From an income tax point of view there is nothing stopping business owners operating a business through one structure, such as a sole trader, then changing to another structure that more meets their needs. The ATO cannot challenge this change in business structure as long as the prime reason for changing was not to obtain a tax benefit. The following is a summary of the benefits and disadvantages of the different business structures. Before deciding on what structure is best for you get advice from an accounting firm that specialises in strategic business advice, like TaxBiz Australia.
Operating as a sole trader is the most common structure used when starting a business. If the non-commercial business loss tests are passed a sole trader can reduce the tax payable on their other income if losses are made. This income tax advantage becomes a disadvantage when the business starts to makes that can result in tax being paid at the higher marginal tax rates. The personal assets of the owner are at risk in the event of the business failing or being sued.
Partnerships are one of the simplest and most common forms of tax structure used. Partnerships do not pay tax as profits are distributed to the partners and tax is paid at their applicable tax rate. Where non-related parties go into partnership it is vital that an agreement is prepared. Under partnership law each partner is jointly and severally liable for the debts of the partnership. The personal assets of the owners are at risk if the business fails or is sued.
Unit trusts are like companies; instead of shares units are issued. Unlike companies that pay tax the profit is distributed to the unit holders who pay the tax. The cost of setting up a unit trust will depend on who draws up the trust deed is and whether a company acts as trustee. The biggest disadvantage of using a unit trust is that the owners don’t benefit from the small business 50% active asset exemption. The personal assets of the owners can be protected when a company acts as trustee.
Discretionary family trusts are more complicated and costly than operating as a sole trader or partnership but they are the most flexible and tax effective. Profits can be distributed to family members so that the marginal tax rate paid can be decreased. As the individual beneficiaries pay tax on income distributed to them, all of the small business CGT concessions are available to them if the relevant tests are passed. The cost of setting up a trust depends on who the trustee is. Where protection of a business owner’s assets is important a trust should have a company act as trustee. Companies
Companies at best delay paying tax, and at worst can mean more capital gains tax is paid. A major area that companies have an advantage over other business structures is when unrelated parties want to own a business together. The personal assets of the owners are protected if the company fails due to unprofitable trading or because of a legal claim. If shareholders are also directors their personal assets can be at risk if they have given personal guarantees, PAYG withholding tax and compulsory employee super contributions has not been paid, or it can be proven that debts were incurred by the company and directors knew the company could not repay the debt. The company tax rate of 30% does have a benefit for business owners wanting to invest after tax profits back into a business. When owners want to take profits out of the company it must be done as wages, dividends, or as loans. Tax will then be paid at their marginal tax rate. The greatest disadvantage of operating through a company is the tax benefit of the general 50% CGT discount and the 50% small business active asset are lost. Starting a business?? To get the best advise on the best legal structure to us, contact us at TaxBiz Australia.