Choosing the right business structure to maximise the return and to minimise the legal and economic risk for you is very important. In deciding the correct structure, numerous factors have to be taken into account including the mix of related and non-related parties in the business, the anticipated profits or losses of the business, the risk involved in the business and your other sources of income and assets.
The summary below shows the differences between the most common structures. It should be noted that as your affairs and circumstances are different, a structure that may be suitable for one client may not be the best structure for another.
Sole Trader
You trade, control and manage all aspects of your business:
Simple to operate. Very few legal and tax formalities and inexpensive to setup.
If you have no employees, you usually have to do all the work.
Only limited opportunities for income splitting (by using salaries, interest etc).
Capital Gains tax paid by the sole trader. CGT 50% discount and small business concessions available to the sole trader.
Superannuation for the sole trader and employees - annual concessional contribution limit - $25,000 for tax deductible contributions.
Business income reported in your personal income tax return, along with any other income.
Losses can be claimed against other income of the sole trader if non-commercial losses tests are met.
The sole trader is personally liable for all aspects of the business. You can lose private assets such as your home, contents and vehicles if the business goes into debt.
Tax paid by the sole trader at marginal tax rate (0% – 47%).
Partnership
This is another simple structure to use, where two or more people start a business and can legally split income between partners based on the terms of the partnership agreement.
Simple to operate. Very few legal and tax formalities and inexpensive to setup. Family partnership: husband and wife. Other partnership - unrelated partners.
There are more people to share the work load.
Income split between the partners per partnership agreement and/or partners salaries.
Capital Gains tax paid by each partner. CGT 50% discount and small business concessions available to each partner.
Superannuation for partners and employees - annual concessional contribution limit - $25,000 for tax deductible contributions.
You must lodge a separate partnership income tax return. Share of partnership profit/loss then reported in your personal income tax return.
Partners share of loss can be claimed against their own personal income if non-commercial losses tests are met.
It is not easy to adopt changes in ownership proportions, all partners are personally responsible for all liabilities, regardless of their ownership interest in the partnership.
A partnership ceases with death of a partner.
You can lose private assets such as your home, contents and vehicles to settle debts of the partnership.
Tax paid by the each partner on their share of profit at their marginal tax rate (0% – 47%).
Private Company
A private company is a more complex structure to use. It is an entity that has a separate legal existence from its owners, who are known as the members or shareholders.
Complex to operate. More expensive to setup, maintain and windup - company constitution, regulated by ASIC.
Income splitting using salaries etc and by payments of dividends to shareholders.
Capital Gains tax paid by the company. CGT small business concessions available to the company but not eligible for 50% discount.
Superannuation paid on salaries to owners and employees - annual concessional contribution limit - $25,000 for tax deductible contributions.
You must lodge a separate company income tax return.
Losses are not available to be claimed by shareholders against their other income but are carried forward and offset against future years income of the company.
A company structure allows for easy additions of new investors co-owners and shareholders. It is also easy to issue additional shares to new shareholders and sell or pass the ownership to others.
A company structure has perpetual existence - it can continue in the event of the death or disability of key people in the business because shares in companies can be transferred.
Liability limited to assets of the company except where directors have given personal guarantees for company debts.
Tax paid by company @ 26.5% tax rate on profits - small business tax rate turnover < $50million or 30%.
Shareholders pay tax on dividends received from the company at their marginal tax rates. A Franking Credit may be available to partly offset this tax depending on the company’s past tax payment history.
When dividends are paid or when the company is wound up, additional tax is payable by shareholders on these dividends if their marginal tax rates are above 26.0%.
Family (Discretionary) Trust
Family trusts are the most flexible but complex trust structure, strictly operated between a family group. It can also provide a form of asset protection for assets of the business.
Complex to operate. More expensive to setup, maintain and windup. Powers of trustees are restricted by the trust deed.
Trustee is responsible for holding property or income for the benefit of beneficiaries. Can have a corporate trustee or individual trustee. As the trustee is personally liable for the trust’s liabilities, it would be suggested that a corporate trustee be used as this limits the trustees’ liability to the assets of the corporation.
The trustee has full discretion to decide how the profit/capital gains are distributed among the beneficiaries/family members including their children. Beneficiaries can also be paid salaries for work performed.
Capital Gains tax paid by beneficiaries. CGT 50% discount and small business concessions available to each beneficiary.
Superannuation paid on salaries to beneficiaries and employees - annual concessional contribution limit - $25,000 for tax deductible contributions.
You must lodge a separate trust income tax return.
Losses are not available to be claimed by beneficiaries but are carried forward and offset against future years income of the trust.
A trust structure has perpetual existence can continue in the event of the death of family members. However most trusts have a limited life of 80 years when the trust will vest and the assets will automatically be distributed among the beneficiaries.
Tax paid on distributions to beneficiaries at their marginal tax rate (0% –47%). Profits distributed to children under 18 may be taxed at higher rates.
Unit Trust
It is a more complex structure to use, with profits split based on unit ownership. It can also provide a form of asset protection for assets of the business.
Complex to operate. More expensive to setup, maintain and windup. Powers of trustees are restricted by the trust deed.
Trustee is responsible for holding property or income for the benefit of unit holders. Can have a corporate trustee or individual trustee. As the trustee is personally liable for the trust’s liabilities, it would be suggested that a corporate trustee be used as this limits the trustees’ liability to the assets of the corporation.
Income is split proportionally between unit holders. Unit holders can also be paid salaries for work performed.
Capital Gains tax paid by unit holders. CGT 50% discount and small business concessions available to each unit holder.
Superannuation paid on salaries to unit holders and employees - annual concessional contribution limit - $25,000 for tax deductible contributions.
You must lodge a separate trust income tax return.
Losses are not available to be claimed by unit holders but are carried forward and offset against future years income of the trust.
A trust structure has perpetual existence can continue in the event of the death of unit holders. However most trusts have a limited life of 80 years when the trust will vest and the assets will automatically be distributed among the unit holders based on their unit ownership.
Tax paid on distributions to unit holders at their marginal tax rate (0% –47%).
* Note tax and super rates quoted are for the 2020-21 year.
It should be noted that as your affairs and circumstances are different, a structure that may be suitable for one may not be the best structure for another. So best to seek advice first for the best option as it can be costly to change structures so reach out if you have any questions.
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