There are many reasons why you might want to change your business structure. This can include the company’s financial performance, a change in the business’ ownership, management or growth. However, before you change your business structure from a company to a sole trader or partnership, you should carefully consider the benefits and detriments of that change. This article explores five points you should consider before changing your business structure from being a company to a sole trader or a partnership.
1. Liability
One of the most attractive features of a company structure is that a company is considered a separate legal entity. This means it can:
- enter into contracts;
- engage in business transactions; and
- take on liabilities in its own right.
As a result, people who own a company (the shareholders) and those who run the business (the directors) are protected from being personally liable for the business’ liabilities.
Hence, transitioning from a company to a partnership or a sole trader can expose you to the liabilities of your business. Nevertheless, a sole trader or a partnership structure does not provide you with the same protection because the law considers neither as a separate legal entity.
| Sole trader | From a legal perspective, the individual running the business and the business itself are considered the same. This means that the individual is personally liable for the business’ liabilities, including debts. |
| Partnership | Like a sole trader, partners are personally liable for the partnership’s liabilities. Additionally, depending on the type of partnership, each partner is generally responsible for the other partners’ actions if they act on behalf of the partnership. For instance, if your partner incurs a debt or acts negligently in their capacity as a partner, you are also liable to repay that debt or remedy that negligence. |
2. Protecting Personal Assets
Any business is prone to debt or legal challenges. Hence, your assets as a business owner could be susceptible to claims. Therefore, it is important to consider how a business structure can protect your personal assets.
Transitioning from a company to a sole trader or a partnership can expose your personal assets to creditors. The personal assets of a sole trader or partner are up for grabs by creditors to whom the business owes liabilities like a debt. On the other hand, a company structure can shield creditors from accessing personal assets due to its separate legal status.
Continue reading this article below the form3. Tax Implications
Transitioning from a company to a sole trader or a partnership may increase or decrease your tax payable, depending on your circumstances. The Australian Tax Office (ATO) generally taxes companies at a flat rate of 30% of profits, and there is no tax-free threshold. Nevertheless, sole traders and partnerships are taxed differently.
| Sole trader | For a sole trading business, the ATO taxes the business’ profits at the income tax rate of the individual running that business. This means, depending on how successful your business’ is, you can be taxed as much as 45 cents on every dollar you earn over a threshold or as low as 19 cents on every dollar you earn over a threshold |
| Partnership | Each partner of a partnership is taxed on their share of the partnership’s profits. Then, that amount is taxed at the income tax rate of the partner, similar to a sole trading business. As a partnership is not a separate legal entity, it cannot own assets in its name. Therefore, since the partners own the assets, this comes with its own tax implications. For instance, a partner’s retirement may mean the other partners have to pay capital gains tax. This is because the remaining partner now has a larger share of the partnership assets. |
4. Ability to Grow Your Business
If your business is growing, it is essential to consider changing from a company to a sole trader or a partnership. A company structure is generally better suited to help a business grow. One reason is companies have options to raise capital through issuing shares or other securities. This is not available to the different structures. Hence, partnerships and sole traders generally have to obtain debts from lenders to gain capital.
5. Changing the Business Structure
Irrespective of which business structure you are changing into, it is essential to be aware of and consider the general steps involved in changing from one business structure to another.
If you are changing from a company to a sole trader or partnership, you cannot use the same Australian Business Number (ABN) as your company. Instead, you must cancel your existing ABN and wind up your company (known as voluntary deregistration). You must then apply for a new ABN which you will use to run your sole trader or partnership business.
If you structure your new business as a partnership, the partners should enter into a partnership agreement. A partnership agreement will dictate how the partnership will run. It should also include details like:
- what happens when a partner retires;
- how new partners are appointed; and
- how disputes will be resolved.
You must also review all existing contracts that bind the company. This is because you must ascertain whether you can assign those contracts to the new sole trader or partnership, which typically requires the consent of all contracting parties. You may need to enter into new contracts with third parties if you cannot assign existing contracts to your new business structure.
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Key Takeaways
Sole traders, partnerships and companies each have pros and cons. A transition from one structure to another is a significant event, and you should consider all consequences before deciding to change. For example, when switching from a company to being a sole trader or a partnership, you should consider the impacts this can have on your liability, asset protection, taxes, business growth and the general process involved in the transition. Given the complexities involved, engaging a solicitor to assist and guide you through the process is crucial.
If you need help changing your business structure, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Unlike company structures, the law treats the person running the business and the business itself as one entity. Hence, sole traders are personally liable for the business’s liabilities.
Only companies have options to raise capital through issuing shares or other securities. Hence, partnerships and sole traders generally have to obtain debts from lenders to gain capital.
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