Advantages and Disadvantages of Operating as a Sole Trader

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Table of Contents

• What is a Sole Trader Business Structure?
• How Can I Set Up a Business as a Sole Trader?
• Tax Considerations For Sole Traders
• What Are the Advantages of Operating as a Sole Trader?
• What Are the Disadvantages of Operating as a Sole Trader?
• Alternative Business Structures To Sole Traders
• Key Takeaways
• Frequently Asked Questions

Once you have decided to start your own business, one of the first factors to consider is how you will structure your business. A sole trader business structure is simple to set up, making it the most common structure for new businesses. However, when making a decision, you need to consider whether this structure is appropriate for your current situation and whether it can support your long-term business goals. This article sets out the main advantages and disadvantages of operating as a sole trader and the alternative business structures you may want to choose.

What is a Sole Trader Business Structure?

A sole trader is a business that an individual runs. If you set up as a sole trader, the law considers you and your business to be the same rather than separate entities. This means that you will:

• own and control the business; and 
• receive all the income and profits from the business. 

However, this also means that you are solely responsible for all the business’s debts and are personally liable for income tax from the money your business earns.

Key features of operating your business as a sole trader include:

• being your own boss and self-employed;
• having unlimited liability, making you personally responsible for all business debts;
• trading alone and not using a company structure;
• typically managing the business, giving you full control over assets, plans, and decisions;
• using your personal Tax File Number (TFN) to file income tax returns; and
• while a separate business bank account is not required, it is recommended for operational efficiency.

How Can I Set Up a Business as a Sole Trader?

Setting up your business as a sole trader is relatively straightforward. To register as a sole trader, you should follow the following steps:

1. register an Australian Business Number (‘ABN’) and use your individual tax file number (‘TFN’) to trade;
2. register a business name; and 
3. register for goods and services tax (‘GST’) if you expect your income to be more than $75,000 annually.

You will only need to register a business name if you choose to operate your business publicly under a different name (rather than using your personal name). You should register a business name with the Australian Securities and Investments Commission (‘ASIC’). Furthermore, if you want the exclusive right to use that business name because it is crucial to your brand, you should register the name as a trade mark with IP Australia.

Once you have completed these steps, you will need to consider:

• having insurance options in place;
• having a well-drafted contract with customers and contractors;
• how you will pay your employees; and 
• any superannuation requirement.

Tax Considerations For Sole Traders

You should be aware of the tax consequences of setting up as a sole trader. Notably, the law will treat your business’ profits as personal income. As a result, you must report the business income you earn (after expenses) and pay income tax using your personal TFN. 

Other tax considerations include that you:

• pay income tax at the same marginal rates as any other individual; and
• are entitled to the tax-free threshold if you are an Australian resident.

Additionally, you are responsible for your superannuation arrangements. You may be able to claim a deduction for personal superannuation contributions, and you must make superannuation contributions for eligible workers you employ.

It’s important to note that as a sole trader, you may be eligible for certain tax deductions related to your business activities. These can include home office costs, vehicle expenses, and equipment purchases. Keeping accurate records of all business-related expenses is crucial, as it can significantly reduce your taxable income. Additionally, sole traders can benefit from the instant asset write-off scheme, which allows for immediate deductions on eligible asset purchases up to a certain threshold.

What Are the Advantages of Operating as a Sole Trader?

Setting up as a sole trader is very common for people starting a small business. This is because it is by far the cheapest and simplest business structure to establish. 

The advantages of operating as a sole trader are that:

• you have complete ownership, control and management of the business, meaning you have the freedom to run the business as you wish without the interference of other business partners;
• there are no specific regulations that apply to sole traders, meaning your reporting requirements are minimal;
• you keep any profits of the business after tax plus any money you have gained after tax if you sell the business;
• tax losses may be offset against any other income you earn (subject only to certain non-commercial loss rules); and
• as an individual, you are eligible for the 50% capital gains tax discount on the money you have gained from the sale of a capital asset (such as the goodwill component of a business sale) that you have held for at least 12 months.

What Are the Disadvantages of Operating as a Sole Trader?

Operating as a sole trader can be very appealing to those starting. However, it is essential to bear in mind the disadvantages of operating as a sole trader.

Most notably, you are legally and financially responsible for all aspects of the business. Consequently, your personal assets are at risk if there is debt or liability, and you do not have the option to share debts and losses with other business partners. 

Also, it is crucial to understand that there is limited capacity for growth. A key reason is that you cannot take on other business partners or co-founders using this structure. Consequently, you may miss the ability to share ideas and concerns that you usually can do when running a business with others. Likewise, when attempting to grow and raise capital for your business, you are not able to offer a share of your business to investors. This means that you will need to seek financing from lenders such as banks. 

Another important consideration is that there is no flexibility when planning your tax. This is because all business income is treated the same as your personal income. Accordingly, the more income your business makes, the more your tax liability increases. Unfortunately, you cannot access flat tax rates such as those enjoyed by companies.

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Alternative Business Structures To Sole Traders

Other business structures can be considered before setting up your business. We discuss these options below.

1. Partnership

In a partnership structure, all partners jointly own the business and its assets. Likewise, partners are equally responsible for the business’ debts. Therefore, there is scope to share profits and losses with others involved in the running of the business.

Similarly to a sole trader entity, each partner carries unlimited liability. So, where the partnership business incurs a debt, each partner has unlimited liability in relation to that debt, and their personal assets may be used to satisfy the debt. 

2. Company

A company is a separate legal entity from you and is regulated by ASIC. Operating through a company provides benefits such as:

• distributing profits;
• receiving investment;
• utilising the company tax rate; and
• protecting your personal assets, amongst others.

A company is a separate legal entity separate from its directors and shareholders. A company has the same legal rights as a person. This means the company can purchase assets and enter contracts in its own name. Generally, when the company incurs a debt, the debt is the company’s to pay as opposed to its directors or shareholders. 

As a director, one of your most essential directors’ duties is to prevent insolvent trading. If you allow the company to trade while insolvent, you will be in breach of your directors’ duties. If you breach your directors’ duty to prevent insolvent trading, you may be legally responsible for the company’s debts during this period of insolvent trading.

Shareholders are generally not liable (or legally responsible) for company debts. As a shareholder, you are only legally responsible for any amount unpaid on your shares.

3. Trust

A trading trust involves a trustee who owns the business assets and enters into contracts on behalf of the trust. The trustee is an entity that can either be an individual or a company. 

It is important to note that the trustee is legally responsible for the operation of the trust and legally liable for the debts of the trust. Commonly, however, the trustee is a company, which can reduce the liability of the owners of the business.

Key Takeaways

When deciding on a business structure, it’s crucial to consider your long-term goals and the potential for your business to evolve. While operating as a sole trader might suit your current situation, it’s important to regularly review your business structure as it grows and changes. Many successful businesses start as sole traders and later transition to more complex structures like companies or trusts to accommodate growth, attract investment, or better manage tax obligations. Consulting with a legal professional or business advisor can help you make informed decisions about the most appropriate structure for your business at different stages of its development.

• trying to grow and expand the business;
• raising finance; and
• the risk of unlimited personal liability for business debts.

If you need help determining whether setting up a sole trader structure is right for your business, our experienced business structuring lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

How do I set up a sole trader business in Australia?

To set up as a sole trader, you need to:

• register for an Australian Business Number (ABN);
• register a business name (if you’re not using your personal name); and
• register for GST if you expect your annual income to exceed $75,000.