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Business Structures Choosing a business structure to suit your particular circumstances is important as it can have a significant effect on the set up and ongoing costs of the business, the tax payable on the profits and the ability to provide some sort of asset protection. The following 4 business structures are the most commonly used – and although one may seem more advantageous than another, consideration should be given to your individual circumstances as various other issues not covered here may also have an impact on your choice of structure.

All four structures require the registration of a Business Name, Tax File Number, Australian Business Number and GST if carrying on an enterprise, and if annual GST turnover is $75,000 or more.

 

Sole Trader

 

A business operating as a Sole Trader is the simplest structure available due its inexpensive set up costs. It is suitable for a business which is relatively small and requires minimal capital investment. The Sole Trader has control over the management, the assets and the profits of the business however, they are also personally liable for all debts – thus providing no form of asset protection as there is no legal distinction between the private assets and the business assets. The Tax File Number is that of the Individual, and all business income less allowable deductions are added onto the Individual's taxable income thereby taxing the individual on this income at their marginal rates. Depending on the profitability of the business, this can result in a higher tax bill compared to say, a business operating with a company structure which has tax currently limited to 30%.


A Sole Trader can cease their business without a formal winding up however, any disposal of assets will have revenue and capital gains tax consequences depending on the nature of the assets. Access to the 50% Capital Gains Tax (CGT) Discount and some CGT Small Business Concessions may be available depending on certain circumstances. However, the resulting net taxable gain will again ultimately be borne by the Individual Taxpayer.


Partnership

 

A business operated as a Partnership is an association of people carrying on a business together for a profit, or who are in receipt of income jointly for tax purposes. General Partnerships are also relatively inexpensive to set up and are suitable where there is a small number of people involved as this can provide greater access to more capital from the partners as well as providing a greater capacity to borrow. Control and management of the business in a Partnership is shared among the partners equally unless there is an agreement stating otherwise. Each partner is entitled to their share of the capital and profits however, they are also responsible for any losses and debts incurred. Accordingly this structure doesn't offer much in terms of asset protection. A Partnership tax return must be lodged annually and each partner is assessed on their share of the net income (or loss) of the partnership in accordance with the partnership agreement. A husband and wife partnership, as an example, may benefit from the tax savings available through income splitting where the profits of the Partnership are shared equally. This may be the case even where only one of the partners performs the majority of the work. Ceasing a Partnership business can be complicated as it involves allocating all partnership property to the individual partners thereby disposing each partner's interest in the partnership assets. This will have capital gains tax implications for each partner however, access to the 50% CGT Discount and some CGT Small Business Concessions may be available depending on certain circumstances. It should be noted here too, that the above will also apply whenever there is a change in the partners as this will result in the cessation of the existing partnership, and the creation of a new partnership.

 

Companies


A business operated as a company has a more complex business structure. It will be regulated by the Australian Securities and Investment Commission (ASIC) and will consequently have greater reporting requirements making it more expensive with higher set up and administration costs. The company is owned by its shareholders however, control over its operations lies with the Directors. A company is considered a separate legal entity and can therefore provide some asset protection however, the Directors can be held personally liable in certain circumstances where there is negligence, or if there is a failure to comply with various tax obligations eg superannuation. A Company does not have access to the general 50% CGT discount however, the CGT Small Business Concessions may be available to reduce the tax liability depending on the circumstances. Company profits are subject to tax at 30% and any tax losses are carried forward to be offset against future profits, subject to passing certain tests. Distributions of profits back to the Shareholders will be by payment of a dividend, and can be declared and paid where the Company is solvent. A Company that ceases business can then be wound up and deregistered. Final profits and assets of the business are generally made through a final liquidator's distribution where dividends are paid from the remaining Company's retained profits and any balance is paid as a return of capital.

 

Trust


A business operating in a Trust will also have a complex business structure, and can be expensive to set up as it requires a formal deed which should be prepared by a legal practitioner. It outlines how the trust is to operate, and sets out the obligations imposed on the trustee and the relationship between the trustee, the beneficiaries and the Trust property. The trustee is legally responsible for the operations of the Trust and has an obligation to hold property or assets for the benefit of the beneficiaries. A Trust structure is suitable when more than one family is involved in running the business however, it can be expensive to maintain due to the complexities involved in regards to the strict adherence to the provisions in the Trust Deed. The various tax implications involved in determining the net income of the trust, and the flexibility in the distributions to the beneficiaries, and the various other reporting requirements with the Australian Taxation Office will also add to the compliance costs. The tax liability will depend on the type of Trust and the Trust Deed as to whether the net income of the Trust is to be distributed to the beneficiaries (often individuals) who will be taxed at their marginal tax rates, or retained in the trust in which case the trustee will be taxed on the accumulated income, but at the highest marginal tax rate. Access to the 50% CGT Discount and the CGT Small Business Concessions may be available depending on circumstances, with the net taxable capital gains to be paid by the beneficiary receiving the distribution from the Trust. A Trust can cease its business operations by having it vested and making a final distribution of the assets. The CGT implications arising from this however, will be payable by the beneficiaries who receive the assets of the Trust.


Summary


The various Business Structures discussed range from the very cheap and simple, to the very expensive and complex, and although some detail has been provided, there are various other issues and tax implications that may need to be considered depending on your individual circumstances. Changing your Business Structure is possible further down the track, but it may end up costing you more. So now that you have a starting point from which to work from let us at LBH help fill in the gaps so that you can get it right from the start.


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