Let me guess: when you started your business journey, which structure to operate out of was the last thing on your mind. Sole trader, trust, partnership, company. What’s the difference? Well, lots actually!
There are advantages and disadvantages to each structure, and one choice might suit your business better than another. Because the type of structure you choose can impact the amount of tax you pay or the level of asset protection your business holds, having the wrong ownership structure could be costing your business money, not to mention the operational and administrative inefficiencies of running your business in a structure that’s misaligned to your day-to-day operations.
By the time you realised that things weren’t ideal, you probably felt like it was too late to change. Well, that’s not necessarily the case.
Issues with using the wrong business structure
One of the key things to consider when looking at the characteristics of each type of structure is the tax implication. The wrong type of structure will provide your business with little to no asset protection or tax advantages.
For example, operating as a sole trader, although cost-effective when you first started your business, could be costing you significantly more income tax today. This is because, as a sole trader, all the profits are taxed at your individual income tax rate. What’s more, if you’re sued for any reason, you own the business personally, which means a litigator or creditors could take it from under your feet!
Types of business structures: what’s right for your business?
The optimal business structure will strike the right balance between tax minimisation and asset protection. Unfortunately, there’s no one-size-fits-all solution – it really does depend on the circumstances of the business.
There are four commonly used business structures in Australia. These are:
- Sole trader: the simplest and cheapest structure, as a sole trader, you’re the only owner and you control and manage the business.
- Company: run by directors and owned by shareholders, a company is a legal entity with higher setup and administration costs and more reporting requirements than a sole trader structure.
- Partnership: inexpensive to set up and operate, you might choose a partnership if you and a friend or family member run the business together. Each partner shares income, losses and control of the business.
- Trust: when operating in a trust structure, a trustee (either an individual or a company) is legally responsible for the operation of the trust and profits go to a beneficiary.
If you’re confident your business will be profitable, then a company structure owned by a family trust is ideal. This provides the lowest tax rate on profits and sets you up to access the best possible capital gains tax concessions down the track if you decide to sell.
However, if your business is not profitable (for now) and you have no intentions of selling, then there are other potential solutions.
How to change your business structure
The biggest issue with changing structures relates to tax – capital gains tax to be exact. What a surprise!
Fortunately, the government recognises that there are lots of great entrepreneurs out there that started a great idea in a terrible structure. To encourage innovation and entrepreneurship in Australia, and to help protect good ideas, the government has provided several ways to transfer your business into a more suitable structure, without having to pay any capital gains tax.
Depending on the mechanism used, you might even be able to put some money into your super, which is becoming harder and harder to do these days.
Next steps: get advice on the right business structure for your needs
If you’d like to discuss the merits of switching your business structure for your particular circumstances, then get in touch with Accounting Director Paul Evans for a no-obligation chat and coffee at our very own Dwayne’s Café.