In Australia, approximately 20,000 new companies are registered each month. There are different types of companies, but the most common company type is a proprietary limited company (a private or Pty Ltd company). The proprietary limited company structure offers: 

  • growth options; 
  • protection from personal liability; and 
  • potential tax benefits. 

However, registering a company does impose serious responsibility on directors. It is important to be aware of your duties as a director. This is because breaching these duties can attract fines or even criminal liability. This article explains the major advantages and disadvantages of running a proprietary limited company.

The Proprietary Limited Company Structure: An Overview

A company is its own legal entity. It can enter into contracts and sue other entities. Other entities can also sue it. A proprietary limited company is a private (not public) company that does not sell its shares to the general public and can have a maximum of 50 shareholders.

There is a limit to shareholders’ legal responsibility for company debts. This is the amount that shareholders have not paid for their shares (limited liability). This is usually zero, as most shareholders pay for their shares fully when they acquire them.

For example, if the company issues a shareholder with $100 worth of shares but they only paid $50, the company could demand the extra $50 from the shareholder to pay company debts. 

Shareholders own the company by owning shares in the company, and the company management consists of:

  • one or more directors; and 
  • the company secretary (optional). 

Advantages of Operating as a Company

Limited Liability

As a company is its own legal entity, it is liable for its own debts. This means that any claims successfully made against the company can only be paid for using the company’s cash reserves and assets. The claim cannot come after the shareholders’ or directors’ personal assets. This is unlike being a sole trader, where your personal assets may be called on to satisfy any claims or debts. However, if a company director breaches their duties or provides a personal guarantee to a contract, their personal assets may be exposed.

While a single company structure protects the personal assets of its shareholders, a large claim may cripple the business if it calls on the business’ assets to pay the debt. You could consider setting up a dual company structure if: 

  • there is a risk that customers or contractors will sue your business; or 
  • you have very valuable intellectual property that you need to protect.

A dual company structure will help protect your business assets from claims made against the company. 

Attracting Investors, Customers and Suppliers

If a business has growth plans that require third-party investment, investors are often only interested in investing in company structures. A company is an attractive investment structure because it gives investors: 

  • security through limited liability; 
  • flexibility to sell their shares or purchase more; and 
  • transparency as company information must be kept up to date on the public ASIC register.

A registered company implies that the business operates on a larger and more serious scale, assisting business owners at the negotiation table. Customers also feel more confident when dealing with companiesIt can even help some businesses win contracts. 

Tax Efficiency

Individuals, including sole traders, are taxed at the standard marginal rates, depending on the level of income, with the highest rate at 45% (as of July 2019). In contrast, a company’s tax rate is a flat 27.5% (or 30% for large companies), regardless of its profits. This can make a significant difference to the viability of a business. 

Further benefits are that companies: 

  • can offset tax losses from one business against profits made by another; and
  • may be able to carry tax losses forward into future more profitable years.

Avoiding Conflict

Registering a company can help avoid conflict between the business owners. The number of shares a shareholder owns determines their percentage ownership of the company.

The essential document governing shareholder relationships is the shareholders agreement. This is typically created when registering the company. This document provides significant protection against company disputes, particularly when one shareholder departs the company. It regulates the rights and responsibilities of shareholders and important business activities such as how shares will be issued, dividends paid and conflicts resolved. 

Succession

As a company is its own legal entity, it will exist indefinitely until it is wound up. If a shareholder or director dies, they can be replaced as needed, and the business can continue trading. 

Difficulty can arise if a shareholder dies and there is no shareholders agreement. In this case, the shares are given to the nominated next of kin in accordance with the shareholder’s will. This might mean that in a 50/50 partnership, the remaining business partner must suddenly own the business with their former partner’s relative, who may have no business experience. To avoid this difficult situation, the shareholders agreement may stipulate that if a shareholder dies or leaves the company, their shares must be sold back to the company. 

Disadvantages of operating as a Company

Directors Duties

Before registering a company, it is essential that prospective directors fully understand their responsibilities. If a director breaches their duties, they may have to pay certain company debts personally or they may be prohibited from managing another company. A director who breaches their duties may need to pay a fine or find themselves criminally liable and face jail time. 

The key directors’ duties are to: 

  • prevent the company from trading while insolvent;
  • ensure the company complies with all legal obligations (see below);
  • act in good faith in the best interests of the company and avoid conflicts with personal interests;
  • be careful and diligent when running the company; and 
  • report on the company’s affairs to the liquidator and give them all relevant books and records if the company in the event of a wind-up.

Directors are unlikely to run into any issues if they take an active role in the business, understand their legal obligations and prioritise legal compliance. If directors are uncertain about their obligations in a situation, it is important to seek legal advice sooner rather than later. 

Complying with Obligations

Directors are responsible for ensuring the company complies with all obligations set out in corporations law. 

 Some of the most important responsibilities are:

  • maintaining up-to-date financial records;
  • ensuring good governance (e.g. ensuring proper decision making);
  • notifying ASIC of certain company changes; and
  • paying ASIC’s fees.

Tax 

Companies must lodge an annual company tax return. Unlike tax for an individual or sole trader, there is no initial tax-free threshold for companies. Companies are taxed at the 27.5% tax rate from the first dollar earned. However, if the company distributes profits to shareholders as dividends, these profits will be taxed at each shareholder’s tax rates (less any franking credits). Companies are also not eligible for the 50% capital gains tax discount (which individuals and sole traders receive).

Notably, unlike the sole trader and partnership structures, if a company makes a loss, this loss is trapped within the company and cannot be used to offset other personal income. 

If a company’s income is mostly derived from one person’s efforts, skill or expertise, the company’s income may be treated as individual income for tax purposes. 

Expenses

Registering a company costs $495 in government fees, plus professional service fees if you are hiring a lawyer or accountant to set it up. An annual ASIC reporting fee of $267 applies, as well as ongoing accounting costs to maintain a proper set of company accounts.

Key Takeaways

A company structure provides the advantages of limited liability, growth potential, and certain tax efficiencies. However, setting up and operating a company is more expensive, can have certain tax disadvantages, and it highly regulated. If you have questions about or require advice on setting up a company, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page. 

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.
Anna Leacock

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