What is the best business structure in Australia?

1. Sole Trader

The simplest and most straightforward business structure is the sole trader. Many opt for this choice when starting out and don’t yet have a clear idea of the business’s potential success or the direction they want it to take.

Sole trader operations and administration

• Being a sole trader isn’t flexible, and business owners often ‘outgrow’ this structure within a couple of years.
• This structure is most suitable for contractors, tradies, entertainers, hobby/home businesses while they are starting out.
• It’s the most common business structure used in Australia.
• Because the structure is simple, it can be changed to a company or trust structure quickly as your small business grows.
• Professional insurance is critical to protect yourself personally as much as legally possible.

Tax implications and benefits of being a sole trader

The structure is low cost and easy to set up.  All you need to do is register an ABN (Australian Business Number) under your personal name

• Your small business may lodge business activity statements (BAS) for GST, and have employer obligations such as Pay-As-You-Go (PAYG) withholding
• You declare your business income as part of your personal tax return.  There is no separate business tax return for sole traders
• Sole traders are taxed at the marginal individual tax rates which means the more you earn, the higher the income tax you pay.  This is ok when the business is starting out but can quickly become a poor tax structure compared to a company (which is taxed at 25% flat rate).
• The ATO allows sole traders to claim a 50% Capital Gains Tax (CGT) discount if they sell assets after one (1) year)

Legal and asset protection of being a sole trader

• You manage the business under your personal name.  This means there is no legal separation (no asset protection) between you as an individual and the business.
• Sole traders are personally responsible for all the creditors, tax liabilities and employees personally, which can have unintended risks.  If the business fails, creditors can come after your personal assets, like your home or your car.

2. Partnership

Partnerships are similar to sole traders in terms of the tax and legal implications and operations of the business.  However, partnerships are formed when two (2) or more individuals come together to jointly run a business and share the income and losses between themselves.

There are two main types of partnerships in Australia: general partnerships and limited partnerships. In a general partnership, all partners share equal responsibility and liability, while in a limited partnership, there is a distinction between general partners, who have unlimited liability, and limited partners, whose liability is restricted to their investment in the business.

Partnerships operations and administration

• This structure is most common for people buying commercial investment properties, small professional services, or consulting businesses (such as lawyers and accountants)

Tax implications and benefits of partnerships

• The structure is generally low cost and easy to set up.  All you need to do is register an ABN (Australian Business Number) under the partnership name
• Your small business may lodge business activity statements (BAS) for GST, and have employer obligations such as Pay-As-You-Go (PAYG) withholding
• Partners pay income tax on the share (%) of the partnership income at their individual marginal tax rates as part of their personal tax returns.  Each partner reports their share of partnership income or loss to the ATO in their individual tax return and is personally liable for the tax.
• The partnership must also prepare and lodge a separate partnership tax return. 
• The ATO allows partnerships to claim a 50% Capital Gains Tax (CGT) discount if they sell assets after one (1) year)

Legal and asset protection of partnerships

• Like sole traders, partners in a partnership are jointly responsible for the debts of the business.  This means there is no legal separation (no asset protection) between you as an individual and the business.
• It is important to carefully pick the person(s) you enter into a partnership with, as all partners are jointly and severely liable for the other partners’ actions. A formal partnership agreement is common, but not mandatory. 

At Blackwattle Tax, we recommend that you have a partnership agreement legally drafted, to outline out how the partnership operates. This agreement should include:

• legal name of the partnership and outline the nature of the business
•  appoint a primary business officer
• name the owners/partners and everyone’s share (%)
• outline how income is distributed
• define a formal process to resolve disputes
• identify key bookkeeping and finances processes and procedures
• outline the process to wind up (end) the partnership

3. Company

A company is a separate legal entity from its owners, known as shareholders. This structure is more complex and provides limited liability for shareholders and business owners, meaning their personal assets are generally protected from business debts.  To put simply, a company can enter into contracts, own a business, employ people, and sue/be sued in its own right.

