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business setup & tax structures

As a potential business owner you should ask yourself – where will my business be and what will it look like in a few years from now?

Other questions worth consideration are whether you want to stay small and work from home, do you want to grow, employ staff and expand an empire, do you want to take on a business partner and what start-up capital do you need? Decisions like these will affect a business's tax treatment and compliance obligations. That's why it is an excellent idea to have a robust and long term plan right from the get-go.

In business you have four basic structures – sole trader, partnership, trust or company. Deciding on which structure is right for your business will depend on your personal circumstances and plans for the future. We'll go through a brief summary of each structure and how it affects the way your income is taxed, operating costs, asset protection and how your clients deal with you.

Sole traders

As a sole trader you will operate the business on your own, and will control & manage all its aspects and be legally responsible for everything the business does.

For tax purposes, your personal financial affairs and your business's affairs are one and the same – there is no separation. Therefore you will use your personal Tax File Number when lodging a tax return and the business income is treated as your personal income, however you will also be able to claim the expenses associated with running your business.

A sole trader structure is inexpensive to set up. You will also receive the full benefit of any profits, and keep all after-tax gains when you sell-up.

Likewise you will personally bear the full brunt of any operating losses. If your business suffers serious debt personal assets including your house and car are at risk and can be targeted in any debt collection action.

As a sole trader:

  • your business income is taxed at personal income tax rates along with your income from other source depending on your turnover
  • you may have to register for goods and services tax (GST) if your annual turnover is more than $75,000; and/or Pay As You Go Withholding (PAYG) if you employ a staff member
  • you will need to take care of your superannuation but may still be able to claim for personal contributions
  • If you decide to take on an employee, you'll need to pay 9.5% of their ordinary time earnings into their super fund.
Partnerships

Partnerships operate with more than one person, and the income from the business is shared jointly. Partnerships are inexpensive to set up.

The structure is similar to a sole trader however there are more people to share the profits, losses and responsibilities. It is also likely there will be greater financial resources available because more people are invested.

All the partners are responsible for any debts the partnership owes, even if you personally did not directly cause the debt. Each partner's private assets may still be at risk in the event of serious debt. This is known as 'joint and several liability'. Partners are jointly liable for any debt entered into the name of the business. If one partnership defaults on their share then the remaining partners may be severally held liable for the whole debt.

For tax purposes, the business itself does not pay tax however it will still need to lodge an income tax return, showing the income and expenses associated with running the business. The partnership income (after deductions and allowable costs) is distributed between the partners and each partner is responsible for paying tax on their share by lodging a personal tax return. If the business makes a loss then each partner can offset their share of the loss against their other income.

For a partnership:

  • if the business makes a loss for the year, the partners can offset their share of the partnership loss against their other income
  • each partner will need to take care of their own superannuation but may still be able to claim for personal contributions
  • The business may have to register for goods and services tax (GST) if the annual turnover is more than $75,000; and/or Pay As You Go Withholding (PAYG) it employs a staff member
  • If the business decides to take on an employee, it will need to make compulsory superannuation contributions to the employees' choice of super fund
Company

Companies are incorporated entities registered with the Australian Securities and Investments Commission and must comply with legal obligations under the Corporations Act. A company is a separate legal entity and has the same rights as a person which means it can generate income and incur debt. This is a more complex business structure and therefore more expensive to set up and administer.

As a company you will have greater access to capital and shareholders are not liable for the debts of the business beyond the amount of capital they contributed. Shareholder's personal assets have greater protection because creditors can only pursue the company's assets in the event of serious debt recovery action. The company is also be directly responsible for paying its debts and its own tax on profits.

As a shareholder in the company you would be entitled to receive dividends which you would pay tax on.

For tax purpose companies are more complex and require greater detail because of additional reporting responsibilities.

For a company:

  • it will need its own bank account, and its own tax file number
  • The company needs to lodge an annual income tax return, showing the income generated, deductions and any tax it is liable for.
  • If the company makes a profit, it will pay tax on the profits.
  • The company may have to register for goods and services tax (GST) if the annual turnover is more than $75,000.
  • Directors of the company are also employees and if paid a wage or it employs other staff the company must register for Pay As You Go Withholding (PAYG)
  • compulsory superannuation payments have to be made where required by law in respect of the company's employees (including yourself, if you are a director of the company)
  • If you receive wages or director's fees, this needs to be shown on your individual income tax return.
Trusts

A trust is where a person or a company agrees to hold income-earning assets or property for the benefit of others. This person or company legally holds the asset and is referred to as the trustee. Beneficiaries are the people who benefit from the income earned in the trust.

A trust separates legal ownership and control (which the trustee has) from beneficial ownership (which the beneficiaries have). This results in increased asset protection because the beneficiaries' personal finances are not put at risk by the business as the business assets are legally owned by the trustee and not by the beneficiaries.

The most common trust is a discretionary or family trust. Another type of trust is a Unit Trust where the beneficiaries and their interests are identified by the number of units they hold in the trust and therefore receive income according to those holdings. Setting up a trust can be more expensive, and administrative paperwork potentially more complicated.

For a Discretionary/Family Trust:

  • The trustee can use their discretion each year to decide which beneficiaries receive income, and how much – as long as it conforms with the rules contained in the trust deed.
  • the beneficiaries pay tax on their share of the trust's net 'distributed' income in their personal income tax return
  • if all income is distributed, the trust itself would generally not be liable for any tax except in limited circumstances, when the trustee would pay tax on behalf of certain beneficiaries (ie if the beneficiary is under 18 years of age)
  • If all the income is not distributed the trustee will be assessed on that income at the highest individual marginal rate. If the trust carries on a business, all income earned and claims for expense deductions must be shown on a trust tax return, which will also show the amount of income distributed to beneficiaries.
  • a trust will need its own tax file number and bank account
  • The trust may have to register for goods and services tax (GST) if the annual turnover is more than $75,000; and/or Pay As You Go Withholding (PAYG) if it employs a staff member
  • If the trust takes on an employee, it will need to make compulsory superannuation contributions to the employees' choice of super fund.

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