Explaining Different Business Structures

One of the key decisions you’ll make when starting a business is which legal structure to use. Because it’s such an important decision, you should get advice from a qualified independent business, financial or legal advisor.

Sole Trader

A sole trader is the simplest form of business structure and relatively easy and inexpensive to start and maintain

Definition: As a sole trader you are the sole business owner and can trade in your own name. (e.g. Fred Smith Plumber).

Advantages

-Simple set up and operation.

-You retain complete control of your assets and business decisions.

-Fewer reporting requirements.

-Any losses incurred by your business activities, may be offset against other income earned (such as your investment income or wages). Subject to certain conditions.

-You are not considered an employee of your own business and are free of any obligation to pay payroll tax, superannuation contributions or workers’ compensation on income your draw from the business.

-Relatively easy to change your legal structure if the business grows, or if you wish to wind things up.

Disadvantages

-Unlimited liability which means all your personal assets are at risk if things go wrong.

-Little opportunity for tax planning – you can’t split business profits or losses made with family members and you are personally liable to pay tax on all the income derived.

Partnership

A partnership involves two or more people (but no more than 20) going into business together.

Definition: A partnership is two or more persons carrying on a business together with a view to a profit.

Advantages

-Simple and inexpensive to set up. You will usually have to register a business name.

-Minimal reporting requirements.

-Shared management/staffing responsibilities.

-Partners make it possible to take a break

-More opportunities for tax planning (such as income splitting between family members) than that of a sole trader.

-A partner’s share of the business’s tax losses may be offset against other personal income, subject to certain conditions.

-Combined skills, experience and knowledge can provide a better product/service.

-Relatively easy to dissolve or exit and recover your share.

-Access to capital.

-Partners are not employees. Superannuation contributions and workers’ compensation

-Insurance are not payable on partner’s profits or drawings.

Company

A company is a separate legal entity capable of holding assets in its own name. Shareholders own the company while directors run it.

Definition: A company is a legal person (apart from its directors and shareholders) providing limited (“Ltd”) liability protection.

Advantages

-Single director & shareholder is all that is needed

-Limited liability for shareholders/owners.

-Asset protection – company liabilities generally remain in the company

-Company structure is commercially well understood and accepted.

-Ability to raise significant capital.

-Profits can be reinvested in the company or paid out to the shareholders as dividends.

-A flat 30c in the dollar tax rate applies

-Retained Earnings can be accumulated

-Dividends can be franked or unfranked

-Easy to sell and pass on ownership.

-Company can carry forward losses indefinitely to offset against future profits.

Disadvantages

-Significant set-up costs and maintenance costs.

-Limited or no control of company affairs.

-Complex reporting requirements.

-Company can’t distribute losses to its shareholders.

Trust Unlike a company, a trust is not a legal entity. They are often used in connection with running a business for the benefit of others.

Definition: A trust is a relationship where the trustee carries on a business for the benefit of certain beneficiaries.

Discretionary Trusts

The trustee has discretion in the distribution of funds to each beneficiary. The most common example is the family trust.

Unit Trusts

Unit trusts are recommended when more than one family is involved. The interest in the trust is divided into units, similar to shares. Each unit holder may have a number of units in the trust. Distribution from the trust is determined according to the number of units held. Importantly, trustees are legally liable for the debts of the trust. They can use the assets of the trust to meet those debts. However, if there’s a shortfall, they are responsible for covering the difference from their own resources.

A trustee must apply for a Tax File Number (TFN) and lodge an annual trust return. The trust is not liable to pay tax, tax is assessed to the trustee or to the beneficiaries that are entitled to receive the trust net income.

Advantages

-There are different types of trusts – discretionary (family) trusts, unit trusts & hybrid trusts.

-A Trust can only conduct business via a trustee. A trustee can be a natural person(s) or a company

-Reduced liability – especially if corporate trustee.

-Income splitting to beneficiaries with tax paid at their respective tax rates.

-Asset protection -trust assets and personally owned assets can often be kept separate. Careful consideration in drafting of the trust is needed here

-Flexibility of asset and income distribution.

Disadvantages

-Can be expensive and complex to establish and administer.

-Difficult to dissolve, dismantle, or make changes once established particularly where children are involved.

-Any profits retained to reinvest into the business, will incur penalty tax rates. Penal tax is levied on retained earnings.

-Cannot distribute losses, only profits.

Cooperative

A cooperative is a member-owned business organisation with at least five shareholders, all of whom have equal voting rights regardless of their level of involvement or investment, although every shareholder is expected to help run the cooperative.

Association

An incorporated association offers a relatively simple alternative to forming a company for small non-profit groups such as charities and hobbyists along with sporting, cultural and recreational organisations.

 

SOURCE: ICB June 2014 Newsletter