The 4 Main Types of Business Structures
For your new business to run smoothly and be profitable, it is essential to select the best business structure for it. The first step in this process is to decide which type of business structure will be optimal for your business. There are four main business structures to choose from and they are: a Company, Partnership, Sole Trader structure and a Trust.
Each of these structures have specific advantages and in some cases disadvantages. Tax obligations will depend on the type of structure you choose for your business. It is important to consider your goals, determine the level of control you want to have over the business, and get advice on any potential personal liabilities before deciding on the most suitable structure. Being familiar with the main types of structures before seeking professional advice will give you an understanding of all the possibilities for your business.
The four main types of business structure are:
The Sole Trader structure is a single individual running a business and is considered to be the most cost-effective business option. Control and the management of the business is solely in the hands of the individual owner, and it is possible for the owner to employ staff. Before commencing business, Sole Traders need to obtain an Australian Business Number (ABN). With this structure, the individual owner is personally liable for all debts and costs accrued by the business, and their personal assets may also be at risk if something goes wrong. The business owner who operates as a Sole Trader will technically own all assets of the business plus the profits from the business will be solely theirs.
One of the main advantages of operating as a Sole Trader is that the initial set-up and the running of the business is simple as it gives the individual full control of the decision making. The start-up costs are generally low. The legal structure of this type of business structure is easily changed if needed and it is relatively easy to wind up.
Anyone operating as a Sole Trader is required to declare their business income (or loss) as part of their personal income tax return and will be taxed at the same rate as an individual. For an individual, the tax-free threshold is $18,200 for the current 2020–21 financial year. An individual income tax rate is currently 19 cents for each $1 over $18,200 and up to $45,001. This rises in line with an increase in income. Sole Trading businesses need to be registered for GST (Goods and Services Tax) if the annual turnover is expected to be more than $75,000.
A Partnership is formed by at least two individuals, trusts or companies who join together for the purpose of establishing a profitable business. There is generally a maximum limit of 20 individual entities who can enter into a Partnership. Within this business relationship, it is considered that all parties involved have a responsibility for the formation and management of the business as well as all ongoing business activities. All income and/or losses are distributed between them.
A Partnership model is similar to a Sole Trader structure in that all involved have personal liability for any debts that the business may accrue–leaving their personal assets potentially vulnerable. If this structure needs to be altered, for example if one individual wants to exit, it is easier to dissolve the existing arrangement and create a new Partnership rather than to altering the current one.
Benefits of using a Partnership include tax-free capital gains and tax incentives. Partnerships do not pay income tax on the profit they earn as each partner is individually responsible for reporting their share of the partnership income in their own tax return. Also, each partner is liable for tax on their share of any profit. This amount is calculated at the individual tax rate. They may also be eligible for the small business tax offset.
GST (Goods and Services Tax) registration is required if the annual income of the Partnership is, or is forecast to be, in excess of $75,000. Registration for an Australian Business Number (ABN) is also essential for a Partnership.
There are two types of company structures. Both are separate legal entities that are set up for the purpose of carrying out of a particular business activity. Each company will need to have its own unique Tax File Number, and is also required to be registered for an ABN (Australian Business Number).
The two types of company structures are:
- A Proprietary C This type of company can have up to 50 shareholders. It is limited by its number of shares and there must be at least one appointed director.
- A Public C This type of company has no limit for the number of shareholders who own it. There must be at least 3 appointed directors. A public company is either listed or unlisted on the Australian Stock Exchange (ASX).
In both types of structure, the liability of shareholders is confined to the nominal amount of the shares owned, and therefore their personal assets are not liable. The Company Tax Rate in Australia is between 26% and 30% – which is lower than the highest tax rate for an individual in Australia of 45% (plus 2% Medicare levy). For individuals who reach this tax bracket a company structure can be a more viable option.
Because the structure of a company is more complex than all other types of business structures available there can be more work involved to wind it down.
A Trust is established by a qualified accountant or business lawyer by firstly creating an official Trust Deed. This Trust Deed appoints an individual or company to be responsible for property and assets within the trust for the benefit of certain parties. Those who benefit are known as Beneficiaries and the holder of the trust is the Trustee. The trustee can be liable for a breach of their duties. The terms of the trust deed will determine the extent of the liability. Administrative duties are required to be completed each year by the trustee or trustees, and they are responsible for all business operations for the trust. As they are responsible for all transactions relating to the trust, the trustees have a personal obligation.
Establishing a trust can be more expensive than setting up other business structures in Australia. However, there are benefits of working within this structure. The trustee can be employed by the trust thus lessening personal liability. The terms of the trust also allow of other employees. Individual beneficiaries are subject to tax obligations, though tax does not need to be paid for this type of business structure as a whole. Beneficiaries may be able to claim tax-free capital gains and tax incentives—this is dependent on how the trust is structured. GST (Goods and Services Tax) may be applicable.
The two types of trusts are:
- A Unit Trust which is a fixed trust. Beneficiaries have a similar status to company shareholders. They hold the beneficial assets in the trust’s assets and are known as Unit Holders
- A Discretionary Trust which is a type of trust that allows the trustee to determine all distributions for the beneficiaries.
A Tax File Number (TFN) must be obtained when establishing a trust, and a tax return is required to be lodged annually. An Australian Business Number (ABN) must be obtained if the trust is an enterprise that conducts any sort of business activity.
There are lesser-known types of Australian business structures including Joint Ventures and these are commonly used in property development. But, when it comes to deciding which business structure is best going to meet the needs of your business, an accountant or tax professional should be consulted to assess these needs. They will be able to offer you the advice and support you need while taking into consideration your personal circumstances as well as any long-term goals and plans. It is vital to seek this expert advice before beginning to put business plans into action.
SDP Tax Accountants have been working with many clients from a wide variety of businesses and industries over the last 20 years and are well equipped to guide you through the process of setting up your business for it to be compliant with Australian tax standards.
Disclaimer: the information contained in this article is for general information purposes only and in no event will SDP Tax Accountants or its affiliated entities be held liable for any loss or damage caused through the use of this information. Independent advice is recommended for all individual circumstances. Data and specifications included correct as of May 2021.