Business Structures

So, you want to set up a business. Where do you start?

First cab off the rank is what structure you want to run your business through – sole trader, company, trust, or partnership.

Each of these entity types has its own pros and cons, and many successful businesses incorporate multiple entity types into their business structure.

Sole traders

What is it?

A sole trader structure is just that – the individual is the business, with all the assets and liabilities of the business also being personal assets of the individual.

Pros

• Free to establish – set up an ABN and off you go
• No ongoing running costs
• Simple
• ?No specific regulation
• Can use business profits however you see fit without dealing without extra taxation
• ?Provides good tax outcomes on low profits

Cons

• ?Tax paid is lost forever
• Adverse tax outcomes on high profits
• The individual has unlimited personal liability for business debts, workplace accidents, etc – can threaten personal assets
• Limited flexibility with tax planning
• Being self-employed can require additional documentation to get finance

When you should consider

You should consider a sole trader structure if you intend to set up a micro-business with minimal employees, minimal assets and profits under $120,000.

Trusts

What is it?

A trust is not a separate legal entity, rather it is an agreement (in the form of a written deed) that one entity (the trustee) will hold and maintain assets for the benefit of other entities (the beneficiaries).

Trusts are considered a flow-through entity in that they do not pay income tax, rather, they distribute income to the beneficiaries who pay the income tax instead.

How the income is distributed depends entirely on the powers that the trust deed provides to the trustee.

Types of trusts can include discretionary, fixed, self-managed superannuation funds, testamentary, unincorporated non-profits, and many others.

This is of course a very basic overview of a very complicated structure – ask your accountant or trust lawyer for a more in-depth understanding.

Pros

• Flexible
• Access to general capital gains tax discount
• Ability to distribute taxable income in a favourable manner
• Ease of estate planning, as children are commonly the beneficiaries
• Use of a corporate trustee limits liability in certain instances
• No ongoing running costs, unless a corporate trustee is use
• Can provide asset protection opportunities
• Fixed trusts can provide relief from stamp duty in some circumstances
• No register of trusts provides a degree of anonymity

Cons

• Limited life, all trusts except for those established in South Australia vest(end) after eighty years
• Complicated and a poorly structured deed can create very unfavourable outcomes
• The ATO does not like trusts, and occasionally introduces legislation to restrict trust capability (see the new developments on s100A)
• Requires maintenance – every year needs a distribution resolution and a review of the deed with any new legislation. Lack of preparation leads to adverse tax outcomes
• Fixed trusts can lead to unfavourable capital gains tax outcomes in some circumstances
• Each state has its own trust legislation

When you should consider

Most business structures include trusts in some manner, whether as an investment vehicle to hold shares in a company, as a separate investment vehicle for a specific investment, or as the business itself.

You should consider a trust if:

• You run a small family business, with multiple family members involved.
• You need an entity to make a specific capital investment.
• Your business is a company, and you would like to distribute dividends to family members.

Company

What is it?

A company is a separate legal entity, with all the rights that you have (except to vote, thankfully). Companies have fixed ownership by way of shareholdings and are maintained by the officeholders (directors, secretaries, etc.) for the benefit of the shareholders.

Pros

• Fixed tax rates
• Fixed ownership makes it ideal for going into business with unrelated parties
• Access to research and development tax incentives
• Most government grants require a corporate body to be eligible
• Tax paid can be recovered with franking credits
• ?Only companies can be listed on ASX as trading businesses
• Limited liability
• Able to create binding agreements to prevent or resolve most disputes

Cons

• Heavily regulated and all information is public
• Only entity with no access to general capital gains tax discount
• Can be held liable for the actions of other officeholders
• Highest setup cost
• Highest ongoing costs and maintenance
• Fixed ownership can provide for poor tax outcomes if shareholdings are incorrectly set up

When you should consider

Many business structures utilise a company to tax advantage of the flat tax rates, either as the core business or as a corporate beneficiary.

If your business has profits of $120,000 or over, or is a research and development entity, you should consider a company as part of your structure.

Partnership

What is it?

A tax law partnership is an agreement between two or more entities (individuals, trusts, companies) to form a business and distribute income to the partners at a fixed rate.

Like trusts, partnerships don’t pay income tax – they instead distribute their profit or their losses to the partners to deal with individually.

Pros

• Can distribute losses to partners
• No setup cost (other than an agreement if you have one)
• No ongoing costs

Cons

• Unlimited liability
• Can be held liable for the actions of your partner
• Fixed distributions limit flexibility
• Some deductions are disallowed and must be recognised at the individual level

When you should consider

Partnerships are an ideal structure for businesses with two related persons (e.g., married couple) that want to evenly split the proceeds of the business. They are also the only entity that can distribute losses.

The tax effectiveness of the partnership depends on the types of entity involved (for example, a trust partner will have more flexibility than an individual partner).

Avoid partnerships with strangers unless you have an iron-clad partnership agreement.

So what should your business be? Like everything else with accountants and lawyers, unfortunately, the answer is “it depends”.

The above information has been generalised for laymen, and there are many industry-specific requirements that transcend tax and cost outcomes.

It can be expensive to change a structure once it has been set up.

Call your friendly Origin accountant to have a chat about your business needs before you do anything permanent.