Choosing a Business Structure
There are four main types of business structures for conducting business in Australia, each with their own advantages and disadvantages. A person can carry on business as a sole trader, partnership, trust or company.
The choice of business structure is an important decision to make at the start of a business venture, as the structure can have significant impacts on factors such as tax action, reporting requirements, and setting up costs.
When setting up a business, the following factors should be taken into consideration:
- What is the initial cost of starting up the business?
- How many people are involved in the business?
- How much control would each business owner like to have over the business?
- What is the level of exposure to liability that each business owner is willing to take?
- What is the level of asset protection that each business owner requires?
- What is the level of regulatory burden that the business is willing to undertake?
- How flexible does the business need to be? Does the business require a structure that can be changed easily?
- What are the likely taxation consequences for each business structure?
The advantages and disadvantages of each business structure is summarised in the table below to provide a quick guide to factors bearing on the selection of business structure.
|Exposure to liability||Unlimited||Unlimited, as well as joint and several||Limited||Limited – subject to trust deed|
|Control over assets||Absolute||Joint||Separated||Uncertain|
|Control over the operation of the business||Absolute||Joint||Separated||Beneficiaries have no control|
|Ability to obtain finance||Might be limited||Might be limited||Good||Reasonable|
|Compliance costs||Low||Low||Medium – high||Medium|
|Ability to restructure||Low||Low||Moderate||High|
|Exposure to family disharmony||Moderate to High||Moderate to High||Low||Moderate – Low|
|Accommodation to Succession planning||Low||Low||Moderate||Moderate – High|
|Income diversion and accumulation||Little opportunity||Moderate opportunity||Low to moderate opportunity||Moderate – High opportunity|
|Tax||Personal marginal tax rates||Personal marginal tax rates||Company flat rate||Beneficiary’s rate|
|Incidence of tax losses||Personal||Partner level||Quarantined in company||Quarantined in trust|
|Ability to carry forward tax looses||Unlimited||Unlimited||Subject to complex carry forward rules||Subject to complex carry forward rules|
A person can own and operate a business on their own behalf. A sole trader is the simplest form of business structure, with low establishment costs and minimal legal and compliance requirements. An individual running a business as a sole trader also has absolute control over the business.
However, a down side of this structure is that the sole trader has unlimited exposure to liability. The individual is solely liable for all obligations incurred during the course of the business. This means that creditors can pursue any assets in the individual’s own name. Moreover, as a sole trader, the business’s access to finance might be limited to the individual’s own resources.
In relation to taxation implications, the income earned as a sole trader is taxed at the same rate as individual tax payers. This means that there is limited ability to minimise income tax if the business earns significant profit.
Two or more individuals or companies can carry on business in a partnership, where the business income is shared jointly by all partners. Partnerships can be formed by a written or verbal agreement, partnerships are thus relatively inexpensive to set up and operate. The partnership itself is not taxable. Each partner pays tax on their share of the net income of the partnership.
Compared to a business run by a sole trader, one of the benefits of partnerships is the contribution of different assets by the partners (i.e skills and resources to the business).
A main disadvantage of this business type is that all partners are jointly and severally liable for the obligations of the partnership. This means one partner will be liable for decisions that other partner/s make. Similarly to a sole trader, the liability of the partners for the debts of the business is unlimited.
A company is a separate legal entity created by being registered with ASIC. Commonly, the words “Proprietary Limited” (Pty Ltd) after a business name show that the business is a registered legal entity trading in its own right.
A company is owned by shareholders and managed by directors. The shareholders of a company receive company profits in the form of dividends. Any undistributed earnings are kept by the company and re-invested in it.
A major advantage of forming a company is the fact that shareholders can limit their personal liability and are not generally liable for the company debts. The financial liability of the company is limited to the company assets. Companies also have the ability to raise finance because a company is a recognised structure for both debt and equity funding.
As companies are governed by legislation, they are generally expensive to set up. Depending on the size of the company and the complexity of business transactions involved, companies will also incur various on-going costs for reporting and accounting. Further, there is a requirement to publicly disclose key information, such as the company’s registered address for service.
A trust is formed when a person (the trustee) holds property for the benefit of someone else (the beneficiary). A trust is a legal relationship, and not a separate legal entity. As such, most legal dealings in relation to a trust rest with the trustee, which can be an individual or a company. The trustee has control over the assets and is entitled to deal with those assets in accordance with the terms of the trust deed and the applicable law.
A trust may be established by a document known as a trust deed (Express Trust) or by conduct (Resulting Trust) or by court order or legislation (Constructive Trust). Therefore, a trust can sometimes be costly and complicated to set up and be administered.
As the distributed income of the trust is taxable to the beneficiary, a benefit of a trust is therefore the flexibility of income distribution, as income can be distributed to the low income tax beneficiaries to take advantage of their low marginal tax rate.
WHICH BUSINESS STRUCTURE IS FOR YOU?
Each business will vary and no business owners’ circumstances will be the same. It is highly advisable to consult a solicitor and an accountant about the costs and risks of each business structure to make sure that the most appropriate one is used.