As a qualified and experienced Accountant, we really understand the importance (and differences) of each of the accounting structures a business can setup under. All entities’ types are definitely not the same and we hope this clears up some uncertainty around accounting structures which are commonly used in businesses.
Sole Traders
These are by far the easiest setup to have. They are also the least effective on many levels. A sole trader is easy, it’s essentially you, the business owner. Other than ensuring you have an ABN, there is very little setup. You may or may not setup a separate bank account and all the profit left in this business structure at the end of the day is your taxable income and it’s yours.
Now, I said, it’s the least effective for many reasons. Starting with asset protection; this structure offers you absolutely no protection. If you have a home, or shares or say even boats, jewellery or other assets, you could lose them if there was a claim made against you or sued you (not that uncommon in Australia).
Sole Traders are also the absolute worst structure to be in if you’re making a semi reasonable or especially a great profit. If you’re earning under $37K, then your individual tax rate is 19 cents in the dollar. However, if your taxable income is more than $37K and you’re anywhere from 32.5 to 45 cents in the dollar as your tax rate plus 2% medicare levy. Compare that to the corporate rate (dropping down to 25 cents in the dollar) and this can mean extra money in your pocket.
Company Pty Ltd
This structure does require setup cost (One Minute Tax charges $888) but that is only once-off. There is a little more required for taxation preparation however, the asset protection is far better than a sole trader. Someone can still sue a company, or take action against it, but if your company has few assets in it, then there is little to be taken. For this reason, do not go buying heaps of assets in this company structure. If you need to purchase a lot of business products or assets, then it may be wiser to operate out of one structure and buy/keep/own the assets in a separate company or trust.
From a tax perspective, the rate (currently 27.5%, but going down to 26% 2020-21 and the year after down to 25%) making it a very reasonable vehicle in which to pay tax. Plus, you can leave profits or losses sitting in the entity. These then can be taken later as franked dividends (if a newly elected Government doesn’t take that away).
Another tip around companies is that be wary of signing Directors Guarantees when setting up trade accounts. Suppliers are not silly and in order to not be left carrying your unpaid supply bills, they will ask for personal assets; usually of all the directors.
A company (or trust) is also a preferred structure for businesses (particularly in the construction industry) to contract to. This is because, if audited, most of the case they won’t need to pay super or Workers Compensation to a ‘shelf entity’ however, if you’re a sole trader, then the ATO will likely see you as a ‘sham contractor’ and heavily penalise the company employing the sole trader if they don’t take tax and pay super and Workers Compensation.
A final reminder, that although you might own the company, the money which comes into that entity is owned by that entity and not you as an individual. Sure, you can take money out of the company, but it needs to be either as a wage, dividend or loan. If it’s a loan, be sure to talk to your accountant before 30 June about Division 7A rules – as if you owe the company you may have to pay interest to the company for that loan. At One Minute Tax we can help and guide you with all that.
For those who own a lot of property, land tax can be a hefty fee; by having a number of structures, each entity may own only one or two properties, meaning no one owner will go over the threshold level.
Trust
Another common entity used in business is a trust. Similar to a company it also has the benefits of asset protection and being able to use as a contractor structure. The main big difference between a trust and a company is that with a trust all profits (or losses) each year has to be distributed to the beneficiaries. This is why a company is often the best vehicle for business accounting structure set up, particularly for a business making that bit more money.
One of the benefits of a trust is the setup cost; it’s cheaper than a company. With both a company and a trust you do need tax returns done in that entity as well as your individual returns but a Trust doesn’t require ASIC registration or some other reporting requirements.
Partnership
There is also a Registered Partnership where 2 or more people get together to form that partnership. Years ago it was common in a husband and wife business, but many people have now switched to companies or trusts. Unless the partnership agreement specifies otherwise, profits are split 50/50 (where there are two partners). This might be fine unless one of the partners also works somewhere else, thus making their total taxable income much higher than the other person.
In my opinion, one of the worse aspects of a partnership is that each partner can act on behalf of the partnership. They might go out (legally) and sign up for a lease on a Porsche or buy a tonne of expensive equipment the business cannot afford. The other annoying aspect is that if partners change, you can’t easily just change the Registered Partnership.
Combinations
To add an additional level of asset protection, you may also have a trust which has a corporate trustee (rather than an individual). Also for the company, the shareholder may be a trust. For this reason, trusts and companies can sit ‘above’ or ‘below’ each other, depending on how you want the structure to work. Again, it’s wise to talk to your accountant about the combination of structures.
There are other structures, such as super funds, incorporated entities and, of course, the combination of structures (such as trust and company which often happens).
I would be remiss to not remind current business owners that what they setup in originally may not be suitable now. For example, perhaps you were starting out and a sole trader structure was fine back then whilst income was low, or you didn’t have many assets. A few years on, you may have bought a home, or started doing better – it may be time to switch your entity to a trust or company (or combination). Remember also, when you swap, you do need to setup a new bank account and also a new MYOB, Xero or Quickbooks datafile.
What I cannot stress enough is the importance of talking to your accountant before selecting a structure. Not every option suits every person and every business. There are benefits and disadvantages to every structure – what might be perfect for one person, may not be perfect for another. At One Minute Tax (accountants based in Melbourne) we help you determine the right structure for you and get things setup right. Call us today on 03 8899 7506.
