • the partnership must apply for an ABN and use it for all business dealings

  • the partnership must be registered for GST if its annual GST turnover is $75,000 or more.

As a partner you can't claim deductions for money drawn from the business. Amounts you take from a partnership are not wages for tax purposes.

TRUST

Setting up a trust can be expensive as a formal deed is required outlining how the trust will operate and there are formal yearly administrative tasks for the trustee.

A trustee is legally responsible for the operation of the trust. The trustee can be an individual or a company. Profits from the trust go to beneficiaries.

Trust - Key features

If you use a trust for your business structure, the trust:

  • must have its own tax file number (TFN) for lodging its annual tax return

  • must apply for an ABN and use it for all business dealings

  • must be registered for GST if annual GST turnover is $75,000 or more

  • may be liable to pay tax depending on the wording of its deed and whether any income the trust earns is distributed to its beneficiaries

  • may be able to access small business tax concessions

  • must pay super for any of its employees (this may include the trustee if they are also employed by the trust).

Who pays income tax?

While a trust must lodge an annual tax return, whether the trust pays tax (or not) is determined by how the trust income is distributed:

  • if all trust income is distributed to adult resident beneficiaries, the trust is not liable to pay tax – each beneficiary reports the income in their own tax return

  • if all or part of the net trust income is distributed to non-residents or minors, the trustee is assessed on that share on behalf of the beneficiary – these beneficiaries may need to declare their share of the trust's net income in their own income tax returns, and can claim a credit for the tax paid on their behalf by the trustee

  • where the trust accumulates net trust income (does not distribute it), the trustee is assessed on that accumulated income at the highest individual tax rate.

If you would like advice on business structures, please call our office on 07 5502 6673 and book a FREE consultation with one of our Qualified Accountants

Information included in this blog was obtained via www.ato.gov.au

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