You have a concept and passion, but which business structure should you choose for your business and why? This article will shed light on the differences between the two structures and provide guidance to start-ups who wonder which structure is the most appropriate for them.
In summary, people choose to be sole traders as it is a simple structure to launch a business. There is less administration including no company tax returns. However, there are considerable limitations on being a sole trader, including personal liability and it is not possible to bring in shareholders as you have no company shares to offer.
Most businesses that seek to grow choose a company structure for limited liability, potential tax advantages, the ability to incentivise employees with shares, and the ability to bring in investor shareholders.
The key differences between a Sole Trader or Company
Registration and fees
There are few fees involved in just being a sole trader. Sole traders may choose to obtain an Australian Business Number, and many purchase a business name.
There are various costs involved in setting up a company, including the ASIC registration (currently $497) and the annual renewal (currently $243).
There are various fees that apply to businesses needing certain licences, such as a liquor licence for an alcohol-related business.
An important advantage of a company structure is that there is limited liability. Shareholders have limited liability; they are not responsible for the company’s debts.
Directors have limited liability unless they signed a personal guarantee, were fraudulent or negligent, or breached their directors’ duties including operating the business while it was insolvent.
Sole traders do not have limited liability; they are personally responsible for the debts of the business. This means that both the business assets and any personal assets eg a house or car are at risk.
Fundraising and Investments
A company can attract investors by offering shares, so shareholders own a portion of the company. The company can issue shares directly or issue options over shares, or convertible notes that convert into shares.
Sole traders cannot offer shares. To raise funds they generally seek a loan. Banks and financiers have guidelines around how much money they will loan, so the sole trader may find it difficult to obtain funding. A loan generally requires regular repayment of interest, which can affect cash flow.
Sole traders make their own business decisions.
In a company, shareholders appoint directors to make key business decisions. Directors have duties set out in the company’s constitution (or, if it has no constitution, by the replaceable rules in the Corporations Act), and other duties in the Corporations Act and general law.
Tax rates and requirements
There are differences in the tax payable by a sole trader or a company. Companies pay 30% tax on their income, whereas sole traders pay personal income tax, so the tax rate depends on the amount that they earn, including the business’ earnings. The highest personal tax rate is currently 45c in the $1 for $180,000 of income and above.
Sole traders must lodge personal tax returns. Company owners must lodge both personal and company tax returns.
Companies must maintain financial records and keep their books up to date in keeping with the reporting requirement of the Australia Securities Investment Commission.
For sole traders, all profits are taxed at the relevant marginal tax rate. Also, a sole trader pays personal tax on money he or she uses or retains in the business.
Companies can choose to pay profits as dividends to shareholders, and/or to retain the profits and use them for the business, for example, to accelerate business growth. Retained profits – profits used for reinvestment purposes – are taxed at the corporate tax rate of 30%.
If a company owns more than one business, it can offset the losses of one business against the gains (or income) of another.
If a sole trader incurs losses from one source of assessable income, such as a rental property, they may offset this against another, such as the income from the business.
A business run by a sole trader ceases to operate once the owner passes away. The assets of the business are disbursed in accordance with the will or estate laws.
‘Perpetual succession’ means that even after a company’s directors/founders have passed away, the company continues to exist and operate. This is partly because a company is considered to be a separate legal entity under the law. The shares of a deceased shareholder pass to the heir under the will or through the estate laws.
The important question to ask when choosing a business structure is: Which structure will be most accommodating in the future? Where do you want our business to be in 3 to 5 years?
A sole trader structure is less expensive to set up and maintain than a company and will allow the owner autonomy when making decisions. On the other hand, it will not benefit from the limited liability of a company structure, and it is not possible to bring in shareholders.
If you plan on growing and scaling, a company has many benefits including limiting your personal liability and bringing in shareholder-employees and/or investors.
Want to understand more about which one suits you? Check out our episode with Australia's fastest-growing law firm Founder LegalVision's Lachlan McKnight on our podcast The Make It Happen Show where he covers all of this, and more, in detail.
This information is not legal advice.
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