Are you in the right business structure?

Many businesses when starting out get caught up in the day to day tasks involved in starting up, that they skim over the important initial steps such as planning out business structures. It is such an important strategic decision to make sure that you are in the right business structure.

As a business grows quite often it is overlooked to review the business structure that is being used and in some cases this can cost business owners many thousands of dollars over time.  Often business owners will not realise the available options that they have when it comes to business structures, and will opt for the most popular three – Sole Trader, Partnership and Company. In a lot of cases there isn’t a detailed discussion of circumstances with their accountant and this can cost them a lot of money.

In this article we will attempt to discuss the pro’s and con’s of the various types of business structures. Please note this is not considered as accounting advice as every businesses situation is different. This is also a very low level look at the different types of structures. For professional advice we recommend that you contact us to have a discussion about your own circumstances or initiate a discussion with your accountant.

Sole Trader

This is often the way that many businesses will start and is easy to get going. Start an ABN, choose a business name and you are up and running.

Pros

• Easy to get started
• Low start up costs
• Less complicated when it comes to tax time
• No accountability to others
• Losses available to offset against other income and carry forward to future years.

Cons

• Full liability on the owner
• Limited Tax reduction strategies when it comes to tax time
• Owner wears “all the hats” within the business.
• No accountability to others.
• Easily dissolved if business circumstances change or business fails

Note: I’ve added “no accountability to others” as this can be a pro and con, as the flexibility to do what you want is sometimes good, however not being accountable to others can be a negative as it sometimes leads to a lack of motivation within the business.

Partnerships

Many people go into this type of structure with their spouse, however this is sometimes not particularly “above board” as a partnership. The Australian Tax Office (ATO) is cracking down on people that use this structure primarily to reduce tax. If there is child support involved then they may disregard the partnership altogether also. When using this type of structure it is important to note that the partners in the business need to be working significantly in the business, and not simply putting their name to the business for tax purposes.

With this in mind, partnerships are not always the simple two person structure that you might expect. You can have partnerships between different entities such as trusts, companies, individuals and more.

Pros

• Shared responsibility
• Ability to split the tax cost in certain circumstances
• Flexible in that the partnerships can be divided in other ways than just two individuals
• Minimal accounting fees as the  complexity is usually minimal
• Losses available to offset against other income and carry forward to future years.

Cons

• Full liability on the partners
• Sometimes is disregarded by ATO and other government agencies
• Less control than working as a sole trader
• Limited tax reduction strategies
• Requires a partnership tax return to be lodged at the ATO

Companies

This is where many small businesses strive to be, and often when they get to a certain level of income will jump straight into this type of structure without considering the options. This can often cost them a lot of money as the tax on all income is set at a standard rate. The tax free threshold does not apply to a company, and the profits in a business are more difficult to distribute in many cases. Directors of a company can still be sued if found to be in breach of their responsibilities as set out under the corporations act, which in turn nullifies their limited liability in some circumstances.

Pros

• Avoids the higher tax bracket as it has a standard taxation amount per dollar (currently 27.5%)
• Money can be left inside the company as an asset without having to distribute
• Ability to draw a wage from the company
• Limited liability. (Subject to reasonableness, and compliance with ATO and company law rules)
• Shared responsibility within the owners(if there is multiple involved)

Cons

• Lack of distribution options
• Higher set up costs
• Higher ongoing accounting fees
• Sometimes results in higher tax bills due to no tax free threshold being applied
• Often misunderstood
• Higher accounting fees each years as the complexity is higher
• Can have additional tax issues (called Div7a) when the flow of funds in and out of the company is not properly managed
• Fringe Benefits Tax can be expensive relative to assets used personally by employees and owners – particularly motor vehicles
• Capital Gains discount of 50% is not available

Trusts

This is one of the most overlooked types of structures but is often the most effective in reducing tax as the ability to distribute money is much more flexible. Many people will be far better off using a trust than what they will be using a company structure as the flexibility is far higher. At the helm of a trust is a trustee which is in charge of the operation of the trust. The money generated within a trust is distributed to beneficiaries and each beneficiary is taxed based on their individual circumstances.

Pros

• Ability to distribute to people that aren’t involved in the company such as children etc. At different amounts per beneficiary. There is however, a restriction on the amount of distributions available to children of $416 unless there is a carer involved.
• Can hold many businesses within it
• Flexibility – there are many ways which a trust can be structured along with different types of trusts

Cons

• Higher set up costs
• More complex when it comes to accounting which results in higher costs
• Can sometimes come under higher scrutiny from the ATO
• Requires a trust deed outlining how the trust operates

What is right for your circumstances?

We highly recommend getting professional advice when it comes to business structures. Although we have outlined some of the pros and cons above regarding the different business structures, however every person and business has different circumstances. Having an accountant ask the right questions will often help to guide you in the right direction so that you have the most effective tax strategy at every phase that your business may go through. Keep in mind that the structure that you start in when beginning a business will likely not suit the way that you should be structured when the business is highly established.

We would love to hear from you and discuss your circumstances to see what the best way forward is for you and your business. We’ve helped many businesses to benefit from having the correct business structure. Read through the following case studies to see how some of our clients have benefited from our knowledge and guidance.