When first setting up your small business, one of the most important decisions you’ll need to make is identifying the right business structure.
There are advantages and disadvantages to each business structure, and it’s important to weigh these up before deciding. Each structure has different responsibilities and your choice will affect the ongoing costs, taxes and the protection of assets.
A sole trader structure has the least legal and tax formalities of all the business structures. It’s also the simplest and cheapest to set up, while giving you decision-making power.
As a sole trader you control and manage the business, meaning you are legally responsible for all aspects. Importantly, deductions cannot be claimed for money drawn from the business and amounts taken cannot be classified as a wage.
However, if you were to die or become permanently incapacitated, your business will cease to exist, because your business does not exist outside of you. This can make expansion and outsourcing more difficult in the future.
A partnership is relatively easy and inexpensive to set up and operate. In this situation, control and management of the business is shared and all partners are liable for obligations, debts and losses of the business. This means that income and losses are distributed among the partners.
It’s important to note that the partnership must have its own tax file number and must lodge an annual return showing all income and deductions. Furthermore, in terms of tax, while the partnership will not pay income tax of any profits, each partner will pay individual tax on their share of the profits earned.
Similar to the issue of being a sole trader, a partnership agreement can make expansion or outsourcing difficult, and can result in troubles down the road if one-half of the partnership decides to leave.
The most important thing to remember when it comes to a “company” structure is that it’s a separate legal entity. This means that the business can incur debt, sue and be sued.
A company is owned by shareholders who are generally not liable for company debts, and run by directors who may be liable for their actions, and in some cases, the debt of the company.
It’s a complex business structure, which means set-up and ongoing costs can be quite high. There are also additional reporting requirements, which push the administrative costs higher.
However, your business is then separate to you as an individual, which can assist in future if you need to raise capital and expand the business.
In the case of a trust, a formal deed is required outlining how the trust is to operate. In this situation, a person (trustee) is obligated to hold assets (in this case, business assets) for the benefit of others, otherwise known as beneficiaries.
The requirement of a formal deed means setting up your business as a trust can be a very expensive exercise. Additionally, there are annual administrative tasks required of the trustee.
The trustee, which can be an individual or a company, is legally responsible for the operation of the trust. It must have its own tax file number and in the annual return, all income, deductions and distributions must be shown.
This is the least common business structure due to the complications involved, and the reliance on the trustee for all legal responsibility.
Each business structure has positives and negatives, however these will largely depend on your individual circumstances and it’s always best to speak to an expert.
The most important things to consider are the tax implications, legal liabilities and the overall cost of the structure. Also, remember to consider any potential future needs, as circumstances may change over time.
David Hill, Founder, Australian Debt Solvers