Sole trader

This is where an individual is carrying on a business in their own name/right. The individual is the sole decision maker, but can still have employees. It is inexpensive to set up and the net profit of the business is simply included in the individual’s personal income tax return.

There are a number of disadvantages to being a sole trader. Most importantly, if someone is suing your business, meaning you, your personal asset are exposed. Meaning you could lose your house, so to speak. Also if you are making a substantial profit your individual marginal tax rate (meaning the amount of tax you are paying) may be much higher than the current company tax rate of 27.5 or 30% percent, pending on the size of the company turnover.

Partnership

A partnership is when two or more persons carry on a business in common with the aim to make a profit. Decisions on the operation of the partnership are made by the partners jointly.

The structure is comparatively simple, quick, cheap and efficient to set up, run and close down. The share of net profit of the partnership goes into the individual partners tax returns, on which personal tax rates apply. This does provide the ability to split income into more than one tax return, however there are provisions designed to stop/limit this where the income is the result of only one person’s efforts.

The main disadvantages are that the structure does not provide any liability protection. Partners are joint and severally liable for the debts of the business.

The share of net profit of the partnership goes into the individual partners tax returns, on which personal tax rates apply. This can mean higher tax rates than a company.

Changing partners results in the end of the original partnership and the commencement of a new one. This can trigger significant tax issues. Partnerships can be inappropriate for businesses that are looking to grow or change direction and bring on new owners.

Company

A business can be operated through a company. A company is a separate legal entity that is run by directors on behalf of the owners (shareholders).

You can be the director and shareholder and even an employee. But the company itself will own the assets and liabilities and receive its own income and pay expenses.

This structure provides limited liability in certain circumstances. Generally, directors can only be sued if they breach their director’s duties or provide personal guarantees.

Companies are the perfect structure for owners to come/go. Think ASX listed companies! The company structure itself endures while the underlying owners (shareholders) or operators (directors) change.

A company’s tax rate is either 27.5 percent (turnover less than $50 million in 2018/19) or 30 percent. This is lower than the higher individual tax rates.

Operating your business through as company structure provides a clear separation of the business operation from your personal affairs.
The set up cost of this structure is higher and there are also higher ongoing compliance costs involved.

Additionally, any losses a company makes are retained in the company and can only be offset against future profits in the company.

Trusts

A business can also be run through a trust. A trust is a legal relationship where the trustees run the trust on behalf of beneficiaries.
In family situations, the trustees and beneficiaries are often the same people.

There are many types of trusts, but the most common type is a family (or discretionary) trust. With a corporate trustee, asset protection or limited liability is provided. Profits of the trust flow through to beneficiaries, meaning income splitting can be achieved. However there are provisions designed to stop/limit this where the income is the result of one person’s efforts.

There are a number of disadvantages. Trusts are complex and have strict compliance requirements. As a result, they are expensive to operate. Comparatively expensive to set up and can be expensive and time consuming to close down. Any losses are trapped inside the trust and are not able to be offset against any individual’s income. Only designed for ‘family’ businesses. It is currently impossible to bring on ‘external’ owners as the trust grows or changes direction.

If individual trustees are used, no asset protection is provided.

Combination

It is possible to use a combination of different or multiple structures to achieve the right combination of advantages & disadvantages to suit your needs.

This summary is intended only to be a brief introduction of the structures, primarily from a tax point of view. Individual and commercial circumstances must be considered in any new business set up decision.