Having the wrong business structure can significantly affect your:

  • Tax liabilities.
  • Personal asset liabilities.
  • Compliance costs.
  • Legal responsibilities.

You should always speak to a professional such as an Accountant before choosing your business structure. Each structure has tax and or reporting implications about its activities. By obtaining advice you will ensure that you are not paying more tax than you are legally required to. You may also be leaving your assets vulnerable by having the wrong business structure.

The four most common business structures are:

  • Sole trader
  • Partnership
  • Company
  • Trust

1. Sole Trader: Advantages and Disadvantages

A sole trader is the simplest form of business structure. It is relatively easy and inexpensive to set up. The sole trader is legally responsible for all aspects of the business, including any debts and losses and day-to-day business decisions.

Basic fundamentals of sole trader structure:

  • Is simple to set up and operate.
  • Full control of assets and business decisions.
  • Requires fewer reporting requirements and is a low-cost structure.
  • Sole traders lodge tax returns using their individual Tax File Number (TFN).
  • Unlimited liability for sole traders.
  • Losses incurred by business activities may be offset against other income earned, subject to certain conditions.
  • Unlike a company structure, a separate bank account is not required.
  • Sole traders can employ workers in their business, but can’t employ themselves.
  • Sole traders are responsible for their own superannuation.
  • Business profits or losses cannot be split with family and all tax liabilities are payable by the sole trader.

2. Partnership: Advantages and Disadvantages

This business structure shares similarities to a sole trader structure, albeit with more members.

A partnership is a business structure made up of 2 or more people who distribute income or losses between themselves.

There are 3 main types of partnerships:

  • General partnership (GP) – is where all partners are equally responsible for the management of the business, and each has unlimited liability for the debts and obligations it may incur.
  • Limited partnership (LP) – is made up of general partners whose liability is limited to the amount of money they have contributed to the partnership. Limited partners are usually passive investors who don’t play any role in the day-to-day management of the business.
  • Incorporated Limited Partnership (ILP) – is where partners in an ILP can have limited liability for the debts of the business. However under an ILP there must be at least one general partner with unlimited liability. If the business cannot meet its obligations, the general partner (or partners) become personally liable for the shortfall.

Basic fundamentals of a partnership structure:

  • A partnership is relatively inexpensive to set up and operate.
  • Partners share income, losses, and control of the business.
  • Require separate tax file numbers (TFN)
  • Must apply for an Australian business number (ABN) and use it for all business dealings
  • Share control and management of the business
  • Do not pay income tax on the income earned. Each partner pays tax on the share of the net partnership income each receives
  • Require a partnership tax return to be lodged with the Australian Taxation Office (ATO) each year
  • Require each partner to be responsible for their own superannuation arrangements
  • Must register for GST if turnover is $75,000 or more
  • Partners are responsible for their own superannuation arrangements.

The relevant legislation for this type of structure is the Partnerships Act 1891 (SA).

Recommendation: Have a Partnership Agreement prior to setting up the partnership. This should outline how income or losses will be distributed to the partners and how the business will be controlled. By having a partnership agreement, you will prevent misunderstandings and disputes, regarding what each partner brings to the partnership relationship, and what they are entitled to receive from the income of the business. This is important for tax purposes. Your Accountant will be able to advise you about tax implications, obligations and requirements.

3. Company: Advantages and Disadvantages

Unlike sole traders and partnerships, a company is a separate legal entity. It has the same rights as a natural person and can incur debt, sue, and be sued. The owners of the company are called the members. As a member you’re not generally liable for the company’s debts. Your only financial obligation is to pay the company any amount unpaid on your shares if you are called on to do so. However, directors of the company may be held personally liable if found to be in breach of their legal obligations.

Companies are expensive and complicated to set up. There are different types of company structures. Your Accountant will be able to explain these and help you decide which type of company structure is best for you. You can also find information about this on the ASIC website – https://asic.gov.au/for-business/small-business/starting-a-small-business/setting-up-a-business-structure. Business SA is another organisation that may be able to assist you.

Basic fundamentals of a company:

  • Is a separate legal entity.
  • A company can have limited liability compared to other structures.
  • Is a more complex business structure to start and run.
  • Involves higher setup and running costs than other structures.
  • Business operations are controlled by directors and owned by the shareholders.
  • Requires you to understand and comply with all obligations under the Corporations Act 2001.
  • This means the money the business earns belongs to the company.
  • Requires an annual company tax return to be lodged with the ATO.

4. Trusts: Advantages and Disadvantages

Trusts are commonly used for investment and business purposes. They can be expensive and usually are. A formal deed is required, specifying how the trust will operate.
A trustee is legally responsible for the operation of the trust. The trustee can be an individual or a company. Profits from the trust go to beneficiaries. There are different types of trusts. Your Accountant will help you determine which type of trust structure is appropriate for your needs. You can also obtain advise from ASIC and the ATO. Business SA may also be able to assist.

Key features of a Trust:

If you use a trust for your business structure, the trust:

  • must have its own tax file number (TFN) for lodging its annual tax return
  • must apply for an ABN and use it for all business dealings
  • must be registered for GST if annual GST turnover is $75,000 or more
  • may be liable to pay tax depending on the wording of its deed and whether any income the trust earns is distributed to its beneficiaries
  • may be able to access small business tax concessions
  • must pay super for any of its employees (this may include the trustee if they are also employed by the trust).
  • Can be expensive to set-up and operate
  • Requires a formal trust deed that outlines how the trust operates requires the trustee to undertake formal yearly administrative tasks.
  • If you operate your business as a trust, the trustee is legally responsible for its operations.
  • A trustee of a trust can be a company, providing some asset protection.

Tax implications for Trusts:

A trust must lodge an annual tax return. Tax liability is determined by how the trust income is distributed to the beneficiaries:

  • There is no tax liability if all trust income is distributed to adult resident beneficiaries, the trust is not liable to pay tax. Each beneficiary reports the income in their own tax return
  • Tax liability if all or part of the net trust income is distributed to non-residents or minors, is assessed on that share on behalf of the beneficiary. The beneficiaries may need to declare their share of the trust’s net income in their own income tax returns, and can claim a credit for the tax paid on their behalf by the trustee
  • Where the trust does not distribute income to beneficiaries, the income is said to accumulate. Tax liabilitiy when this occurs is assessed on that accumulated income at the highest individual tax rate.

Personal services income

If you have a trust structure and the income the trust receives is mostly for your personal efforts, skills or expertise, you need to work out if the personal services income (PSI) rules apply. If the PSI rules apply, the income will be treated as your individual income for tax purposes. This will also affect the deductions you can claim. Getting professional help from an Accountant is prudent to meeting your tax obligations.

Disclaimer: Matthews Lawyers has prepared the information contained herein. It is of a general nature only. It should not be relied upon. It is not a substitute for professional advice. Advice regarding your specific circumstances, can be obtained from an Accountant, business advisor, ASIC or the ATO. Legal advice may also be necessary to draw up associated documents such as contracts of employment, confidentiality agreements and so on. The Law Society of South Australia can also direct you to a Solicitor who practices in this area of the law.