Choosing the right business structure
Selecting the appropriate business structure is a vital consideration for anyone commencing a new business. The structure a business operates in can significantly impact tax obligations, legal liability, and daily operations. Also, as a business grows and evolves a review of its operating structure can often be beneficial.
The type and size of a business helps determine the structure which should be used, and more complex structures like Trusts and companies may not ultimately be tax effective in some circumstances.
Below is a high-level summary of the most common business structures in Australia and their tax implications.
Sole trader
This is the simplest business structure, where one individual owns and operates the business. Sole trader operators tend to be smaller businesses with relatively low turnover and profits.
Sole trader operators tend to be smaller businesses with relatively low turnover and profits.
Tax considerations for sole traders
Your business profit is treated as your own income and taxed at personal income tax rates.
As profits increase, sole traders can reach a point where their average tax rate is higher than would be the case in a company structure, or a structure such as a partnership or Trust where the taxable profit can be shared by two or more taxpayers.
Partnership
A partnership involves two or more people or entities running a business together. A partnership can be between spouses, business partners or even entities (for example a partnership of Trusts). Partners do not necessarily have to hold equal equity in a partnership. It is advisable that a partnership agreement be drawn up setting down the rules which all Partners will be required to abide by in conducting the business.
Partners are not considered employees for tax purposes and cannot be paid a salary from the business.
Tax considerations for partnerships
A partnership itself does not pay tax.
Instead, each partner declares their share of the profits on their personal tax returns and pays tax at their applicable rates.
Company
A company is a legal entity separate from its owners. Owners hold shares in the company, and Directors are appointed who have legal responsibility for the operation of the business. In some instances, Directors can be held personally liable for the actions of the company or any unpaid debts it may have. For that reason, asset protection planning is a vital consideration when establishing a company.
The rules governing the operation of a company are set out in its constitution.
Directors and/or shareholders of a company may also be employees of the company.
Tax considerations for companies
Profits of companies are taxed at a flat corporate tax rate, currently 25% for most small to medium sized businesses. This means that for taxable income above approximately $135,000 a company will pay less tax than an individual from 1 July 2024.
Profits distributed as dividends to shareholders can come with a tax credit (known as franked dividends). Depending on the taxable income of the shareholder from other sources, this can have a very positive tax impact for the recipient of the dividend.
A company is generally not a tax effective structure in which to hold ‘passive’ investments such as shares or property not used in a business operated by the company. This is because a company cannot access capital gains tax concessions available to other entities, resulting in the possibility that the tax rate is higher than even the maximum effective rate for an individual on the sale of such investments.
Trust
A trust is an arrangement where a trustee holds property or income for the benefit of others, known as beneficiaries. A Trustee can be either a company or one or more individuals. Similar to a Director of a company, a Trustee can be held liable for any debts of the Trust.
The rules of operation for a Trust and its initial beneficiaries are set out in a Trust deed.
There are two main types of Trust. A fixed Trust (commonly known as a unit Trust) entitles specific beneficiaries to a specific share of the income and assets of the Trust.
Superannuation funds – whether large public funds or private self-managed super funds – are in fact a type of fixed Trust.
Alternately, a discretionary Trust (often referred to as a family Trust) offers the flexibility to distribute income and capital to people or entities referred to either specifically or generically in the Trust deed. In a discretionary Trust, no person or entity has a fixed right to any of the income or assets of the Trust.
A Trustee or beneficiary of a Trust may also be an employee of that Trust drawing a wage from it.
Tax considerations for Trusts
The taxable profits of a Trust are distributed to beneficiaries, who then include the applicable amount in their tax return and are taxed at their applicable rate.
A Trust cannot distribute any net losses it makes for a year, but instead losses are offset against any profits made in later years.
Our experienced team of advisors can explain the rules and tax rates which will be crucial in deciding the best structure – or combination of structures – for your business.
We can help you understand the options available and the implications of each structure, ensuring you make the best choice for your business.
Contact us to find the right business structure.
