This article is for informational purposes only and is not intended to be legal or tax advice regarding business formation. If you’re starting a business, consult with your lawyer or accountant before deciding on a structure.
Entrepreneurs have many decisions to make when starting a business. But none may have more of an impact than deciding on a legal business structure, also referred to as declaring a business entity.
That’s because the business structure you use helps to determine the income tax return form you have to file. So, your decision affects your taxes, your earnings, and, ultimately, your business’ bottom line.
Which business structure is right for you?
The nuances to the types of business structures — and the details of your business — can make selecting and filing for the right type of business entity a complex decision. So we’ve put together a guide to help you determine the type of business formation that works best for you. Plus, creating a business plan ahead of time will help you determine what business structure is right for you.
Business entities explained
Here are some of the most common business structures you may file for when you’re establishing a business entity.
A sole trader is just as it sounds — an individual owns and runs their business alone and is personally liable for the company’s debts and obligations.
There are several reasons why a sole trader is appealing to new business owners. First, it is the easiest small business entity to start and operate because it involves fewer reporting requirements and is generally a low-cost business structure.
Additionally, a sole trader is in complete control of the business and has total authority to make decisions. This control, of course, comes with several disadvantages as well. Because the business belongs solely to the owner, it’s all the more important to have accurate books and records (financial records must be kept for at least five years) to clearly delineate one’s business from one’s personal assets. As a sole trader you’re not required to maintain separate bank accounts, though it is highly recommended. This also means that any financial decision made for the business also affects the owner’s personal finances.
Tax responsibilities for entities taxed as a sole trader
There are several tax differences for a sole trader compared to other types of business structures. The owner of a sole trader business structure pays income taxes at the individual income rate, and uses an individual tax file number (TFN) to lodge taxes.
Other taxes and withholdings a sole trader may be required to pay include:
- Goods and Services Tax (GST)
- PAYG income tax instalments
- Fringe benefits tax
- Capital gains tax (CGT)
- Payroll tax
Starting a sole trader business structure
When you start a sole trader business you don’t have to register a business name if you use your own name. This saves you time and allows you to open up shop faster. If you choose not to use your own name you will need to register your business name with the Australian Securities and Investments Commission.
But there are still other steps to take. First, register your business and obtain all permits at the city, state, and government level, such as applying for an Australian Business Number (ABN) and registering for Goods and Services Tax as needed. Also, you might create a business checking account to help you better separate your business and personal finances.
A general partnership is a business entity in which two or more people agree to share all assets, profits, and liabilities of the business. Unless agreed otherwise, in all jurisdictions in Australia (with New South Wales being the exception) all general partners may contract on behalf of the partnership business, meaning that a single general partner can bind the partnership and other partners to a contract with a third party. This means trust is a key component in the success of a general partnership business structure.
Forming a general partnership can be advantageous because you and your partner(s) can quickly make decisions and create a lean business model. General partnership business structures are also usually inexpensive. Unless you are hiring a lawyer to review the legal structure of a business partnership agreement (which isn’t required but may be a good idea), there is little cost to start this type of business.
The informal nature of a general partnership can have drawbacks as well. Because there are no limitations on liability, all partners share the liability for issues that arise, and the personal finances of all partners can be affected.
Tax responsibilities for business entities taxed as a general partnership
Generally, the tax responsibilities of a partnership are that they are shared by all partners. The partnership does not pay income tax on the profits it earns. Instead, each partner reports their share of the partnership income on their own tax return. The general partnership may be liable for additional taxes and forms, such as:
- ABN for all business dealings
- GST if annual turnover is $75,000 and over
- TFN and must lodge an annual partnership return showing all income and deductions
- Personal services income (PSI) if you’re paid mostly for your skills and expertise
Starting a general partnership
To create a general partnership business entity, you have to decide how you will enter into partnership (i.e. as individuals, or through company or trust structures) and then enter into a partnership agreement. Once that is decided on you will need to register your business name and register for an Australian Business Number (ABN). Check with your official state office to determine the required documentation for your local area.
And although your company’s business structure isn’t contingent on a written agreement, you might think about creating a formal partnership agreement that a lawyer can review.
Limited partnership (LP)
A limited partnership (LP) is a type of business structure that has two or more partners, but liability is limited to the amount of money they have contributed to the partnership.
