In Australia there are several different structures you can use when starting a business. Each of these business types has its pros and cons, so it’s important to know the benefits and pitfalls of each. In this article, we’ll look at the importance of choosing the right business structures, the different types of business you can choose, and how to make the right selection.
Importance of choosing the right business type
How you structure a business can have significant legal and tax ramifications for yourself, your partners and other stakeholders such as investors. For example, choosing the wrong business structure could result in you paying more tax than necessary. It can also affect the types of records you need to keep, the paperwork you need to complete and even how you manage employees.
There is also a security element to choosing your business structure. As you’ll see when we discuss each one in detail, certain business structures can leave you personally liable for debts and lawsuits while others offer personal protection against this.
Overall, some structures simply won’t make sense for certain types of business, so make sure this decision forms part of your business planning checklist.
Types of Businesses
There are generally 7 main business types to choose from in Australia, and each of them has its own set of unique characteristics. Let’s take a deeper look into each type.
1. Sole trader
A sole trader is the easiest business type to set up. All you really need is an ABN, and you can start earning. If your income is over $75,000 or you work in certain industries such as taxis/ride-share, you also need to register for GST. This means keeping accurate records and collecting, reporting and paying GST accordingly.
As a sole trader, you don’t need a separate tax return – you simply report your business income as part of your personal return. This means you pay the same tax rate as an individual, and you may also be eligible for benefits such as the Small Business Tax Offset. You control the business, nobody makes decisions for you, and you have the freedom to operate however you like.
On the downside, as a sole trader you’re personally responsible for debts and lawsuits, should they arise. You also need a lot of discipline, especially when it comes to putting aside money for tax at the end of the year (or quarterly if using PAYG). You also need to pay your own superannuation, however, you’ve got control over how much you want to put aside.
Being a sole trader doesn’t prevent you from hiring employees or contractors to work for you, provided you follow all applicable guidelines relating to the employment of staff.
A partnership is also relatively easy and inexpensive to set up, with the main difference being you need a new tax file number for the partnership. This means you lodge a separate partnership tax return, but the partnership doesn’t pay tax on the income. Each individual in the partnership declares their share of the income in their personal tax returns.
On the plus side, it’s a great way to share the income from a business, but it also means you share losses and control. Even though it’s not a requirement, a partnership agreement is good to have in writing, so that everyone understands their obligations and responsibilities.
Much like a sole trader, money drawn from the partnership isn’t considered ‘wages’, meaning you can’t claim them as a deduction.
3. Limited Partnership
A limited partnership essentially works the same way as a normal partnership, however, it often includes one person who works in the business, and another who is more of a financial partner. This is a popular business structure in the US but is still relatively new in Australia, and as such the taxation guidelines are a little murky.
This type of business usually relates to venture capital operations, for example, an entrepreneur needs capital to start their business. They find a financial partner, however that partner doesn’t really participate in the day-to-day running of the business.
Currently, Australian tax law states that a limited partnership is a tax-paying entity. So, unlike regular partnerships, the limited partnership is required to pay tax on income. Furthermore, all partners are equally liable for the debts and other liabilities. If entering into this type of arrangement, it’s definitely worth seeking legal advice first to completely understand your obligations.
A trust is a more complicated business type, but it is quite popular in Australia. It’s more expensive to set up because you need a formal deed outlining how the trust will operate. Income from a trust goes to beneficiaries, but there are several ways that income can be distributed and this affects how tax is paid.
A trust needs its own Tax File Number and must lodge tax returns. However, the income tax could be paid by the trust, or by the beneficiaries in their personal returns. The trustee may also be personally liable for tax. Again, this is a business structure where you should certainly seek legal advice to understand how it will work and who is responsible for paying tax.
5. Proprietary Limited (Pty Ltd)
A proprietary limited (or LLC) is relatively easy to set up, however, there are more complexities in record-keeping. To set up a Pty Ltd company in Australia, you need a set of bylaws, company directors, a business name, a tax file number and ABN and business bank accounts.
The benefit to operating a Pty Ltd company is the owner and directors aren’t directly liable for debts. However, the owners can’t draw money from the business unless it is in the form of wages or formal distribution of profits. As such, those funds are then subject to applicable tax laws. The company also needs to lodge business tax returns, pay superannuation for employees, and keep impeccable records.
A corporation is much the same as a Pty Ltd company in Australia, however, a corporation is much larger. Both are legal entities separate from the owners, meaning owners have limited or no liability for company debts. However, there are a few differences.
Companies are generally owned by a small number of people, whereas corporations are likely to have more shareholders. Companies are often privately owned, whereas a corporation may trade as a public entity. In addition, rather than having a couple of key owners or directors making decisions, a corporation may include a full board of directors.
Corporations also have more responsibilities in terms of record-keeping and compliance, as there is more scrutiny on them. So, if you’ve got dreams of having an incorporated company, be ready for a big learning curve, and get the right legal and financial advisors around you.
Finally, there are non-profit organisations. These businesses, as the name suggests, are not for profit, but are usually established to provide a service. That doesn’t mean people work for free because a non-profit can still pay wages. However, any profits generated throughout the year must be put directly back into the services they provide.
How to choose the right business structure
Choosing the right business structure is all about knowing how you want to run your business. Hopefully, the information above helps you make an informed choice. If you like to be solely responsible for the success of your business and are also willing to accept responsibility for liabilities, a sole trader setup is perfect. If you build a business with a close partner but still want a cost-effective business structure, partnerships are great.
If you want to set up a separate legal entity and free yourself of liability, companies are the best structure, but be aware there are more requirements in terms of compliance, and therefore more expenses along the way.
Ultimately, it’s a personal choice, and even if you start with a basic business structure, you can always change down the track if it makes sense for you.
How Square can help your startup
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