Sole trader or company: the pros and cons

by The Cleardocs Team

Many readers may hold dreams of breaking the shackles of their workaday existence to start their own business. It’s only natural to want to be your own boss and control your destiny, however, once you get past the initial flight of fancy, you will need to address the practical realities. One question you may face is whether it’s more advantageous for you to start a business as a sole trader or via a ‘Pty Ltd’ company.

This piece provides some general information regarding the 2 different business structures, however, you should always seek legal help about your own particular circumstances.

 

 

Pty Ltd company

Sole trader

How decisions are made

The Corporations Act (the Act) provides that the majority of decisions will be made on behalf of a company by the directors. However, the Act also sets out other decisions that will be made by shareholders.

There are no such restrictions for sole traders. He or she alone makes all decisions about the business.

Liability

One of the advantages of operating a company which is limited (including Pty Ltd companies) is the restriction regarding liability.

Shareholders: liability is limited to the unpaid capital of shares owned. For example, in the event that a shareholder has no debts associated with their shares, then their liability will be zero. What this essentially means is that if shareholders have paid all amounts owing; yet the company goes into debt, then any creditors will be unable to recover any debts from the individual shareholders.

Directors: for the most part, if a company goes into debt, creditors cannot recover any debt from directors, unless they have given the green light for the company to continue trading after insolvency.

The liability of sole traders is not limited. Loans provided to sole traders will generally be secured by their personal assets – which can sometimes include the family home.

Security for loans

Any loans provided to companies can only be secured by its assets, however in certain circumstances, directors may be requested to provide personal guarantees.

Loans provided to sole traders will generally be secured by their personal assets, which can often mean the family home.

Investment and capital raising

Companies are able to procure investment from outside parties by offering shares.

Sole traders aren’t able to offer shares, so if they wish to add capital, they must seek financing from lenders such as banks, or join other sole traders in forming a partnership. 

Capital raising & start up costs

 Shareholders cannot claim their investments in a company as a deduction against their assessable income.

Sole traders can claim expenses used in setting up their business as a deduction against their assessable income.

Tax

Companies pay tax at the corporate rate of 30%.It is also essential for a company to have financial accounts on hand in order to submit a tax return.

Sole traders pay tax depending on their personal marginal rate. This is because income derived through a business operated by a sole trader, is considered as the sole trader's assessable income.

Retained profits

Companies are generally not required to issue profits to shareholders and can use the profits to facilitate growth in the business. However, retained profits are taxed as income of the company.  

Profits of sole traders will be taxed at their personal marginal rate; furthermore, sole traders cannot retain any profits.

Tax losses

Companies that have multiple businesses can offset any losses from one of the entities against the income of the other. For companies that form part of the same consolidated tax group, the situation is similar, in that losses can be offset against the other sources of income in the submission of a group’s return.

Sole traders have the ability to offset any losses from one source of assessable income to another. For example, any losses incurred in regards to rental property can be offset against any income from the business of the sole trader.

Carried forward losses

Taking into account any special ownership and business continuity rules, a company can carry any tax losses to future years.

Sole traders can carry tax losses to future years.

Consumer protection

The Competition and Consumer Act 2010 (Cth) protects consumers whenever they are dealing with a company.

Consumers are protected when dealing with state based sole traders by various legislative instruments, such as the Fair Trading Act

Registration and fees

There are a number of costs associated with a company, including an ASIC registration fee and an ASIC annual review fee.

If the company is to engage in certain types of activities, then the company must pay licence fees (eg a liquor licence) and such fees are often more expensive for a company than for a sole trader.

There are no registration or annual fees for sole traders.

Business licensing fees are often lower for sole traders than for companies.

Creditors and Insolvency

The Act outlines the rights of creditors in the event that a company becomes insolvent. For more information, creditors should contact the Australian Securities and Investment Commission (ASIC).

The rights of creditors of sole traders who become insolvent are contained within the Bankruptcy Act 1996 (Cth) (and associated legislation).For more information, creditors should contact the Insolvency and Trustee Service Australia (ITSA).

Regulated by specific legislation

Companies are regulated by the Act and governed by a constitution, or the Replaceable Rules contained within the Act.

The requirements which govern companies and officeholders under the Act are complex, and any interested parties – such as officeholders and members – should have an awareness of the various requirements. If you wish to gain more information on setting up a company, please click here.

There is no equivalent legislation regulating sole traders.

Succession

Companies enjoy ‘perpetual succession’ and are treated as a distinct legal entity, allowing the organisation to survive the death of members and directors (with share ownership being dealt with under the deceased person's will).

Sole operated businesses don’t enjoy ‘perpetual succession’, therefore, the assets will be dealt with under the sole trader’s estate plan, etc.

Source: This article was first published in Cleardocs' ClearLaw legal bulletin. To subscribe to ClearLaw legal bulletin, or for more information, please

  • see http://www.cleardocs.com/home.html; or
  • contact the Cleardocs helpline on 1300 307 343.

Need more information?

If you have any questions about this article, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Corporate and Commercial Team.

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