There are numerous types of business structure and it can be difficult to figure out which one to choose when you are starting your business or expanding it. Your choice will depend on the size, type, and needs of your business and how you want to run it.
You must choose carefully because they all differ in key areas such as setting up costs, licenses you require, how much tax you pay, your potential personal liability, and the ongoing costs and amount of paperwork which you will be required to keep and submit to the Australian Tax Office (ATO). The model you choose can also determine how much control you have of the business and whether you are considered an employee or the owner.
Just remember though, if you are starting a business the decision you initially make on your structure is not necessarily the one you will have down the track. As your business grows, it is possible to move from one model to another.
Four of the most common types of business models are Sole Trader, Partnerships, Private Companies (Pty Ltd) and Discretionary trusts.
This is the simplest business structure and it gives you full control. You need to obtain an Australian Business Number (ABN). You may also need to register a business name if the name you are trading under is different to the company’s name.
The advantages of this structure are that it gives you full control of all assets and business decisions. It also allows you to use your own Tax File Number (TFN) to lodge tax returns so you don’t have to lodge two returns. It has fewer reporting requirements and costs are generally low. There is also no requirement to have a separate business bank account, although this is recommended to make it clear what is business and what is personal. NOTE: It does not allow you to split any profits or losses with family members, but you are allowed to employ people if you want.
On the cautionary side, a sole trader is legally responsible for any debts or losses the business may incur. You are also personally liable to pay tax on all income as the ATO treats business income as your personal income, although you are allowed to claim business deductions. You also carry unlimited liability, which means that if anything goes wrong all of your personal assets are at risk.
Partnerships are made up of two or more people who share control and management of the business, income, or losses. Partnerships are relatively easy and inexpensive to set up and have minimal reporting requirements. You must have an ABN which must be used for all business interactions. You can trade under your personal legal name(s), but if you want to trade under an unrelated name, then you must register a business name. If the turnover reaches $75,000 or more, the partnership must register for GST. Partners are generally personally liable for the liabilities that arise in the business.
Unlike sole traders, partnerships require separate TFNs and a partnership tax return must be lodged each year. Partners pay tax at their respective rates. Each partner pays tax on their share of the net partnership income each receives, and each partner is responsible for their own superannuation payments.
In Australia there are 3 main types of partnerships:
General partnership (GP)
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)
Limited partnerships consist 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)
Partners 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.
Before embarking on a partnership, you and your partner(s) should be very clear about your obligations and rights and how you will share the running of the business.
Private Companies (Pty Ltd)
Companies are complex and expensive to set up and run. They are a separate legal entity from the individual, which limits your liability. Generally, shareholders own the company and directors run it. A shareholder is not liable for a company’s debts, but directors may be held personally liable if they are found to be found to be fraudulent, negligent or reckless. A company can sue and be sued in its own right.
A proprietary company is limited to a maximum of 50 non-employee shareholders own the shares in the company. The company cannot offer its shares to the general public.
‘Limited’ in ‘proprietary limited’ means that liability of shareholders is also limited to the number of shares they own, so if a company becomes bankrupt, the shareholders only lose the money they used to purchase their shares. Companies can also be limited by guarantee. In this case, at the time of buying shares a member agrees to guarantee a certain amount of liability to the company.
Company directors must understand and comply with legal obligations under the Corporations Act 2001. Any money the business earns belongs to the company and directors are required to make an annual declaration of solvency.
If your annual turnover is $75,000 or more, you must register for GST. Tax records must be kept for at least five years and financial records for at least seven years. Reporting obligations are numerous and there are strict legal requirements on the keeping of financial records.
Pty Ltd is the most common structure for trading businesses.
Under the trust model, a trustee (or trustees) is legally responsible for business operations. A trustee is a person or company who is ‘trusted’ to hold property or assets for someone else and can control the allocation of income and capital to beneficiaries. A trustee does not own the assets.
Discretionary (family) trusts nominate family members as beneficiaries. Trusts are often used in bankruptcy cases to provide protection of family assets, or in cases of family breakdown. They are also commonly used when there is a challenge to a will, or to ensure the financial protection of orphaned children.
This structure requires a legal deed which outlines exactly how the trust is to be operated, and the trustee is required to undertake annual administrative tasks. Discretionary trusts can be expensive to set up and operate as a lot of legality is involved.
Before deciding a business model, seek advice from an accountant who can explain all the complexities of the various structures and advise you on which model is best for both you and your business.