Business structures play a significant role in the internal workings of your business. Tax, liability and administrational costs all vary greatly between the differing business structures, hence the importance of implementing the correct business structure from the very start.
Sole trader structures have a plethora of advantages for the small business owner. Initial costs are very low (a sole trader ABN can be registered for free, and a business name can be registered for $33/year), accounting fees are much cheaper than other structures (with the added advantage of compiling both the business and your individual tax return on the same form) and tax is paid at your marginal tax rate. Compared with a company structure (30% flat tax rate), if your total income is less than $115,000 (including other sources of taxable income), you will be paying less tax (although a company may pay you a wage in order to take advantage of the tiered individual tax rates). Liability is however one area of weakness for sole trader structures. Should any legal issue arise, you as the owner are 100% liable for the repercussions (although taking out appropriate insurance can mitigate this risk somewhat).
Other matters to be aware of are as follows:
-Difficulty in raising capital
-More troublesome to sell the business
-Inefficient to run at high income levels
-Discounts available on capital gains (unlike company structures)
With similar liability/financing issues (although mitigated slightly due to having two owners) as a sole trader and additional administrational costs, partnerships are definitely falling out of favour in today’s business world. Tax is still paid at the partners marginal tax rate, although a separate partnership tax return form must also be lodged (basically a sole trader divided between two people with additional administrational costs). Accountancy Matters would definitely advise against a partnership structure except in very specific situations (or there is insufficent capital to operate a company/trust structure).
Companies pay tax at a flat rate of 30%, they also offer protection against legal liabilities for the owners (although generally with financing the director will still be liable should repayments not be met). Accountancy fees are also much higher than with sole traders, as well as higher set up costs. The biggest drawback with a company is not a weakness in the inherent structure but the fact that most benefits of a company structure can be achieved in a trust structure (with a corporate trustee) as well as the trust offering tax/capital gain savings (no discount on capital gains offered for companies). The only favor company structures have over trusts is lower accounting fees (assuming corporate trustee) and an easier time acquiring finance from institutions.
Trusts have almost all the benefits of company structures with additional tax benefits. Trusts are able to distribute their income to their beneficiaries however they see fit (Discretionary family trust with related beneficiaries). Should the beneficiary be an individual, the income will taxed at the individuals tax rate and company beneficiaries will be taxed at 30%. Any undistributed income will be taxed at the trustees top marginal tax rate although by having a corporate trustee, this will be capped at 30%. It is due to this flexibility which allows trusts to be the most effective structure for tax (SMSF’s aside), although if beneficiaries with a comparative tax rate below 30% cannot be sourced, the trust offers little advantage over a company structure (apart from a discount on capital gains). The biggest drawback with trusts (using a corporate trustee) is simply setup and administrational costs. Unlike a company, a trust is not a separate legal entity but merely an agreement between the trustee and the beneficiaries.
For a further in depth discussion regarding the correct business structure for your business please feel free to contact Accountancy Matters for a free consultation.