Before I answer this question let’s consider the various structures through which a business can be operated
Sole trader: This is the simplest structure and has the lowest set up and administration costs. However you are the business and as such it limits you in regards to tax planning and raising capital. Importantly it also exposes your personal assets such as your home to liabilities created by the business.
Partnership: This is also a very simple structure and has low set up and administration costs. It has the same disadvantages as the sole trader plus a very important one to consider…Through the partnership you may be exposed to debts created by the other party.
Company: A company is a completely separate entity from you. This separation gives you additional flexibility in relation to tax planning and financing plus has the additional bonus of protecting your personal assets. It can also reduce the tax applicable down to 28.5% compared with a rate of up to 49.5% as an individual.
Trust: A trust is a structure where a trustee carries on the business on behalf of the trust members (or beneficiaries). A trust is not a separate legal entity. It requires the use of a trustee which may be an individual or a company. A trust doesn’t pay tax, it passes the income through to individuals or companies who then pay the tax, so a trust can have the advantage of being able to split income to the most beneficial location so tax can be minimised.
Deciding on which structure suits you can be complicated. It is important to obtain advice as to your individual circumstances and the various alternatives available to you. It can make a significant difference as to minimising tax and protecting your assets. You must also consider whether you are able to comply with the obligations or the structure you are using.
Decisions that have to be made could include who should be a director of a company and also who the shareholders should be. It can also be appropriate to use a trust as part of the structuring, either to operate the business or as a shareholder.
There are obviously costs involving in getting advice and putting a structure in place and sometimes the costs outweigh the benefits so… back to the original question …when should you consider business structures?
When you START your business
This is the best time is decide which structure is best for you.
The kind of things to consider… What level of turnover do you expect to create with your business and what are the profits that you expect? The higher the profit the more useful and cost effective a trust or company structure may be which in turn can provide flexibility in regard to distributions of profits.
Do you own any assets in your own name? This is important as if you do and you operate as a sole trader they may be at risk from creditors, employees and/or customers. Companies and trusts may not eliminate all the risks but do provide a good deal of protection.
If you didn’t consider business structuring when you started then NOW is a good time.
If you didn’t get good advice when you commenced your business the sooner you do obtain advice the better – so organise it NOW. You should obtain advice from someone who not only advises as to the tax aspects of business structures but also is skilled in the area of asset protection. The ATO has made it more cost effective from 1 July to restructure businesses so now is definitely a good time to consider your options.
I have come across clients who have been advised by their past accountant to operate under a particular structure. I have identified that the recommended structure was not ideal in their circumstances. Unfortunately, they are now faced with the prospect of losing all their assets, when if they had been structured correctly this would not have been the case.
If for example you commenced your business as a sole trader simply because it was the easiest and simplest thing to do it is not too late to now consider the issues raised above. If you think that you are paying more tax than you need to as a sole trader (a sole trader’s profits are treated as personal income) and you employ at least one person a company structure may be of benefit to you.
Also if you have assets in your name then asset protection may be a factor for you to consider as there are options to limit your liability if something goes wrong.
Most of us don’t want to think about the things that can go wrong in business. Unfortunately, the reality is that sometimes they do go wrong. The consequences in those situations can be minimised if thought is put into the most appropriate structure beforehand. It’s too late when something goes wrong to change. You should consider the options as it can be quite a simple process to change from a sole trader to a company or trust.
Are there any circumstances where operating as a sole trader is ok?
If you work on your own in a personal services capacity, have profits of less than $37000 and don’t own any assets in your own name the answer is that it would be unlikely that a more complex structure would be of benefit.
What about partnerships? I would not recommend a partnership of 2 individuals in any circumstances due to the potential liability risk. A partnership of 2 companies or trustees can be an appropriate use of a partnership in some circumstances.
If you have been operating as a sole trader what are some of the reasons to change?
The following factors may be useful to consider prior to making a change:-
- Profits – if you are generating profits in excess of $80,000 you should consider the benefits of a change to structure if there is an ability to split those profits (i.e. if you don’t receive more than 80% of your income from one client/source)
- Risk – if you have personal assets that could be placed at risk from your business activity then you should consider a change in structure. This equally applies if you have significant assets in use in your business.
- Use of Vehicles or Travelling for work – If you utilise a commercial vehicle or travel overnight for your business, there may some benefits by utilising a company or trust that are not available to sole traders or partnerships
- Employees – if there are others working in the business there are tax planning advantages as well as risk factors that make companies or trusts a more attractive option as a way to do business compared to a sole trader.
- Reinvestment of profits – If you’re looking to put your profits back into the business to allow it to grow, then a company structure can be a much more effective way to operate compared to a trust or sole trader/partnership
- If you’re looking to have other business partners in the future, or raise capital to fund the business then a company structure may be more appropriate.
And a final reminder… make sure you get great advice as soon as possible as it could end up saving you a fortune.
Wishing you success in all things.
Michael Hart, Strategic Tax Specialist, Hart Accountants