While it’s true that many individuals hold aspirations of starting their own business, the reality is that many start-ups in Australia find it difficult to decide on an appropriate business structure. This article will help to shed light on the many differences between the two structures and hopefully provide guidance to the many start-ups who are confused about which structure is the most appropriate for them.
Under the Corporations Act (the Act), the directors of the company make the majority of the decisions and shareholders play a more minor role. These roles are regulated by the company’s constitution or, if it has no constitution, by the replaceable rules in the Act.
Sole traders, on the other hand, make all business-related decisions and do not have any statute that governs their structure.
An important advantage of a company structure is that it benefits from having limited liability.
For shareholders, for example, there is limited liability with respect to any money owed on shares owned. If a shareholder is debt-free with respect to his or her shares, he or she won’t have any liability to creditors looking to recover debts in the event that the company goes into debt.
Like shareholders, directors have protection from creditors if the company goes into debt. Unless, of course, the directors continued operating the business while it was insolvent.
Sole traders, unfortunately, do not enjoy limited liability and generally are required to secure loans with personal assets, such as property.
Company directors secure loans with the company assets, although will sometimes need to give personal guarantees.
Fundraising and Investments
As a company, it is easier to attract investors and raise funds by issuing shares.
Sole traders cannot offer shares, so to raise funds, they needs to seek funding from a financial lender or merge with other sole traders to establish a partnership.
It is quite common for an individual, during the initial stages of a business, to claim certain expenses as deductions against his or her ‘assessable income’. For instance, sole traders can claim the expenditure of setting up the business, whereas shareholders cannot claim their investments in the company.
There are also certain tax-related distinctions between the two structures. Companies pay 30% tax on their income, whereas sole traders pay personal income tax because the income they derive from the business is typically their only source of income. The marginal rate of tax paid by sole traders will depend on the business’ earnings.
In addition, companies need to maintain financial records and keep their books up to date, both to lodge annual tax returns and in keeping with the reporting requirement of the Australia Securities Investment Commission (“ASIC”).
Companies do not have to give their profits to shareholders and may instead utilize them to accelerate business growth. Retained profits – profits used for reinvestment purposed – are taxed at the corporate tax rate of 30%.
For sole traders, all profits are simply taxed at the appropriate marginal rate, which means they cannot retain profits for reinvestment without paying the personal tax rate (maximum of 45%).
If a company owns more than one business, it can offset the losses of one business against the gains (or income) of another.
If a sole trader incurs losses from one source of assessable income, such as a rental property, they may offset this against another, such as the income from the business.
Registration and fees
It’s important to keep in mind the various costs involved in setting up a company, such as the ASIC registration ($497) and the annual renewal ($243).
There are also various fees that apply to businesses needing certain licences, such as a liquor licence, which are typically more expensive for companies than for sole traders. In addition, sole traders pay no registration or ongoing renewal fees.
‘Perpetual succession’ means that even after a company’s directors/founders have passed away, the company will continue to exist and operate. This is partly because a company is considered to be a separate legal entity under the law. This means that the shares of a deceased member of a company can be passed on to another entity under a will.
A business run by a sole trader ceases to operate once the owner passes away. This means that the assets of the owner are disbursed in accordance with the will/estate plan.
There are various considerations when choosing the right business structure. A sole trader structure will be less expensive to set up and maintain than a company, and will allow the owner complete autonomy when making decisions. On the other hand, it will not benefit from the limited liability of a company structure, which protects the personal assets of directors and shareholders in the event of bankruptcy or the need to repay debts.
The important question to ask when choosing a business structure is: Which structure will be most accommodating in the future? If you do not plan on a certain level of growth, a sole trader structure may be much more accommodating because of its simplicity and affordability.
If you plan on global scalability and exponential growth, a company will serve your needs by reducing personal liability and reducing the overall tax on business income.