Are you thinking of setting up that small business that you’ve always dreamed about?
Do you know what business structure is best suited to you?
Hint: it’s not always about the cost.
There are three common business structures other than trading in your own name as a sole trader: partnership, trust, and company or a combination of these.
If you are planning on setting up a business, it is best to choose the optimum business structure suited to your current and future needs.
- Asset protection
Any business is subject to a variety of risks. One type of risk includes claims from any number of people and entities such as creditors, clients or customers, employees, or even business partners. There also is divorce to consider.
Having the appropriate business structure can help ensure that any claims against a business are made against the assets of that business rather than against assets owned by individuals or other entities. For example, a successful claim against an individual operating as a sole trader may include claims against the family home.
However, if the business is operating under a company structure, claims should be limited to assets owned by the company only. The use of a corporate trustee may provide even better protection.
- Tax implications
Paying the appropriate rate of tax in any business should be considered at all levels during a business’ life cycle, and, depending on your business structure, you may be paying more tax than necessary
Operating as a sole trader or through a partnership, your business income may be taxed at the top marginal income tax rate of 45% (plus other levies such as the Medicare levy), but you will have access to the tax free threshold. In comparison, a company or a trust (who distributes to a company) will pay tax at a flat rate of 30% (or 28.5% from 1 July 2015 for small businesses), but these structures do not have access to the tax free threshold.
Also, when a company pays dividends or provides other benefits to shareholders or associates, further tax may be payable.
Companies do not have access to the capital gains tax (CGT) 50% discount which can be utilised for assets held for 12 months or longer whereas sole traders, partnerships and trusts may. It is important to consider not only your initial goals in setting up your business but your long term goals as well (e.g. selling your business in the future and having access to the CGT 50% discount).
- Flexibility and costs
There can be tax advantages to choosing the right business structure, but a structure’s ongoing and compliance costs can offset its tax advantages. The overall costs and compliance requirements while operating as a company or a trust can be high while offering more flexibility than operating as a sole trader or partnership. As a company or a trust, you will need to comply with specific requirements for these structures which can be complex and will more than likely cost you more in compliance costs.
Funding and expansion
The future and how your business will operate is important to consider now because your business structure may determine how easy it is for your business to obtain funding in the future or even how your business will attract business partners along the way.
It is generally easier to obtain funding and future equity partners through a company or trust structure, and if this is important to you, choosing the right structure now will help save you costs and possible adverse tax implications from having to change structures or restructure down the track.
Although it has become easier over the years to change your business structure, should your current structure not suit, it is still helpful to get the best structure in place from the beginning, doing so could save you time, money and a splitting headache in the future!
Jamie Arrington is a Chartered Accountant at Butlers Taxation and Business Advisors.
She has experience in the tax and accounting industry mostly working with complex business structures and client groups.
Jamie firmly believes in providing exceptional advice and service to clients and aims to help clients implement effective strategies in their businesses.