Choosing the right structure for your business can make a big difference to your risk and your bottom line.

There are several types of structures available to consider which can affect you in more ways than you would realise. The type of structure has a direct impact on expected profitability and future growth of a business. It is important to address this seriously and get it right from the get-go.

If you have the correct structure in place, you can legally protect your business & personal assets by operating under the right structure. Other factors such as tax liabilities, costs and tax effectiveness are affected by structure.

In this article we focus on sole trading Vs company structures for running your business, and point out the key differences for management of income, debts and control of the business.

Snapshot Company Vs Sole Trader:

Business Income

Sole Trader

  • Money earned is treated as your individual income.
  • You can claim deductions for costs incurred in running your business.
  • You can withdraw money from business bank account (separate business bank accounts are recommended to your personal bank account, but not compulsory).

 

Company

  • Money earned by the company belongs to the company.
  • A separate business bank account is mandatory for a company.
  • As a director, the company may pay you wages or directors’ fees, but you cannot simply draw money from the company as ‘personal drawings’ from the company. You may also receive money via shares, dividends or loans.
  • Private companies that make tax-free distributions to shareholders or in the form of payments, loans or debts forgiven, have to adhere to Division 7A Income Tax Assessment Act 1936 (Division 7A).

 

Business Debts

Sole Trader

  • Sole traders are personally liable for financial or tax debts.
  • There is no division between business assets or personal assets, (including your share of joint assets e.g. house or car).
  • Assets in your name can be used to pay business debts.

 

Company

  • The company is generally liable for all business debts, however your personal assets can also be at risk if you're a director of a company and the company can’t pay its debts.
  • As a director you are personally liable for tax debts including Super Guarantee contributions and Pay-As-You-Go (PAYG) withholding. Even when you cease as a director, you are liable for the period you were a director.

 

Full control of the business

Sole Trader

  • As a sole trader business structure you will have full control over the business.

 

Company

  • If you are the only director then you have full control but certain decisions must still be recorded as resolutions of the company.
  • If there is more than one director, you will not have full control – the internal management of the company will be governed by all the directors and in line with certain rules, for example, the company's constitution or the ‘replaceable rules

The below table gives a thorough breakdown of the differences between operating as a Sole Trader and a Company.

DifferencesSole TraderCompany
Established byN/AConstitution
Establishment and operating costsLowHigh
Perpetual existenceTerminates on deathYes, until wound up by members or creditors
Limited liabilityNoYes
Controlled byIndividualsDirectors – day to day management

Shareholders – ultimate decision making

Flexibility for new equity holdersNoYes

Care needed if incorporated pre-CGT

Does principal have fixed interestYesYes
Method of distribution to equity holdersWholly to sole traderDividends according to shareholding

Flexibility via different share classes, can emulate discretionary trust

Ability of principal (or associate) to withdraw moneyAs drawingsMay be unable to frank dividends until tax paid on profits and franking credits available

Loans may be deemed dividends Division 7A

Asset protectionLegal structure provides no protection, can be managed with insuranceYes, subject to personal liability of directors
Issues for familiesN/APersonal liability of directors

Principal can give income & assets to family and retain control by issuing voting shares

Issues for unrelated partiesN/ANo joint and several liability

Established legal rights for shareholders

Tax rateIndividual marginal rates

Average rate (including Medicare) is lower than company rate below $142,000 (2010/11)

Company rate (30%)

Allows deferral of tax on income in excess of $80,000 (2010/11) by delaying dividends until low income years

Basis of accounting for tax purposesAccording to type of business

Former STS taxpayers can use cash

Accruals

Former STS taxpayers can use cash

Streaming of IncomeNoUnequal dividends via different classes of shares, but not unequal franking percentage

Can’t stream different classes of income

Distribution of lossesIndividual can useRemain in company, must meet tests to recoup (except PSI)
Transfer of lossesNoYes, if part of consolidated group
PAYG instalment arrangementsPaid by individualPaid by company
Employment of principalNoYes
Remuneration for associatesYes, limited by s26-35 and PSI rulesYes, limited by s109 and PSI rules
FBT applicable to benefits provided to principalNoYes
Superannuation contributionsSelf employedEmployer sponsored

Possible maximum contributions for family employees (Ryan case)

50% CGT discountYesNo

Generally unsuitable for real estate or passive investments expected to increase in value

Small business CGT concessionsYesYes

Significant individual test and other conditions apply

Tax concessions availableAll primary production

Small business trading stock, prepayments & depreciation

Entrepreneurs’ tax offset

Some primary production (no averaging or farm management deposits)

Small business trading stock, prepayments & depreciation

Entrepreneurs’ tax offset

Some concessions “lost” because untaxed book profits become unfranked dividends.

Non-commercial losses rules applyYesNo
Personal services income rulesLimited deductionsLimited deductions and attribution to individuals

Personal services entity loss is deductible to the individual

Specific anti-avoidance provisionsDivision 7A
Debt & equity rules

Value shifting rules

 

We can help you weigh-in the risks and benefits of each structure to help you decide the best possible structure to support your business today and in the future. If you have questions, you can call us at (07) 5413 9300 or book a no obligation consultation with one of our advisors on this link.

Kim Cameron Hospitality and Accommodation Accountant

Kim Cameron, Bbus, CPA

Senior Accountant

Kim has an accounting background in Local and State Government and has run her own accounting practice. Kim is highly experienced in all facets of accountancy compliance, but most enjoys advising her clients and seeing their business and lifestyle flourish.