What business Structure should I trade out of?
One of the main decisions a business owner must make when they start a business is what type of entity should they trade out of. Should it be a sole trader, partnership, trust or a company? This should be a decision that is made in consultation with a trusted accountant. The reason being is that each one of the structures mentioned above has its own advantages and disadvantages. The main points that should be addressed is what are the start up costs, what are the ongoing compliance areas, are the personal assets of the business owners at risk and are there any tax benefits or pitfalls.
Consider a sole trader for a moment. The initial start up costs would be very minimal. This type of entity could be up and running within minutes after an online application for an Australian Business Number (ABN) which is free. After one year of business, if they decided to sell, the sole trader would be entitled to receive the 50% general CGT discount and quite possibly some other small business CGT concessions. Furthermore, a good accountant would probe to see if the business is in fact a hobby and then avoid being recognised at all as a business. However, there are some disadvantages of the sole trader entity, the biggest one is does the business operate in an industry that the owner could get sued as if that is the case, the sole traders personal assets, being their house, bank accounts and investments are very much at risk. Likewise, if trade creditors are chasing payment for their invoices, the sole traders personal assets are yet at risk. Further, a sole trader bears all the profits in their own name each year and is taxed at an individual rate. There is no opportunity to share out or retain the profits. The exact same results as outlined above would apply for a partnership as well.
Alternatively, there is the possibility of trading through a Trust. The start up costs can range between $1,000 – $2,200 in set up and registration fees. It all depends if the trustee is going to be individuals or a company. A company trustee is the best way to go as the company then provides asset protection. On going compliance will be the annual ASIC review (if a corporate trustee is in place) and a yearly Trust income resolution (usually around $150 if completed by an accountant). The resolution is where the Trustees put in writing by way of a minute before June 30 on how they intend the profits to be distributed. Trading through a discretionary trust has mainly tax advantages in particular for a business that has many family members the trust can share the profit with a spouse, children, parents and a bucket company. By doing this, tax is minimised as the profit is spread thinly among beneficiaries to keep the applicable tax rate as low as possible. Capital gains tax is favourable in a trust after one year of trading and assets are protected in a trust that has a corporate trustee. The disadvantage to a Trust though, is that losses cannot be distributed to beneficiaries but are trapped there. The loss is carried forward each year and can only be used to offset future trust income.
Finally, there is the company structure. Similar to a trust, the start up costs are around $1,400 and there is the ongoing annual ASIC review that will need to be paid. A company does protect its Director with asset protection should the company be sued or have creditors chasing them, but there are exceptions. The ATO can make the company Director personally liable for staff superannuation that the company cannot pay and if illegal actions are performed by a Director, well the company veil will be lifted so that the Director cannot avoid personal consequences. A company enjoys a base rate entity tax rate of 26% for the 2020 – 2021 financial year, and can retain the profits. This contrasts to a trust where all profit must be farmed out to beneficiaries in a given year. If a company decides to sell then no 50% general capital gains discount applies but other small business concessions may be available.
The above is a very simple snap shot of the main 4 possibilities of entity structures for a business. There are numerous other types of structuring such as a partnership of trusts rather than individuals, Unit Trusts with discretionary trust unit holders and many more combinations. Each business is different and will have a customised recommendation given by their accountant.
If you’re thinking about starting a business, Leanne Apiata from LA Accountants will help you arrive at the right structure. Phone 07 3155 6596.
LA Accountants Cleveland help their clients make wise financial decisions today so that they can have a better financial future.