Understanding the 4 types of business structures

A business structure refers to the legal structure of a business. When you are starting a business in Australia there are 4 main types of  business structure including:

• Sole Trader
• Partnership
• Company
• Trust

These are the most common small business structures, each with different obligations that will affect the tax you are required to pay, business set-up costs and ongoing reporting requirements

Choosing the right business structure for your small business is one of most important decisions to make as a new business owner, so we’ve created an outline of advantages and disadvantages of each type to help you decide which one is right for your business:

1. Sole trader business structure

A sole trader is the simplest form of business structure, formed when one individual owns the business and they are legally responsible for the business. A sole trader will usually make all the decisions about running the business and are able to employ people to help run their business.

Tax liability: You pay tax as an individual on any income you earn from the business. You are also required to pay GST and submit a Business Activity Statement if you turnover more than $75,000 a year.

Advantages:

• Easy to set-up and maintain
• You have complete control over the business
• You retain all the profit
• You can change business structure easily

Disadvantages:

• You are personally liable for any debt the business incurs which means your personal assets (car/house etc) are also at risk
• If your business makes decent money you will start to pay tax at the highest marginal individual income bracket quite quickly
• Can be hard to take time off
• Can be harder to obtain finance
• You are responsible for paying yourself superannuation, workers compensation and other employee entitlements.

2. Partnership business structure

These are formed when two or more individuals are co-owners of a business. This structure allows individuals to pool their assets and skills to increase their chances of success. A partnership is also able to hire employees to help them run the business.

Tax liability: Partners pay tax as an individual with income from the business divided between partners. You are also required to pay GST and submit a Business Activity Statement if you turnover more than $75,000 a year.

Advantages:

• Easy to set-up and maintain, with the addition of a partnership agreement
• Additional owners bring new capital investment and skills to the business
• Can change business structure easily

Disadvantages:

• Partnership agreement required to set out the rights and obligations of each of the partners which can be expensive.
• You must share control of the business
• You and your partners are personally liable for any debts the partnership incurs which means your personal assets (car/house etc) are also at risk
• If your business makes decent money each partner will start to pay tax at the highest marginal individual income bracket quite quickly
• There can be disagreements among partners which can cause disruption to the business

3. Company business structure

These are formed when an owner registers their business with the Australian Securities and Investments Commission (ASIC). The business then becomes a separate legal entity from the original business owner. This means the company itself can own assets and enter into contracts directly with third parties.

Tax liability: Companies are subject to company tax rates which are different than an individual tax rates. The current company tax rate is either 27.5% or 30% depending on the criteria you meet. You are also required to pay GST if you turnover more than $75,000 a year.

Advantages:

• Reduced personal responsibility for any business debts and liabilities and the company is a separate legal entity
• Company tax rates are much lower than the higher marginal tax rates and is therefore far more tax effective once your business earns over a certain amount.
• Easier to raise finance

Disadvantages:

• Business operations are controlled by directors and owned by shareholders
• Higher set up costs associated with incorporating the new company
• More paperwork, reporting and ongoing compliance requirements and costs.
• You must understand and comply with all obligations under the Corporations Act 2001.
• An annual company tax return to be lodged with the ATO.

4. Trust business structure

In its basic form a trust is a legal structure that holds property or income for the benefit of others. The trustee can be either an individual or a company and is responsible for any debts and liabilities. Trusts are commonly used to to manage, protect, and pass on family assets including shares, personal property, and the family’s business from one generation to another. Running your business through a trust involves a trustee owning and operating the business’ assets and distributing the business’ income to the beneficiaries included in the trust deed.

Tax liability: The trustee distributes the business profits to the beneficiaries who pay then pay tax on the income received under their marginal individual tax rates.

Advantages:

• Reduced personal responsibility for any business debts and liabilities if the trustee is a company
• Trusts typically do not pay tax, provided they distribute all the profits. This is because profits are distributed annually to beneficiaries who pay tax individually
• Flexibility in distributing profits to beneficiaries. This allows Income to be distributed at the trustee’s discretion to beneficiaries with the lowest marginal tax rates to minimise the total tax beneficiaries pay.

Disadvantages:

• Typically, a trust structure is more expensive and complex to establish and maintain than a company structure.
• Limited lifespan (usually 80 years)
• Difficult to dissolve or alter when established

How to choose a business structure?

Which business structure is best for your business depends on the nature of your business. Some options have benefits on paper, but they may not be the right choice for your business. Understanding the differences between each structure can help you make the right decision.

Consider the following table when deciding when structure is right for you.

Still unsure? This Government tool can help you work out the small business structure that will best suit your needs.