Once you have decided to establish a business, there are a multitude of complex questions to be addressed such as business name, location, registrations and insurance. But one of the most important decisions to make is about business structures. Which business structure are you going to operate your business under? The problem is none are perfect and what works in one situation may not necessarily be appropriate in another. Business structures affect taxation, asset protection and when you sell your business, capital gains tax. Adding to the problem, moving from one structure to another is not necessarily easy either.

In Australia the basic options and a short list of their pros and cons for your business structures are:

Sole trader

You are the sole owner of the business and can trade under your own name or a registered business name. You need to get an ABN. Profit is treated as your income in your taxation return and is taxed at individual rates.

Pros

• Easy and low cost set up
• Lower compliance and legal requirements
• You are not an employee and therefore there is no compulsory superannuation, payroll tax or workers compensation

Cons

• The owner has unlimited personal liability (no asset protection)
• Unable to split income with family members
• More difficult to raise finance

 Partnership

The business is owned by two or more partners and usually a partnership agreement outlines details such as drawings, profit share, salaries, termination of partners, admitting new partners and how disputes are to be resolved. Partners do not have to have equal percentages of the partnership although this is more usually the case. Each partner pays tax on their share of the profit in their individual taxation returns.

Pros

• Easy to set up but legal agreements add to the cost
• Can carry on business under a registered business name
• Subject to certain conditions a partner’s share of tax losses may be offset against other personal income
• Broader management and skills base

Cons

• The partners are personally liable for the debts incurred by the other partners
• May be difficult to transfer a partner’s ownership to someone outside the partnership
• Personal disagreements amongst partners may cause business problems

 Company

A company is a separate legal entity from its shareholders and directors. Directors are appointed to run the company and shareholders (the investors) own the company. A company will require its own tax file number and will need to lodge its own income tax return.  All assets and liabilities are the company’s and do not belong to the directors or shareholders.

Pros

• Ownership can be easily transferred
• Limited liability for shareholders
• The company tax rate is a set rate
• The company can raise finance in its own name
• Can carry forward losses to offset against future profits

Cons

• Directors may be asked to provide personal guarantees
• Companies are highly regulated
• Profits are paid to shareholders by dividends which are taxable in their personal returns
• If directors do not meet their legal obligations they may be personally liable for the company’s debts

 Trust

A trust is a relationship where a trustee carries on business for the benefit of the beneficiaries. The trustee can be an individual or a company. A trust is not a separate legal entity and may be a family trust, or discretionary trust, where the trustee decides how profit will be distributed amongst the beneficiaries or a fixed trust where the benefits are in predetermined proportions.

Pros

• Can provide asset protection and limit liability especially if a corporate trustee
• Flexibility of asset and income distribution
• Beneficiaries of a trust are generally not liable for the trust debts

Cons

• Can be relatively expensive to establish and administer
• Can only distribute losses, not profits
• Lodges its own income taxation return but beneficiaries pay tax on income they receive from a trust at their own marginal rates

There are also other possible structures such as a partnership of discretionary trusts, a limited partnership, co-operatives, joint ventures and so on. It is very important to get advice on your business structure before you begin trading. Don’t take shortcuts at this stage of your business where mistakes can cause long term problems. At Riverwood Group we have the expertise to advise you on the best structure for now and the future.