Companies have more complex regulatory and reporting requirements, making them suitable for larger and more established businesses. There are two main types of companies in Australia: proprietary limited companies (Pty Ltd) and public companies (Ltd).

Company operations and administration

• Companies have higher set-up and administration costs than other types of business structures and have additional reporting requirements.
• A company’s income and assets belong to it, not its shareholders or directors. There may be significant tax implications if you are using your company’s money and assets for private purposes.
• This structure is most suitable for established businesses or all types that want to grow and have higher levels of business risks.

Tax implications and benefits of establishing a company

• The structure is more costly to set up and requires more complex annual tax and compliance administration.
• The business may lodge business activity statements (BAS) for GST, and have employer obligations such as Pay-As-You-Go (PAYG) withholding
• Companies pay tax at its applicable company tax rate on their profits which is currently 25%. This is generally lower than most individuals, sole trader, and partnership tax rates.
• A company can distribute retained profits from the business to shareholders via dividends.  Dividends may have franking credits attached to those dividends, which is essentially a credit for the tax already paid by the company on its profits.  Dividend strategies is one of the most effective tax minimisation strategies business owners use to reduce personal income tax.

Legal and asset protection of a company

• The business must register the company with ASIC (Australian Securities & Investments Commission). Company officers must also comply with other legal obligations under the Corporations Act.
• The biggest advantage for setting up a company is that shareholders’ liability is limited to the money they invest into the company as equity.  Shareholders cannot be held personally liable for the business liabilities or debts. This makes it the preferred structure for most businesses that have risks with employees, customers, operations, and creditors.
• While a company has limited liability, it is a more complex business structure, with higher set-up and administrative costs.  It also has higher levels of legal responsibilities for the company and directors.  Directors are the people with the legal and fiduciary duty to properly managing the company.  Failure to manage the company can have serious consequences such as insolvent trading and director personal liability such as Director Penalty Notices (DPN).
• All directors are legally required to verify their identity and apply for a director identification number (director ID) prior to being appointed as a director of a company.

4.Trust

Trust structures are separate legal entities or more specifically they are a legal arrangement where assets are held by a party (trustee) for the benefit of another party (beneficiary). 

There are several types of trusts in Australia. Discretionary trusts are the most common type in a business structure for families because of their flexibility.

Most business owners use a combination of a trading company owned by a discretionary family trust as a preferred group business structure to maximise tax outcomes with franked dividends, and trust distributions. To understand these tax strategies, you should speak with a qualified small business accountant and Registered Tax Agent.

Trust operations and administration

• It is recommended that you have a trust deed that sets out how the trust operates, including the powers of the trustees and the interests of the beneficiaries in the trust.  The trustee manages a trust’s tax affairs.
• It is recommended that trusts have a corporate trustee (rather than an individual trustee) to allow for simpler administration of a trust.
• Trusts are commonly used for estate planning, family businesses, investments, and asset protection
• Discretionary trusts provide flexibility and discretion over how to distribute business profits to beneficiaries in the most tax efficient manner. 

Tax implications and benefits of setting up a trust

• The structure is common for owning shares in a company or assets such as real estate property or share portfolios.  It is generally not the best structure to operate a small business through due to the tax implications outlined below.
• One potential limitation is that trusts must distribute all income to beneficiaries each year (and cannot pass on losses, instead they are retained by the trust as carried forward losses).  This means that if the business is growing and is highly profitable, the beneficiaries can face paying high tax at their individual marginal tax rates.
• Individual beneficiaries pay the tax on all income distributed from a trust each year in their personal tax returns.
• The trustee must lodge an annual tax return for the trust
• Your business may lodge business activity statements (BAS) for GST, and have employer obligations such as Pay-As-You-Go (PAYG) withholding

Legal and asset protection of having a trust

• The trustee, who manages the trust, has legal ownership of the assets, while the beneficiaries benefit from the income generated by the trust. Trusts offer flexibility and can be tailored to specific needs, but they also involve intricate legal and financial considerations.
• Trusts provide asset protection by holding the asset of a business (such as a commercial property) in a separate legal entity from the trading business itself.