Choosing the right business structure for your business can be a tricky business in itself. There are several ways in which you can structure your business. The most common structures include:
- Sole trader
Before examining the advantages and disadvantages associated with each structure, let's look at some important considerations involved in the choosing the best structure for your business. The choice of business structure depends upon your business and personal circumstances. Factors affecting your choice will include:
The method by which tax liability is calculated for each of the above structures is different. Taxation rate considerations include tax on profits, land tax, municipal and water rates, payroll tax and other forms of taxes and levies.
Every business involves risk and as an owner, it is in your interest to minimize your personal liability. Generally, sole traders incur the greatest personal risk as they personally liable for all debts of the business. Partners are generally jointly and severally liable for certain acts of the partnership. There are many variations of the corporate structure and of those, a feature of the limited liability company is that the shareholders' liability for the debts of the business is limited by their share in the equity of the business. However, the downside of limiting risk is that suppliers and lenders may be less inclined to advance credit to your business.
A necessary aspect of running any business is the injection of capital from time to time. Generally, it is more difficult for sole traders and partnerships to raise capital from external sources. These business operators will often have to provide the funds themselves or from debt financing. Where your business needs large amounts of capital, it may be necessary to use a public company structure and to list it on the stock exchange.
As owners of a business, it is understandable that you will want to retain managerial and administrative control of the business. Some forms of structures are more appropriate for this than others. A sole trader will retain the greatest amount of control over a business and at the other end of the scale is the public company, where the 'owners' may not have a majority shareholding.
Purpose of the business
The purpose for which a business is formed and operated will be an important factor in determining which structure you choose. It may be that you would like your business to have the effect of income splitting between yourself and members of your family. You may have a need to divest assets to protect them from creditors. Or the business structure you choose may have an impact on your eligibility for subsidies, pensions and other forms of government assistance.
Costs of business structure
The costs involved in establishing a business structure and also the on-going costs of maintaining it are relevant factors to take into account. Generally, corporate structures are more expensive to set up and run than a sole trader or a partnership. Generally speaking, the characteristics of a good business structure are:
- Flexibility so that the structure will be able to accommodate changing circumstances with minimum consequences
- Provision of adequate asset protection for the owners of the business
- Minimization of costs, in particular tax
- Facilitates efficient distribution of profits
Let's now look at some of the advantages and disadvantages of each structure.
As a sole trader, all the assets and liabilities of the business belong to you, the owner. There is no dividing line between your business assets and your personal assets so you are personally liable in all aspects of the business.
- Simple set up and operation
- You retain effective control
- Minimal reporting requirements
- Income tax rate for the business is the same as your personal tax rate, which allows for the tax advantage of tax losses being offset against any other income you might have (for example, negative gearing)
- For capital gains purposes, you obtain the full benefit of indexation
- You are not an employee of your business, which means that there no compulsory superannuation contributions to be made.
- You also don't have to pay payroll tax or workers' compensation.
- Inability to split income to family members and hence limited opportunity for tax planning
- Unlimited liability which means all your personal assets are at risk in the event of bad business
A partnership is an association of individuals or entities for the purpose of carrying on a business venture or activity with a view to profit. A partnership is not a separate legal entity so all assets of the partnership are owned by the partners jointly.
- Income splitting between family members is less restricted than that of a sole trader
- A partner's share of any income tax losses of the partnership can be offset against other income of the partner
- Subject to any partnership agreement, the capital of each partner can be increased or withdrawn from the partnership without restriction
- Joint and several liability of partners. This means that each partner is fully liable to third parties despite any agreement amongst the partners.
- Certain capital gains tax disadvantages
- No continuity of business where there is a change in partners, unless there is an alteration of the partnership agreement
A company is a separate legal entity and capable of holding assets in its own name.
- Limited liability for shareholders
- Company structure is commercially well understood and accepted
- Ability to raise significant capital.
- Company tax imputation system which means that company profits are no longer subject to the traditional double layer of tax.
- Contributions made by the company for employee superannuation may be claimed as a tax deduction.
- No requirement to distribute profits so that tax is paid at the current maximum rate of 34% and any further tax liability can be deferred indefinitely. The company tax rate will be reduced to 30% for the next financial year.
- Significant set up costs and maintenance costs, generally driven by greater reporting and accountability obligations
- Control is in the hands of a board of directors.
The above information is a brief introduction to the choices you have for your business structure. Choosing the most appropriate structure for your business is an important step and many considerations are relevant. Some of the more important ones have been highlighted above but you should seek the expertise of an experienced business and financial adviser. Tina Doan BCom LLB (UNSW) Legal Practitioner