In my experience there are three main reasons a sole trader would move to a company structure for their business:
People assume that by operating via a company structure they’ll pay less tax than continuing as a sole trader. This assumption comes about because the current small business company tax rate is 28.5% (previously 30%) whereas a sole trader pays the standard individual marginal tax rates which can go as high as 49%.
Where this line of thought falls over is that when you’re operating as a company, but there’s only one of you in the company (with maybe a little admin help) it’s possible the income you’re earning will be considered Personal Services Income, in which case the ATO will want to see all the profits from your business passed through as a wage to you. This means the net outcome is no different to when you were a sole trader, more or less.
However, if your business has multiple people carrying out the same work as you (i.e. billable work and not admin work), or you’re in the business of selling goods rather than services, then it’s likely you won’t be affected by this rule and you can retain excess profits in the company to be used for working capital and taxed at the company rate.
If this is the case for you then you’ll likely be interested to know about the magic number. This is the amount of taxable income you can earn before you are paying more than an average rate of tax of 28.5%,( i.e. the amount of wages you can be paid before it makes sense, from a tax perspective, to leave the rest of the money in the company). This number is currently around $117,000.
Some people find this number a useful benchmark for deciding when to start a company. They know they need to be netting (as a sole trader) more than $117K before even considering a company.
What are other tax benefits there? The truth is that most of the tax deductions available to SME companies are also available to sole traders. One of the core tax deduction differences we see day-to-day is the ability to pay yourself travel allowances (aka. per diems) from a company which you can’t do for yourself as a sole trader. But, aside from that, there isn’t a load of difference when it comes to deductions.
The big difference, from a tax perspective, comes when it is time to sell your business. Sole traders who sell their business will be liable for the resulting tax completely, whereas if it’s a company structure then you can enjoy some flexibility. Ultimately it will be the shareholders paying the tax and with some clever planning on day one you can ensure you’ll be paying the least amount of tax you legally are required to pay. Something to think about.
Bottom line? There are some savings to be had, mostly by those building the business to be more than just themselves and mostly when it comes time to sell the business.
If you’re happy operating your small business as a sole trader then that’s great, nothing to worry about. But, if you have big growth plans then operating as a sole trader simply won’t cut it in the long run. You won’t easily, if at all, be able to take on investors as they’ll want the security and flexibility of the company structure in place.
You may also find that some suppliers won’t engage with you or add you to their preferred supplier lists if you’re not operating as a company. This is typical of larger organisations that are worried about getting into trouble for not paying employee entitlements, such as superannuation, which can happen if you are a sole trader, but typically isn’t an issue if you operate the business via a company.
It can also help simply to be able to say to possible clients that you are a company and that it isn’t just little ol’ you. Whilst this impression can sometimes be a little misguided, a company implies a certain scale and level of seriousness that a sole trader business simply can’t match.
In addition to this, having a large business can be inherently risky and for that reason alone you’ll likely want it to operate out of a separate legal entity (i.e. not yourself) which leads me to reason number three …
We can’t give you legal advice, that’s what you pay your lawyers for, but what we can say is that company structures generally provide some level of legal protection – a barrier – between yourself and third parties. This can be important if you employ people, ever have supplier issues, dramas with clients, etc. Definitely something worth thinking about and speaking with your lawyer about.
If you’ve read above and thought that a company is a way to go for you, nice one! It’s now a good idea to compare the benefits you’ve identified with the associated costs to ensure it makes strategic sense for your business to make the switch. Some of these include:
- Superannuation – whilst you may not have needed to make superannuation contributions for yourself as a sole trader you will need to make them for yourself as an employee of your new company so be sure to factor this in
- Setup and registrations – you can skip professional advice and DIY for under $600, or you can engage a professional to handle everything for you including advice for anywhere from $1,000 to $2,000+
- Shareholders agreement – if you’ve got a business partner you should have a formal agreement. Expect to pay $1,500+
- Annual ASIC fee – is currently around $250
- Annual company tax work – this really varies and you get what you pay for, but something decent generally starts at $2,000
- Bookkeeping, payroll, BAS – you need to ensure your books are always up-to-date, payroll and superannuation obligations are looked after as well as the BAS being done on time each month/quarter. Prices vary a lot here and can depend on the size of your business, but expect to pay at least $200 a month for this service plus whatever costs are associated with your bookkeeping/payroll software (we recommend Xero and it starts at $25 a month).
If your sole trader business has any goodwill attached to it there may be Capital Gains Tax consequences of shifting the business from yourself personally into the company structure. There is generally, a relief available from having to pay tax here, but you should still take the advice to make sure there won’t be any tax bills associated with the move.
You’ll also want to be across the extra legal and compliance responsibilities that come with being a director of a company. We can’t advise on this but you might want to check out this page on the ASIC website for further guidance.
Setting up your own company to run your own business is a key strategic step for most successful businesses. What is key here is to ensure you’re doing it for the right reasons and at the right time for you.