The 4 Main Types of Business Structures
When laying the foundations for a profitable business, deciding on the optimal business structure is crucial to your success. You may be familiar with the main types of business structures in Australia which include Sole Trader, Partnership, Trust and Company.
Each has its own advantages and disadvantages or tax implications—and depending on your own situation—one may be more suitable over another. It is worth considering your potential personal liability, goals and any future plans you have for your business. The type of business structure you choose will impact how much control you have over the business as well as your ongoing costs.
It’s worth familiarising yourself with the key types of structures before seeking expert advice. Here we break down the main types of structure so you can be prepared and informed before you seek any advice regarding your personal circumstances.
Sole Trader
The Sole Trader structure consists of one individual running a business. This structure is seen as being the most cost-effective. The control and management of the business is performed by the individual however, it is possible to employ staff under this model. Sole traders are required to obtain an Australian Business Number (ABN) and operate under it. The individual in this instance is personally liable for all debts, costs and their assets may be at risk. They technically own all the assets of the business plus all the business profits are theirs. Whilst having maximum privacy is an advantage of working as a Sole Trader, the establishment and operation of the business is simple and start-up costs are low. This is the simplest structure that gives the individual full control. Within this model, it is possible to have employees.
A sole trader business structure is taxed as part of your own personal income, and the tax-free threshold for individuals is $18,200 for the 2020–21 financial year. The Sole Trader structure is taxed at the individual income tax rate. This legal structure can be changed later if needed and is easy to wind up.
Partnership
A Partnership involves either two or more individuals, companies or trusts coming together for the purposes of making a profit. Income and/or losses are distributed between the parties. The Partnership association is formed for the purpose of business activities, with the view that all parties have a responsibility for, and an input into, the management of these activities. The maximum number of parties in a Partnership is generally 20.
As with the Sole Trader Structure, individuals involved in a Partnership are personally liable for debts, this, therefore, has the potential to leave their assets vulnerable. Although a Partnership is relatively easy to dissolve, a change in Partnership i.e. one person exiting and another joining is more difficult. In most cases, it becomes easier to dissolve the Partnership and commence another.
The benefits of a Partnership structure include tax-free capital gains and tax incentives which are available to involved parties. The model is not a separate entity, with all profits and losses moving via the partners. An annual Partnership tax return needs to be lodged. No Income Tax is payable by the Partnership however, GST can be applicable and payable.
ABN registration is required for this type of business structure, with GST registration being required after an annual turnover has been or is forecast to be over $75,000.
Company
A company is a separate legal entity created for the purposes of business activity. There are two types of enterprise that are possible, and these are a proprietary company and a public company. A proprietary company has shareholders up to a maximum of 50 and is limited by its shares, it must have at least one director appointed. A public company must have at least 3 directors appointed and has no limit to how many shareholders own it. It can be listed or unlisted on the Australian Stock Exchange (ASX).
For both proprietary and public company shareholders, liability is limited to the nominal amount of their shares, so no individual’s assets are personally liable. The tax rate for a company is between 26% and 30%. This is lower than 45% (plus 2% Medicare levy) which is the highest tax rate for an individual in Australia, therefore, a company structure may be a more viable option for individuals who reach this bracket.
A company structure is more complex than other types of business structures and there is more involved in winding it down. A company has a unique Tax File Number as well as its registered Australian Business Number.
Trust
A Trust is an obligation imposed on an individual or company to hold property or assets for the benefit of others. The holder of the trust is called the Trustee and the others are Beneficiaries. Trusts are not at a separate entity therefore liability lies with the Trustee. The Trustee is responsible for all business operations and there are yearly administrative tasks to complete. All transactions are undertaken by the Trustee and all are therefore a personal obligation.
A Trust is a more expensive business structure to set up, but there are benefits to working within this model. The Trustee can be employed by the Trust, and there can be employees. Income Tax doesn’t need to be paid for this structure as an entity but is passed on to beneficiaries, however GST may be applicable. Tax-free capital gains and tax incentives can be claimed by the beneficiaries should the structure be set up to allow this. A Trust requires an official Trust Deed to be completed by a qualified accountant or business lawyer.
There are two types of trusts and they are a Unit Trust and a Discretionary Trust. Unit Trusts are fixed, and Discretionary Trusts are not fixed. Beneficiaries of a Unit Trust are similar to shareholders in a company, beneficiaries can be referred to as Unit Holders. In this model, the beneficiaries hold the beneficial assets in the trust assets. A discretionary trust allows the Trustee to determine distributions for the Beneficiaries.
As with other types of Australian business structures, an annual tax return must be lodged and a tax file number must be obtained. If the trust is carrying on an enterprise or business activity in Australia, then an Australian Business Number registration must be obtained as well.
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There are also the less common types of business structures including a Joint Venture which is more common in property development. Your accountant or trusted financial adviser will be able to advise if this or any of the above types of structures are more suited to your business, enterprise or investment. Remember it is always best to seek expert advice to suit your personal circumstances and take into consideration your long-term goals and plans. Factor1 has been working with clients from many industries for over 20 years, so are well equipped to guide you in setting up your business to be compliant with Australian tax standards.
Disclaimer: The information contained in this article is for general information purposes only and in no event will Factor1 or its affiliated entities be held liable for any loss or damage caused through the use of this information. Independent advice is recommended for all individual circumstances. Data and specifications included correct as at May 2021.