When going into business with someone else, one of your first decisions will be which business structure to choose. Although there are several different options to choose from, two common choices are a partnership or private company structure. Both structures have very different consequences for:

  • how the business will be run;
  • your tax obligations; and
  • your ability to take on additional business partners or sell the business.

This article will go through the key features of partnerships and companies and the advantages and disadvantages of each.

Partnerships

Setup and Costs

A partnership is a group of people carrying on a business together and sharing the business’s income and losses. Partnerships can be very cheap and simple to set up and operate. You do not need a written agreement to form a partnership. A verbal agreement is enough. However, it is recommended that you have a written partnership agreement in place that sets out the roles of the partners and how you will distribute the income and losses.

Management and Control

Generally, all partners can participate in the management of the partnership. This can make decision-making difficult and the business vulnerable to personal differences and disputes. The best way to avoid this is by having clear and distinct decision-making roles set out in a well-drafted partnership agreement.

Liability

Although partnerships may have their own Australian Business Number (ABN) and Tax File Number (TFN), they are not separate legal entities. Partners have unlimited personal legal responsibility for the debts and liabilities of the partnership business, even if they are another partner’s. This is a significant disadvantage, particularly in businesses or industries with a higher level of risk. You could protect personal assets by appointing a company or a trust as a partner in the partnership. However, this also has advantages and disadvantages that you should consider when making a decision.

Tax

Because partnerships are not distinct legal entities, the partnership itself does not pay tax (although it must lodge an annual partnership tax return). Instead, the business income is distributed between the partners. The partners then pay tax on their share of the business income (in addition to any other personal income) at their personal (marginal) tax rates. This is different to companies which are taxed at a lower company tax rate before distributing income to shareholders in the form of dividends. However, unlike companies, partnerships can take advantage of the 50% discount on capital gains tax (CGT) upon the sale or transfer of assets held for a minimum of 12 months. This can depend on the type of partner. For example, if a company is a partner in the partnership, it is not eligible for the 50% CGT discount.

Flexibility

If a partner leaves or a new partner joins the business, normally the partnership is dissolved, and a new one is formed. This can have tax implications. A partnership can only continue as a “reconstituted continuing entity” following a change to its membership if:

  • the partnership agreement allows it; and
  • if there is no break in the continuity of the business.

Furthermore, a partnership cannot have more than 20 partners. This means that partnerships are somewhat inflexible when compared to companies.

Companies

Setup and Costs

A company is a separate legal entity which is made up of shares owned by shareholders and is controlled by directors. Companies have higher setup costs than partnerships, including:

  • a $495 Australian Securities and Investments Commission (ASIC) fee; and
  • potential professional service provider fees (such as a lawyer or accountant) who you may engage to help incorporate your company for you.

There are also ongoing maintenance costs including:

  • an annual $267 ASIC fee; and
  • various accounting and financial reporting obligations. For example, lodging an annual company tax return.

Management and Control

Under a company structure, directors make management decisions, while shareholders have control over the appointment or removal of directors and have a stake in the company’s profits. This distinction between shareholders and directors means it is also possible for people to have an ownership stake in the business without making management decisions. The different opinions between shareholders and directors can also cause internal company disputes. However, decision-making and dispute resolution mechanisms in the company’s constitution or shareholders’ agreement can help mitigate these problems.

Liability

As companies are a separate legal entity, they afford you limited liability. This means that when third parties such as employees or suppliers contract with the business, they are not engaging with you personally. Instead, they are engaging with the company as a separate legal entity. Shareholders and directors are generally not personally legally responsible for the company’s debts or liabilities, except in limited circumstances such as a breach of director’s duties. This is a key advantage over partnerships, in which partners are legally responsible not only for their own conduct and debt in the partnership but those of their partners as well. However, appointing a company or trust as a partner in this situation may help mitigate these issues.

Tax

Under a company structure, the company itself earns and owns the business income as opposed to the individual shareholders. The company tax rate is 27.5% for small companies and 30% for large companies, both of which are lower than most people’s marginal income tax rates. This means that if you plan to reinvest business profits into the business, a private company structure has significant tax benefits when compared to a partnership. If you wish to take company profits as an individual, you must receive these profits as dividends. These dividends will then be taxed at your marginal income tax rate. A key tax disadvantage of companies is that they are not entitled to the 50% CGT discount, unlike partnerships. However, if a partner in a partnership is a company or trust, the partnership will not be eligible for the 50% CGT discount.

Flexibility and Control

Companies consist of shares which new and existing shareholders can trade. A company can also issue new shares in addition to its existing shares or buy back existing shares from shareholders. As a separate legal entity, a company exists independently of its directors and shareholders. This means companies can easily survive the death or departure of such individuals. Furthermore, a private company can have up to 50 shareholders, unlike partnerships which have a limit of 20 partners. This makes a company a more flexible business structure compared to partnerships.

Key Takeaways

There are significant differences between companies and partnerships in terms of their:

  • setup and ongoing costs;
  • tax obligations;
  • management and control;
  • flexibility; and
  • owner’s or partner’s liability.

Ultimately, whether a partnership or company structure is more suitable for your business will depend on your circumstances and the business’s goals. If you have questions about the best business structure for your business, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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