Choosing the Best Business Structure: Pros and Cons for Australian Small Businesses
Navigating the maze of business structures can be daunting for Australian business owners. With options ranging from sole trader through to corporation and a myriad of choices in between, each comes with its own set of legal, tax, and operational repercussions. In this article, we’ll explain each business structure and their pros and cons to help you make an informed choice for your business.
Understanding the Basics of Business Structures in Australia
What is a Business Structure in Australia?
The definition of ‘business structure’ is the way in which your business is legally structured, informing how you operate and trade. There are four types of business structures in Australia: sole trader, partnership, company, and trust. Just to complicate matters further – within each of these structures are variations and often, business owners will require more than one structure as part of their tax strategy. For instance, you may own a trust under which your company operates – or vice versa.
Why Does Choosing the Right Structure Matter?
The impact of business structure is far-reaching with tax liabilities, setup and registration costs, and asset protection being directly impacted by your business classification – among other things. The ongoing administration and compliance needs of the business will change according to the business formation type. Whether you’re an employee of your own business will be dictated and how much control you have over it will also be determined by your business structure.
Comparing Business Structures: A Detailed Overview
| Structure | Pros | Cons |
|---|---|---|
| Sole Trader |
– The simplest and cheapest way to set up a business – Aren’t many tax or legal formalities to meet |
– Owner is personally responsible and liable for all aspects of the business – Must lodge annual returns (more admin than sole trader) |
| Partnership |
– Responsibilities and liabilities split between owners – Inexpensive and relatively easy to set up |
– As a partner you can’t claim deductions for money drawn from the business – More expensive to set up and higher admin and legal compliance needs |
| Trust |
– Can be very beneficial for tax purposes – Owner has limited liability for the company |
– More expensive to set up and higher admin and legal compliance needs – Tax compliance higher and more complicated |
| Company | – Taxed at the set company rate rather than the individual income rate (highly beneficial once earning over a certain amount) | – The most expensive and complicated business structure to set up and comply with |
Legal and Tax Implications of Different Business Structures
What are the Tax Obligations for Each Business Structure?
The tax obligations of business structures will differ according to your exact circumstance, however broadly there are clear implications whether you choose to go down the sole trader, partnership, trust or company route. A common question we get asked is “what are the tax benefits of business structures in Australia?” Here’s your answer!
| Business Structure | Taxation | Tax Rate | Deductions | Superannuation |
|---|---|---|---|---|
| Sole Trader | As a sole trader, the business income is considered personal income. You report your business income and expenses in your individual tax return. | You pay tax at the individual income tax rates, which are progressive. The more you earn, the higher the tax rate you pay. | You can claim deductions for expenses incurred in running your business. | You need to pay your own superannuation (this is however not a legal requirement – but we highly recommend doing so). |
| Partnership | A partnership does not pay tax on its income. Instead, it distributes the income (or losses) to partners. | Each partner reports their share of the partnership income in their individual tax return and pays tax at their personal tax rate. | The partnership can claim deductions for business expenses, but these are then distributed among the partners. | Each partner is responsible for their own superannuation. |
| Trust | Trusts are complex structures with specific rules. Generally, the trust does not pay tax if it distributes its income to beneficiaries. | Beneficiaries pay tax on the income they receive from the trust at their own marginal tax rates. If income is retained in the trust, it may be taxed at the highest marginal rate. | Trusts can claim deductions for expenses before distributing income to beneficiaries. | Trustees may be responsible for contributing to superannuation for any employees of the trust. |
| Company | A company is a separate legal entity and pays tax on its income. | Companies are subject to a flat company tax rate (currently 25%). | Companies can claim deductions for business expenses. | Companies are required to pay superannuation for their employees (and you as the owner will be an employee of your own company). |
Choosing the Right Business Structure for Your SME
What Factors Should You Consider?
Factors to consider when choosing a business structure include not only the practical questions like what your income looks like and how it’s projected to track over the next 12-24 months but also variables like whether you want a business partner or how you plan to operate the business (is it bricks and mortar? Is it a product or a service?). Does your business plan come with high or low associated risks?
A lot of the decision making also comes down to what you’re comfortable with. If you do have some high risks associated with the business, are you comfortable with potentially wearing those risks personally? Or would you prefer the security of a company where your personal liability is limited?
Tax strategy is often the biggest factor when making a business structure decision. The intricacies of this are very much case-by-case and require a tax accountant and business advisor to strategise.
Another factor to consider when choosing a business structure is succession planning. The four structures vary in options when looking to pass a business on – which won’t be the intention of everyone.
- Sole Trader: Business ceases upon the owner’s death unless transferred through a will.
- Partnership: Continues with remaining partners or as outlined in the partnership agreement.
- Trust: Can provide continuity if the trust deed allows for the appointment of new trustees.
- Company: Continues to exist beyond the life of the original owners, providing continuity and easier transfer of ownership.
Our Advice on Selecting Business Structures for SMEs
As you are now very aware, selecting the right business structure is not a one-size-fits-all solution. It’s very much decided on by your personal situation, your business and the intricacies of how it operates and what your goals are – both personally and professionally.
What is the best structure for a small business?
There’s no such thing as a ‘best’ structure!
Our case studies
Case Study 1: From Sole Trader to Company
Business Type: Cleaning Services
Initial Structure: Sole Trader
Current Structure: Company
The Challenge
Our client began their journey as a sole trader, providing cleaning services to commercial clients in Melbourne. As the business grew, they began receiving requests from larger commercial clients, which required more resources and higher liability coverage.
Transition
We decided to transition the client from a sole trader to a company to limit her personal liability and to create a more professional image that larger clients would trust. This move also allowed her to attract investment and hire employees more effectively.
Pros:
- Limited Liability: Our client’s personal assets were protected from business liabilities
- Income Tax: Capped income tax rate @ 25%
- Investment Opportunities: Easier to raise capital.
Cons:
- Higher Costs: Increased setup and compliance costs
- Complex Administration: More rigorous record-keeping and reporting requirements.
Case Study 2: Establishing a Trust for Property Development
Business Type: Property Development
The Challenge
Our clients – experienced property developers – aimed to undertake a large-scale residential development project. They needed a business structure that offered flexibility in income distribution, protected their personal assets, and provided efficient tax planning.
Establishing the Trust
- A discretionary trust was chosen, allowing the trustees to distribute income among beneficiaries flexibly.
- The trust was registered for an Australian Business Number (ABN) and Goods and Services Tax (GST).
- A Tax File Number (TFN) was obtained for the trust.
Pros:
- Asset Protection: Personal assets of our clients were protected from any business liabilities
- Tax Efficiency: Flexible income distribution allowed for optimal tax planning
- Succession Planning: The trust structure provided a clear pathway for business continuity, allowing the development project to continue seamlessly even if one of the trustees stepped down.
Cons:
- Complex Setup: Establishing a trust involves higher initial costs and complexity compared to other structures like sole trader or partnership.
Conclusion
The four main business structures in Australia are a sole trader, partnership, trust, and company. Each of these come with their own pros and cons – particularly in regards to the personal liability for the owner to the business and its operations, tax repercussions, ongoing cost of setting up the business structure and managing it, and the legal and administrative time and requirements that it takes.
Choosing the best business structure for your circumstance requires answering many questions before making a decision – most of which should stem from a comprehensive business plan.
Remaining compliant and utilising the best tax strategy possible are both non-negotiable pieces of running a business, no matter which structure you opt for. The best way to choose the best business structure is to involve a trusted, experienced tax accountant and business advisor. Please feel free to contact us to start the conversation.
FAQs on Business Structures
For more detailed information on business structures, visit our blog.
