Which Business Structure and Why?
If you’re contemplating starting a business, the four (4) most common business structures are:
- Sole Trader
If you are a sole trader, you operate the business as an individual and you are the sole person legally responsible for all aspects of the business. All profits derived from the business will be treated as your personal income and taxed at marginal rates. It is the least costly to run of the available structures.
A company operates as a separate legal entity to the shareholders of the company. Any profit of the business is earned by the company and not the shareholders. The liability of the shareholders for the debts of the company is limited to the amount of any unpaid capital on the shares.
Having paid tax at the flat corporate rate, the company may then reinvest the surplus or declare a dividend and pay the shareholders. Depending on who holds the shares, there could be further tax paid at the shareholder level. To add flexibility, shares in the company are often held by family discretionary trusts associated with the business founders. The dividend paid to the trust can then be streamed to the beneficiaries of the trust at the discretion of the trustee.
A partnership exists where two (2) or more entities carry on business together with a view to profit. There is usually a partnership agreement regulating and governing the operation of the partnership and the rights/obligations of the partners. The structure is relatively simple and inexpensive to establish and although not a separate legal entity at law, the partnership will be required to file a separate tax return. At the end of each financial year, the accounts of the partnership will disclose a profit or loss which will then be allocated to the individual partners at the partner level. There is no tax payable by the partnership. The members of the partnership may be a combination of different legal entities and it is not uncommon for there to be a partnership of family discretionary trusts.
The downside is that all partners are jointly and severally liable for the debts of the partnership.
Broadly, a trust is an entity that holds income or property for the benefit of others (the beneficiaries of the trust). In business, they are primarily used to minimise individual risk and facilitate the distribution of income to the beneficiaries of the trust (be they individuals, companies or other trusts).
More recently, the use of trusts in business and trading activities has again attracted the attention of the ATO resulting in the publication of a set of guidelines (so-called safe harbour arrangements) relating to distributions from the trust. Although there is no guarantee from the ATO, it is generally accepted that adherence to the safe harbour arrangements should mean that an audit is unlikely.