In this case, the general partner(s) owns and operates the business and assumes liability for the partnership while the limited partner(s) serves as an investor to the company. Limited partners usually aren’t subject to the same liabilities and often don’t have rights to make business decisions. Limited partners are seen as passive investors in this type of business entity and don’t deal with day-to-day management.
This is a great small business entity for an entrepreneur who wants complete control of the business but needs financial support. General partners have the right to make strategic business decisions on their own. But that comes with some downsides—they have unlimited liability that puts them at higher risk.
Tax responsibilities for entities taxed as a limited partnership
In many ways this is the same as for general partnerships in that the income/loss of a partnership is passed through to its partners and taxed at their contribution level rather than at the entity level. However, certain limited partnerships that are taxed as companies must lodge a company tax return. This does not apply to a limited partnership (including an incorporated limited partnership) that is a venture capital management partnership, or a limited partnership that’s unconditionally registered with Innovation Australia, an early-stage venture capital limited partnership, or an Australian venture capital fund. These limited partnerships are taxed as ordinary partnerships (which fall under special rules about the utilisation of their losses) and are not taxed as companies. If you plan to pursue a limited partnership, check with a tax lawyer to ensure you are following the necessary guidelines on taxation and contributions.
Starting an LP
Starting a limited partnership business structure can take more time than a general partnership because of the necessary documentation. You need to draft a partnership agreement with legal assistance in order to standardise terms of the business and lay out liability. The cost of a limited partnership depends on the complexity of the partnership agreement and liability structure between the partners.
You have to apply for a limited partnership registration, and display the certificate at the registered office your business is in to complete this process.
Proprietary Limited Company (Pty Ltd)
A proprietary limited is one of the most common types of business entities in Australia and creates a separate and distinct legal entity by isolating business assets from the members’ personal assets. Pty Ltd owners are referred to as members and there can be an unlimited number of them in this business entity.
The primary benefit of a proprietary limited company business structure is this liability protection. If a business is sued, the plaintiff can only go after the Pty Ltd’s business assets and not the owner’s personal assets.
This business structure also allows for fewer corporate formalities and potentially greater tax flexibility, compared to corporations. While this sounds appealing, there are drawbacks. Without a specific operating agreement, the departure of a member can shut down the business. The cost to file paperwork can also be more expensive than other business entity types. As a Pty Ltd in Australia, you’ll need to be able to produce annual financial statements. However, you won’t need to register for GST unless your sales exceed AU$75,000 in a year.
Tax responsibilities for entities formed as a Pty Ltd
Tax responsibilities of a Pty Ltd depend on several formation factors. A Pty Ltd may be taxed as a public or private limited company depending on the legal structure of the business.
Starting a Pty Ltd
You’ll need to submit all the required paperwork to the Australian Securities and Investments Commission (ASIC) and Department of Industry, Innovation and Science. You’ll also need to do the following:
- Reserve your company and/or business name
- Draft and sign bylaws for your company
- Appoint company directors and other officeholders
- Get your tax file number (TFN) which is automatically generated when you receive your Australian Business Number (ABN)
- Open a business bank account
A company is a business entity that is taxed separately from shareholders entirely, meaning the business has its own legal rights independent of its business owners. In this business formation, shareholders are not personally liable for debts or obligations beyond the initial investment.
Company business structures receive several advantages such as:
- Companies have limited liability protection, meaning shareholders aren’t responsible for business liabilities.
- The money the business earns belongs to the company.
- They follow an internal structure. Shareholders are the owners of the company and elect a board of directors who oversee the decision-making processes.
Tax responsibilities for entities taxed as companies
The tax responsibilities as a company can be complicated and have additional reporting requirements. For instance, a company must apply for a tax file number (TFN) and use it when lodging its annual tax return and must lodge an annual company tax return. Further, when hiring employees, a company business structure must pay super guarantee contributions (SGC) for any eligible workers. This includes you, if you are a director of the company, and any other company directors.
Starting a company
A company has different legal, financial, and record keeping responsibilities compared to other business structures, so it’s important you know what’s involved. You can register your company through the Business Registration Service. Before you register, make sure you:
- Choose a name for your company
- Designate your company as a private or public business entity
- Understand your legal and tax obligations
You will also need to ensure that you have all the required licences and permits for your company.
Whichever business structure you choose, it’s important to seek professional advice to ensure that everything is up to snuff before you start doing business. Square is here to help you with everything from starting a business to employee management and navigating payment solutions.