The second big decision – after deciding to go it alone as your own boss – is whether to set up under a company structure, or to operate as a self-employed sole trader. The decision you make will affect many current and future aspects of your business, including your legal and tax obligations. Choosing the wrong business structure can cause you to pay more tax than is necessary, and can open you up to personal liability. Each structure has its own pros and cons, so choose the best one for your situation.
A sole trader is an individual running a business. It is the simplest, cheapest and most popular business structure in Australia.
As a sole trader, you are the only owner and you control and manage the business. You are legally responsible for all aspects of the business. Debts and losses can’t be shared with other individuals. You can employ workers in your business, but you can’t employ yourself.
Sole traders are responsible for paying yours and your worker’s super.
As a sole trader, you:
- use your individual tax file number when lodging your income tax return
- report all your income in your individual tax return, using the section for business items to show your business income and expenses (there is no separate business tax return for sole traders)
- apply for an ABN and use your ABN for all your business dealings
- register for Goods and Services Tax (GST) if your annual GST turnover is $75,000 or more
- pay tax at the same income tax rates as individual taxpayers and you may be eligible for the small business tax offset
- put aside money to pay your income tax at the end of the financial year – usually, you will do this by paying quarterly Pay As You Go (PAYG) instalments
- claim a deduction for any personal super contributions you make after notifying your fund.
You avoid the cost and hassle of lodging annual accounts and paying company tax. Instead you just need to complete your individual tax returns each year. To help with this process, you should keep accurate records of your expenses, receipts and invoices.
A major drawback of this structure is a lack of distinction between yourself and the company; you as an individual are essentially the business. If the business fails for any reason, and there are debts outstanding, a sole trader is held personally liable and must ensure the debt is cleared. In extreme cases, you could be declared bankrupt as a result of your business’ financial difficulties.
You must pay income tax on any profits which take you above the tax threshold (currently $18,201). You should be aware that this threshold includes any income received from other sources, for instance if you are in paid employment elsewhere.
A company is a legal entity with higher set-up and administration costs than a sole trader. Companies also have additional ongoing reporting requirements.
A company is run by its directors and owned by its shareholders.
While a company provides some asset protection, its directors can be legally liable for their actions and, in some cases, the debts of the company.
Companies are regulated by the Australian Securities & Investments Commission (ASIC).
The key features this business structure are that the company:
- must apply for a tax file number (TFN) and use it when lodging its annual tax return
- is entitled to an Australian business number (ABN) if it is registered under the Corporations Act 2001. A company not registered under the Corporations law may register for an ABN if it is carrying on an enterprise in Australia
- must be registered for GST if its annual GST turnover is $75,000 or more
- owns the money that the business earns – the individuals who control the business cannot take money out of the business, except as a formal distribution of the profits or wages
- must lodge an annual company tax return
- usually pays its income tax by instalments through the pay as you go (PAYG) instalments system
- pays tax at the company tax rate or lower company tax rate (if a base rate entity)
- may be eligible for small business concessions
- must pay super guarantee contributions (SGC) for any eligible workers. This includes you, if you are a director of the company, and any other company directors.
The benefits of this structure include potentially paying substantially less tax than you would as a sole trader. This is because you can take a dividend instead of receiving an income; dividends are taxed separately, and are not subject to Superannuation Guarantee (SG) charges. Due to this, companies have more complex accounting responsibilities, however you can employ an accountant to ensure you are fulfilling your tax and legal obligations.
A major difference between a company and sole trader structure is that a company is a separate legal entity to its shareholders and directors. This means that unless fraudulent activity has taken place, you will not be held personally accountable for any financial difficulties the company finds itself in. This creates a clear distinction between your personal affairs and your business, which reduces the financial risk to any individuals involved with the company.
The decision to operate as a sole trader or company is difficult. There is no definitive right or wrong choice; the best structure for a small business venture will be different to a larger enterprise with a high turnover. Whichever path you choose, your decision isn’t final – you can change your business structure down the track if your needs change. Your accountant will be able to help and guide you through these key decisions.