For many small business owners, the decision about which business structure to choose can be confusing. Here are four common business structures and some essential things to consider when making the choice.
Depending on your circumstances, there are advantages and disadvantages with all structures. It’s important to understand these, as the structure you choose will affect such things as taxation, asset protection and how your business is perceived.
The following outlines of four common entity structures are intended as a guide only. It is essential all business owners seek professional advice relating to their business prior to setting up, as once your business structure is chosen it can be very costly to undo.
Many businesses begin as sole traders, as it is the simplest and least costly structure available. Essentially you may need to simply apply for an ABN (Australian Business Number), perhaps a trading name and you are ready to go. Any profits are included on the individual’s Income Tax Return and taxed at marginal rates. However, this structure offers the least defence of protecting your personal assets.
Again, this is a very simple structure involving two or more partners, in which any business profits are distributed between the partners in accordance with the partnership agreement. While everything may be amicable between the partners when starting the business, a written partnership agreement is essential – particularly in the event it all turns sour. A key point to note is that all partners are both jointly and severally responsible for all partnership debts, even if you did not incur or cause the debt.
This structure is more costly as it involves setup costs, annual ASIC fees and increased accounting expenses. This is because financial reports must be prepared in addition to a tax return. A company pays a flat taxation rate of 30 per cent on all profits and is a legal entity in its own right. This structure may provide greater asset protection with limited shareholder liability, but keep in mind that company directors may become personally liable for employee PAYG withholding and superannuation in some circumstances. Another possible advantage is the perception of legitimacy in the business world, since some customers, suppliers and government departments prefer to deal with corporations.
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A discretionary trust has similar asset protection to that of a company, but also has more flexibility. Trusts are not considered separate legal entities and therefore a trustee – whether an individual or a company – has control over decision making. A trust does not pay tax in its own right but instead distributes its profit to the beneficiaries who are taxed at their marginal rates. Although recent ATO changes regarding distributions to minors have reduced the benefits of a trust structure somewhat, they still have their advantages.
This information is intended as general in nature only. Other factors, such as the ATO’s Personal Services Income and Non-Commercial Losses rules may change your circumstances and affect which entity structure is right for you. It is also possible that you may want to change your business structure at some point. It is recommended business owners speak to a professional regarding your own specific circumstances when deciding on the best structure for your business.
Are you clear on which business structure is right for you?