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Legal Business Structures-Differences Between A Sole Trader, Partnership, Company And Trust

Legal Business Structures-Differences between a sole trader, partnership, company and trust

Australia has 4 commonly used business structures. Each type has a different setup and ongoing costs, asset protection and method of tax calculation. Before selecting a structure, you should seek independent advice from a qualified Accountant and understand your obligations in advance.

Here is a snapshot of the key differences between each type of business structure:

  Sole Trader Partnership Company Trust
The complexity of the business structure Simple Moderate Complex Highly complex
Cost Low Medium Medium-High High
Legal Obligations Low Low – Medium High Medium
Tax Obligations Low Low Medium High
Separate legal entity No No Yes Yes
Liability Unlimited Unlimited Limited Limited (with a corporate trustee)
Source: Australian Securities and Investments Commission

 

Sole Trader

Sole traders are the simplest, easiest and cheapest structure to set up and operate.

“A person who trades alone, without the use of a company structure or partners, and who bears alone full responsibility for the activities of the business. A sole trader can trade under his or her own name or can register a business name” Source: LexisNexis Concise Australian Legal Dictionary

Consider the following:

  • you have full control of your business decisions and assets.
  • you will still need an ABN to avoid withholding tax.
  • registering a business name is optional.
  • your personal assets are at risk if it goes wrong, as it has unlimited liability.
  • there are fewer reporting requirements.
  • if income exceeds $75,000 you will need to register for GST.
  • you will use your individual tax file number (TFN) to lodge your returns.
  • you can’t split Profits or Losses with family members.
  • You are personally liable for the payment of tax on profits.
  • you cannot accumulate losses from previous years to use against profit of future years.
  • you can use a personal bank account, this is not preferable though as it is more challenging to track transactions associated to the business.
  • you can hire team members, whit will create obligations such as tax, super and workers comp.
  • most records need to be kept for 5 years, some need to be kept longer.

Partnerships

Partnerships are a relationship that exists between two or more people, they are easy and inexpensive to set up. You should be aware of the Partnership Act within the state that you conduct your business in and seek advice from a qualified Accountant regarding your obligations operating under a Partnership structure.

There are 3 main types of partnerships.

General Partnership (GP)

The management of the business is the responsibility of all partners equally and all partners have unlimited liability for any debts and obligations it incurs.

Limited Partnership (LP)

Limited partners usually don’t have control of the daily management of the business and their liability is limited to the funds they have contributed to the partnership.

Incorporated Limited Partnership (ILP)

There will always be at least one partner with unlimited liability, who becomes personally responsible if the business cannot meet its obligations.  The other partners can have limited liability.

Consider the following for a partnership structure:

  • share control and management of the business.
  • must apply for an ABN and use it for all business transactions.
  • the risks to your personal assets if you don’t have limited liability.
  • minimal reporting requirements.
  • must register for GST if your turnover exceeds $75,000.
  • requires each partners’ separate tax file number (TFN).
  • a partnership tax return must be lodged with the ATO each year.
  • each partner pays tax on their share of the nett partnership profit.
  • each partner is responsible for their own superannuation.
  • you can’t use accumulated losses from previous years to use against profits of future years.
  • you can still use a personal bank account, but again this is not preferable though as it is more challenging to track transactions associated with the business.
  • you can hire team members, whit will create obligations such as tax, super and workers comp.
  • most records need to be kept for 5 years, some need to be kept longer.

Company

A company is a separate legal entity and has the same rights as a natural person; it can incur debt, sue and be sued.

As a shareholder, you are not liable for the company’s debts. You do have an obligation to pay the Company any unpaid amounts on your shares if called upon to do so.

Directors of Companies may be held liable if found to be in breach of their legal obligations.  Companies are complicated and expensive to set up and have more complex returns to complete.  Companies can be used to offset losses against future profits.

The Directors and Officers of the Company have legal obligations they must comply with under the Corporations Act 2001 ASIC – Company Officeholder Duties

Consider the following for a Company structure:

  • it is a separate legal entity,
  • it’s complex to start and run, with higher costs to start and run.
  • requires you to understand and meet all obligations under the Corporations Act 2001.
  • It is under the control of the Director/s and owned by the Shareholders.
  • members have limited liability.
  • the profits belong to the Company.
  • is required to register for GST if the turnover is above $75,000.
  • has its own tax file number (TFN) and it is required to lodge its own annual tax return.
  • an ASIC annual review and review fees are due each year.
  • Directors must complete a declaration of solvency each year.
  • Directors must understand and comply with all obligations.
  • has wider access to capital.
  • any changes to company details must be updated with ASIC by the due dates
  • most records need to be kept for 5 years, some need to be kept longer.

Source: business.gov.au

Trusts

Where a nominated Trustee is responsible for the operations of the business.  There is an obligation imposed on a person (the trustee) to hold the business assets for the benefit of others, known as the beneficiaries.  You can have a trust and a company.

Trusts are not separate legal entities.  It is not owned but controlled, it’s a fluid-structure.  They are expensive to set up and operate. The Trustee is either a person or company (Corporate Trustee) who carries out the business on behalf of the trusts’ members.  It can be a separate company or a trading company.

Legal liability for the debts of the trust is on the Trustee, who may use the assets to meet the debts.  You will need to select a Trustee/s, have a trust deed drafted, the trust must be settled by a settlor and you pay stamp duty.

There are 2 common types of trust, Discretionary and Unit.

Discretionary Trust

Is a Trust with an obligation imposed on the trustee to hold property or assets including business assets, for the benefit of the beneficiaries.  The trustee has discretionary power for distributions and can decide the percentages if any, each beneficiary receives. Trusts are commonly used for family companies.

  • the trust needs a tax file number (TFN) and lodges an annual trust return.
  • the ABN is attached to the Trust.
  • income can be distributed to beneficiaries with the lowest marginal tax rate for tax savings.
  • tax is payable by the beneficiary at their marginal tax rate dependant on gross income.
  • beneficiaries may be liable for PAYG instalments.
  • the beneficiaries do not own the trust assets, giving protection from third party creditors.
  • can only distribute profits, not losses.
  • losses can be accumulated and used for future profits.
  • if the business retains profits to reinvest in the business, penalty tax rates may apply.
  • trusts are difficult to dissolve, dismantle or change, especially where children are involved.
  • most used for family companies who are comfortable with the trustee having the power of distribution percentages.

Unit Trust

Unit Trusts are better suited when it’s not a family company.  Each beneficiary has its number of units set out in the Trust Deed to determine their share.

  • the trust needs a tax file number (TFN) and lodges an annual trust return.
  • the ABN is attached to the Trust.
  • income is distributed as per the units held
  • tax is payable by the beneficiary at their marginal tax rate dependant on gross income.
  • beneficiaries may be liable for PAYG instalments.
  • the beneficiaries do not own the trust assets, giving protection from third party creditors.
  • can only distribute profits, not losses.
  • losses can be accumulated and used for future profits.
  • if the business retains profits to reinvest in the business, penalty tax rates may apply.
  • trusts are difficult to dissolve, dismantle or change.
  • if it’s an individual Trustee, the trust is liable for all payroll contributions for employees including the Trustee/s if employed by the Trust itself.

Selecting your Structure

Always seek independent advice from a suitably qualified professional, your Accountant. It is important to ensure you consider all options and select a structure based on your needs.

Each structure has different requirements, and your choice can determine the following;

  • how much control you have over your business,
  • how the taxes are calculated,
  • what licenses need to be held,
  • your exposure to personal liability,
  • start-up and ongoing expenses.