The best choice of business structure for anyone is subjective. The choice will depend on circumstances specific to you. Set out below are some of the advantages and disadvantages of structures (sole, proprietary, trust, and partnership) which can be adopted in undertaking a business.
Sole Trader
The main advantage of operating as a sole trader is that it is simple and quick to get started. If you trade as a “sole trader” then you are trading under your own name (or a business name), without setting up a formal legal entity such as a company, partnership or trust. Operating in this manner avoids the time, costs and formalities of setting up a separate legal entity such as a company. For tax purposes, your income is simply taxed at progressive individual tax rates.
The main disadvantage of operating as a sole trader is that your personal liability is unlimited. In addition, operating as a sole trader can make it more difficult to split your income with other family members who may be involved in your business. For tax purposes,
Operating as a sole trader is best suited to small businesses operated by one person where issues such as income-splitting is not a consideration.
Proprietary Limited Company
A company structure has several advantages. The primary advantage is that as a shareholder, your liability is limited to the amount you have invested in the company. You are able to operate as a company even if you are the sole shareholder and director. To the extent you are planning to operate with other business partners, a company is also advantageous as you can share in the ownership of the company via the ownership of shares. The income of a company can be split between the shareholders in proportion to their shareholdings by the payment of dividends. A company structure is also advantageous if you are planning an exit from the business in years to come. This is because the business is owned and operated in the name of the company, and this makes it efficient to dispose of the business via a sale of shares or assets. A company’s profits are taxed at the prevailing company tax rate. There may be other tax advantages of running your business as a company (for example, the availability of franking credits).
The main disadvantage of a company structure is the cost associated with establishing and operating a company. A company must comply with the legal and regulatory requirements that apply to companies. Compliance with such requirements can be complex, costly and onerous. While operating your business as a company can limit your liability as a shareholder, in practice financial institutions lending to small companies usually require personal guarantees from shareholders. In addition, if you are a director of a company, you must comply with statutory directors’ duties. You can be personally liable if you breach those duties. From a tax perspective, profits distributed to shareholders are taxable at the shareholders’ personal tax rates (however, shareholders should be offset any tax already paid by the company).
Running a business as a company is best suited to businesses with adequate resources to ensure that the company is operated and administered in compliance with all the legal and regulatory requirements that apply to companies.
Trusts
The main advantage of a trust structure is the relative flexibility of this structure. A trust may be discretionary (i.e. the trustee decides how profit will be distributed among beneficiaries) or have fixed interests (i.e. it will benefit certain people in predetermined proportions). A trust is a relationship where a trustee (an individual or a company) carries on business for the benefit of other people (the beneficiaries). Other advantages of such a structure include:
- A trust provides asset protection and limits liability in relation to the business.
- Trusts separate the control of an asset from the owner of the asset and so may be useful for protecting the income or assets of a young person or a family unit.
- Trusts are very flexible for tax purposes. A discretionary trust provides flexibility in the distribution of income and capital gains among beneficiaries.
- Beneficiaries of a trust are generally not liable for the trust debts, unlike sole traders or partnerships.
- Beneficiaries of a trust pay tax on income they receive from a trust at their own marginal rates.
The main disadvantage of running your business via a trust structure is that trusts are not always well understood and can create confusion. Key disadvantages include:
- The costs of establishing a trust are more than establishing sole trader and partnership structures. This is because a trust is a complex legal structure and therefore should be set up by a solicitor.
- The trustee has a strict obligation to hold and manage the property for the exclusive benefit of the beneficiaries.
- The business must be conducted in accordance with the provisions of the trust deed.
- Trusts must comply with extensive laws and regulations.
- Losses derived in a trust are not distributable and cannot be offset by beneficiaries against other income they may have.
- Unlike a company, a trust cannot retain profits for expansion without being subject to penalty rates of tax.
Running a business through a trust is best suited to family businesses with sufficient resources to ensure that the trust is operated and administered in compliance with trust law.
Partnerships
Advantages of a partnership structure include:
- It is simple and therefore easy to set up. This is because partners are individuals who trade together under a business name, without setting up a company.
- Assuming business partners have a written partnership agreement, their rights and obligations should be clearly set out reducing the chance of a dispute moving forward.
- The costs and formalities of establishing and operating a partnership are usually less onerous than for a company.
- From a tax perspective, each partner’s income is taxed at progressive individual tax rates. Some partnership losses may be deductible against other income which is clearly advantageous.
There are a number of disadvantages of operating as a partnership. These include:
- Partners together are personally liable for the debts of the partnership (i.e. each partner is individually liable for debts incurred by the other partners). This is commonly referred to as being “jointly and severally” liable (i.e. unlimited liability).
- Tax is levied at the personal tax rates of the individual partners.
- Personal differences may interfere with business.
A partnership structure is commonly adopted by professional service providers including accountants, engineers, medical practitioners, and lawyers.
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