Starting a business: Choosing a business structure

There are several different legal structures which can be utilised to own and operate a business.

Choosing the right business structure is important because each structure has different rules regarding issues such as tax, liability, succession, ownership and disposal of the business.

Have a chat with your accountant about the best business structure for you and any related legal, financial and tax issues to consider.

The basic business structures available are:

• Sole Trader / Partnerships
• Company
• Single Discretionary Trust

 

Sole Trader / Partnerships

These are the easiest and most inexpensive business structures to operate. A sole trader has full control of the business including ownership of all profits and responsibility for all debts. A sole trader is therefore personally liable for the actions / debts of the business and income from the business is taxed at the personal rate of the individual (which may be higher than the company tax rate). Similarly, the assets of a partnership are owned by the partners jointly or in the proportions set out in the partnership agreement. The partners are jointly and severally liable to an unlimited extent for the actions of the partnership and the other partners.

Advantages:

• Low cost to set up and to maintain.
• Easy to understand.
• No difficulties in “obtaining net proceeds” from a business sale/operation.

Disadvantages:

• Minimal tax planning strategies are available and income is subject to maximum personal tax rates.
• Minimal asset protection is available. All assets of the individual are “up for grabs”.  This is both for marital and business situations.
• No WorkCover available for partners if desired.
• No employment relationship for the individual/partners.

 

Company

A company must be registered and operate under the Australian Corporations Law. It is a separate legal entity in that it can borrow money, make investments, “fail” and go into liquidation etc. separately from it’s directors and/or shareholders. This factor allows for asset protection, as the company can fail with the business while the assets of the individuals (such as the family home) are kept separate and safe as long as there is no insolvent trading or negligence.

Advantages:

• Asset protection.
• Relatively simple structure makes it easier to understand for outside parties (in comparison to partnership of discretionary trust).
• Constant 27.5% tax rate (businesses with less than $50m turnover) or 30% tax rate (businesses with over $50m turnover).
• Ability to utilise WorkCover if desired.
• Ability to have employment relationship between the company and the individuals.
• Ability to easily separate ownership (based on number of shares held.

Disadvantages:

• Inability to obtain full Capital Gains Tax concessions.
• Cost – $1,320 to set up plus ongoing ASIC fees of $273 per year (2020-21 rate).
• Companies are more regulated than other business structures and company Directors have legal duties and obligations under the Corporations Act.
• Under the Director Penalty Regime, if directors fail to meet their legal obligations they may be held personally liable for the company’s debts.

 

Single Discretionary Trust

A trust is a legal relationship where a trustee (an individual or a company) carries on business for the benefit of other people (the beneficiaries). The operations and actions of the trust are governed by a Trust Deed. The trustee is thus held liable for the obligations of the trust.

This business structure is generally best suited to an individual family.  This is due to the high level of flexibility in how the income/capital can be distributed from year to year.  Under a discretionary trust, there is no set fixed formula as to the sharing of profits or capital.  It is completely up to the trustee.  Therefore, any beneficiary can receive between 0 and 100% of the income in any financial year.  There is no limit to the number of beneficiaries, although the “class” of beneficiaries is normally set down within the trust deed (for example, the family of Joe Brown).

Advantages:

• Unlimited ability to distribute income in a flexible method – allows for full utilisation of changing tax rates for different entities and individuals.
• If a company is used as trustee, allows for additional asset protection – the trustee “wears” the risk of the business, and this can be separated from other assets held by the family (e.g. the family home).
• Capital Gains Tax concessions (50% discount for assets held in excess of one year, small business active asset exemption for small business assets) are fully available assuming the family group passes the $6million asset test or $2million turnover test.
• Ability to utilise WorkCover if desired (not compulsory for trustees/directors of trustee company).
• Ability to have employment relationship between the trust and the individuals. Allows for full claim for superannuation.

Disadvantages:

• Complete flexibility – this means there is no set percentage as to what each person is entitled to. This advantage for a single family is a disadvantage if “arm’s length” parties (two separate families) attempt to utilise this structure. It is therefore not recommended to have more than one family within this structure.
• A Trust and trustee company is approximately $2,640 to set up. An additional $273 per annum (2020-21 rate) is payable to ASIC for the trustee company’s annual return fees.
• Trust loss provisions can be quite complicated if a loss is incurred within the business. It should be noted that although a trust does not pay any income tax, the income is always distributed through to the beneficiaries (the beneficiaries pay the tax). In the case of a loss, the loss is “trapped” within the trust and cannot be distributed through to the beneficiaries (to offset income from other sources, such as wages).

 

Further help

For everything you need to know in one comprehensive guide, download our Starting a Business Guide. In this free guide, we’ve put all the information in the one place, so you don’t have to go searching. We’ll take you through each step of starting a business, give you options to consider and help you understand what’s ahead.

If you would like some help to get your business off the ground, we invite you to contact us for a chat. You can reach us on (07) 3023 4800 or at  mail@marshpartners.com.au.

Lastly, you can find out more about working with Marsh & Partners here. As your Absolute.Account.Ability partner we’re on a mission to make your business life better. We’ll help you set goals for your business, devise an Action Plan to make them happen and meet with you regularly to ensure you stay on track.

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