Clients often ask us, when setting up or restructuring a business, which structure is best. There is no one correct answer.

Tax

An important factor is minimising income tax. This applies especially if your intention is to run a profitable business well into the future.

The current company tax rate is 25% in most cases, which is far below the top individual rate. However, if and when the company’s earnings are withdrawn by individuals, in effect, they pay the difference between the company rate and their individual tax rates. Even so, using a company structure to defer tax can be important.

Capital gains tax and Small Business Relief

If your purpose is to build up the value of your business and sell it at a profit, a different tax structure may be called for. If you can tick the boxes for Small Business Relief your CGT when you sell your business can be reduced substantially, sometimes to zero. The rules are too complicated to explain in this article.

Asset protection

If your business carries risk, it should be structured in such a way that, if the business fails it will not take you down with it. The best mechanism for asset protection is still a company, or a trust with a company as trustee.

Available business structures

There are several types of business structures for doing business in Australia, each with their own advantages and disadvantages. A person can carry on business as a sole trader, partnership, trust and company.

Sole Trader

A person can carry on a business on his or her own behalf, as a sole trader. A sole trader can trade under his or her own name or a registered business name. The income earned as a sole trader is taxed at the same rate as individual tax payers.

This is the simplest form of business structure, with lower establishment costs and with minimal legal and compliance requirements. The main disadvantage to this type of business structure is that a sole trader is personally liable for all obligations incurred in the course of the business.

Partnership

Two or more individuals can carry on business in partnership, where the income from the business is received jointly. There can even beat partnerships between companies. Partnerships are relatively inexpensive to form and operate. Most partnerships are established by a partnership agreement which sets out the rights and obligations of the partners. A partnership itself is not taxable, rather each partner pays tax on their share of the net income of the partnership.

The downside to this type of business structure is that partners are severally and jointly liable for the obligations of the partnership. There is also potential for dispute and loss of trust between the partners.

Trust

Under a trust, a trustee owns the property or assets of the trust and carries on the business on behalf of the beneficiaries of the trust. The trustee is usually a company. A formal Deed is required to set up a trust and there are annual tasks for a trustee to undertake. As such, it can be expensive and complicated to set up and administer a trust.

The advantages of a trust are that there is flexibility in income distribution and income can be streamed to low income tax beneficiaries to take advantage of their lower marginal tax rate. Furthermore, assets can be protected through a properly drafted Deed. The disadvantages are that trusts can be costly to set up and there are more compliance and legal requirements.

Company

A company is a separate legal entity capable of holding assets in its own name. The words “Pty Ltd” at the end of the name show that it is a company whether trading in its own right, or as trustee of a trust.

A company is owned by shareholders and directors manage the company’s day to day business and affairs. The shareholders of a company receive any company profits in the form of dividends, though there are other ways of taking money out of a company. Shareholders can limit their personal liability and are not generally liable for the company debts. Instead, the financial liability of the company is limited to the company assets.

Companies are governed by the Corporations Act and there are a number of duties and obligations for company directors. Primarily, directors have an obligation to act in the best interests of the company.

Conclusion

Each business is different and no business owners’ circumstances will be the same. It is advisable to talk to us about the costs and risks of each business structure to make sure that the business structure used is the right one for the business and its needs going forward.

If you or someone you know wants more information or needs help or advice, please contact Tim Somerville  or Andrew Somerville on (02) 9923 2321.or email enquiries@somervillelegal.com.au.