There are 4 main 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. Some businesses operate as a combination of these. There are other types of business relationships and arrangements that might also be implemented such as joint ventures, share farming agreements and syndicates that are often complicated and are not specifically covered in this article which is why contacting an experienced business lawyer can be beneficial.
The choice of business structure is an important decision to make at the start of a business venture, as the structure can have an impact on tax implications and reporting requirements during the lifetime of the business. When setting up a business structure, consideration should be given to factors such as how many people will be involved in the business, what the business will do, how much income is likely to be earned from the business and the intended growth of the business. The structure of the business can have consequences for how it can be sold or transferred in due course, and what may happen in the event of the death or loss of capacity of one or more the people involved in it.
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 an alternate registered business name. The income earned as a sole trader is taxed at the same rate as for 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. It is the least effective structure from both an asset protection and income tax flexibility perspective.
Partnership
Two or more individuals can carry on business in partnership, where the income from the business is received jointly. 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. Like a sole trader the asset protection benefits of a partnership are limited as are the income tax flexibility options however with more complex planning they can be increased through a combination of structures such as a partnership of trusts.
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. There are different types of trusts. They can be discretionary trusts, where a trustee has a discretion as to payments of income and capital between a range of potential beneficiaries or they can be fixed trusts where certain beneficiaries have fixed entitlements. A trust can be a combination or hybrid of fixed and discretionary entitlements. A trustee can be an individual or a company. It can have more than one trustee. A formal Deed is usually required (and recommended) to establish a trust and there are annual tasks for a trustee to undertake. As such, it can be more expensive and complicated to set up and administer a trust than a partnership.
The advantages of a trust are that there is flexibility in income distribution (potential tax benefits) and income can be streamed to low income tax beneficiaries to take advantage of their lower marginal tax rate. Furthermore, assets held in a trust might enjoy some protection particularly with a combination of good administration of the trust and a properly drafted Deed. The disadvantages of trusts are they can be costly to set up and operate and there are typically increased compliance and legal requirements.
Company
A company is a separate legal entity capable of holding assets in its own name. The words “Pty Ltd” after a business name show that the business is a a private company. Most companies are privately owned rather than public companies that are often listed on and their shares traded on a stock exchange. A company is owned by shareholders and its directors manage the company’s day to day business operations and affairs generally. The shareholders of a company receive any company profits in the form of dividends. 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 companies own assets. The “corporate veil” protecting the assets of a company’s directors from the company’s debts and insolvency can be lifted in certain circumstances such as where a company trades whilst insolvent.
Companies are governed in Australia by the Corporations Law including the Corporations Act xxx and there are a number of duties and obligations imposed upon a company and its directors personally. Primarily, directors have an obligation to act in the best interests of the company. Establishment of a company and ongoing administrative and compliance costs associated with the Corporations Law can be high. There are also some requirements to publicly disclose certain information relating to the company’s share structure, shareholders and officers.
Conclusion
Each business will vary and no business owners’ circumstances will be the same. It is advisable to talk to an accountant or solicitor 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.
We often work with our clients and their professional advisors on structuring (and re-structuring a business. The key is to get the structure right from the start in order to avoid and shortfalls later.
If you or someone you know wants more information or needs help or advice, please contact us on (08) 8344 6422 or email [email protected].