As a self-employed business owner, one of your first decisions is to choose your business structure. Most people choose to become a sole trader or start a company. The business structure you choose will determine the amount of tax you have to pay for your business. This article explains your tax obligations as a self-employed business owner, based on your choice of sole trader or a company structure.
Taxation as a Sole Trader
As a sole trader, you are taxed at individual income tax rates. You report your business income in your individual tax return. The amount of tax you pay will depend on:
- the revenue from your business;
- additional income sources; and
- any deductions you can claim.
If you run a thriving business as a sole trader, you could pay up to 45% in tax (excluding levies). However, you will be able to take advantage of the tax-free threshold of $18,200, that apply to both sole traders and individuals.
The individual rates can change from year to year, but below you can find the current Australian Resident tax rates for the year of 2018/19:
|Taxable income||Tax on this income|
|0 – $18,200||Nil|
|$18,201 – $37,000||19c for each $1 over $18,200|
|$37,001 – $90,000||$3,572 plus 32.5c for each $1 over $37,000|
|$90,001 – $180,000||$20,797 plus 37c for each $1 over $90,000|
|$180,001 and over||$54,097 plus 45c for each $1 over $180,000|
Taxation as a Company
A company is a separate legal entity. You must report any company income in a company tax return, not your individual tax return.
There is no tax-free threshold for companies and the tax is not calculated on a progressive scale. Instead, a flat company tax rate applies to all income generated by the company.
There are two different company income tax rates:
- the “base rate” of 27.5% that applies to companies that have an aggregated turnover of less than $50 million; and
- 30% that applies to companies that have an aggregated turnover of more than $50 million.
Unlike a sole trader, you cannot offset any tax losses against your individual income. The company’s tax losses are contained within the company. However, a a flat tax rate is appealing to fast-growing businesses as the tax rate remains steady despite revenue growth.
Tax Liability as a Shareholder
If your business is a company, you can distribute company profits to yourself as a shareholder by issuing dividends. These dividends will affect your yearly tax liability as they will be part of your personal income. Australia uses an imputation system to determine tax liability so that you avoid being taxed twice at the company and shareholder level.
First, your company distribute profits on which income tax has already been paid, such as when your company pays a dividend to you. Then the company has the option of passing on (‘imputing’) credits for the tax. That process is called ‘franking’ the distribution.
If your company pays fully franked dividends to you as a shareholder, you will receive franking credits for the tax already paid by the company. Therefore, you do not have to pay tax on the whole dividend. You will only pay tax if your personal tax rate is higher than the company’s tax rate. Otherwise, you will receive a tax refund if your personal tax rate is below the company’s tax rate.
Goods and Services Tax (GST)
Registering for Goods and Services Tax (GST) is mandatory for both a company and a sole trader if your business:
- has a turnover of $75,000 or more;
- provide rideshare services for money, such as driving for Uber; or
- want to claim fuel tax credits for your business.
If none of the above applies to your business, it is optional for you to register for GST.
If you do not register for GST, you should remember to keep a close eye on your turnover. Otherwise, the ATO may fine you with penalties if your revenue surpasses $75,000 and you fail to register.
‘Small Business’ Tax Concessions
If you have started out as a self-employed business owner, you can take advantage of small business tax concessions.
The small business tax concessions apply if you operate a business for all or part of the income year and have less than:
- $10 million in aggregated turnover (for all concessions except for capital gains tax concession); or
- $2 million in aggregated turnover (for capital gains tax concessions only).
The main difference between operating as a sole trader or a company for small business tax concessions is the use of capital gains tax (CGT).
Capital Gains Tax Discount for Sole Traders
As a sole trader, you can receive a 50% CGT discount on your capital gain before including it in your income in certain situations. You must have owned the asset for 12 months or more. You can reduce the capital gain after applying all the capital losses for the income year, as well as other non-applied net capital losses from earlier years.
Capital Gains Tax Discount for Companies
Unlike sole traders, companies do not have the 50% CGT discount. However, if your company is a small business entity, you could access small business CGT concessions.
Your company may be eligible for the small business CGT concessions if:
- the business has an aggregated turnover of less than $2 million; or
- the company has a total net value of assets (including any affiliated entities like subsidiary companies) that does not exceed $6 million.
The small business CGT concessions allow you to disregard some or all of the capital gains made from an active asset.
An active asset is an asset used in the course of carrying on a business, or an asset inherently connected with the business. For example, the corner store you bought to sell your candy merchandise could be an ‘active asset’.
If you sell an active asset that has been continuously owned for 15 years, and you are aged 55 or over and retiring, you can disregard the entire capital gain.
If this 15-year exemption is not available, you can:
- reduce the capital gain by 50%;
- use the small business retirement exemption to reduce capital gain for amounts up to $500,000; or
- defer all or part of the capital gain for two years or longer if you acquire a replacement active asset or spent money on making capital improvements on that active asset.
The purpose of these concessions is to boost your cashflow and potentially eliminate tax payable on a business exit.
Personal Services Income
If you run your business by yourself, you should be aware of the rules concerning Personal Services Income (PSI). This is income produced mainly from your personal skills or efforts as an individual.
Your income can fall under PSI in almost any industry or profession. Examples include professionals in the financial industry, information technology consultants, engineers, construction workers and medical practitioners. If the ATO classifies your income as PSI, they will tax all the profits from your business as a wage to you. Therefore, even if you are making the money through a company structure, the net outcome is similar to a sole trader.
However, if you have employees or you are selling goods, the PSI rules are unlikely to apply. You can retain any excess profits in the company to be taxed at the company rate.
As a self-employed business owner, you can take advantage of different tax concessions depending on whether you start out as a sole trader or a company. If you need help on how to choose a business structure or how to navigate your tax considerations, get in touch with LegalVision’s taxation lawyers on 1300 544 755 or fill out the form on this page.
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