One of the first of many choices business owners make involves their structure; in Australia, there are four main ones to select from. There's really no right or wrong answer to any one of them. But before arriving at a conclusion, it's important to understand what each of them are, what makes them unique and what your responsibilities are with such a structure set up to the government, your employees and your customers.
Here are a few more details about each, starting with the most basic and straightforward of the bunch:
1. Sole trader
In terms of setup and startup costs, becoming a sole trader is the simplest of the four most common business structures. As its description more or less suggests, when you're a sole trader, you're the one who makes all the decisions and have 100% ownership. At the same time, though, this also means you have all the responsibility and liability when it comes to day-to-day affairs. This means that if you incur debt, you'll have to come up with a strategy to get out of it. This includes surrendering assets to a lender for unpaid balances. If someone is injured on your property, be it a customer or employee, you may be deemed financially responsible for any medical bills.
Other key elements of being a sole trader include:
- Entails less paperwork and reporting requirements to the government.
- Able to use your individual tax file number for tax returns.
- Doesn't require you to arrange a separate bank account for business use.
Traditionally when you think of a partnership, you probably think of two people working together. A partnership in the business sense can be two or more people. It's up to the individuals involved for how to split ownership and liabilities, whether it's 50-50, 70-30 or roughly a third apiece among three parties.
Similar to what it's like for a sole trader, setting up a partnership is relatively simple, but it comes with a few more decisions due to the fact that there are several types of partnerships. The most common of the three is general partnership (GP). In this arrangement, each partner is equally responsible not only for the day-to-day management of the business but also the liability and debt obligations. Limited partnership (LP) refers to liabilities, meaning that whatever stake of ownership a partner has, their liabilities translate to that percentage (e.g. 30% ownership = 30% liability). Yet unlike a general partner, LPs typically work behind the scenes, uninvolved in terms of day-to-day management.
Last but not least is incorporated liability partnership. Here, at least one general partner holds unlimited liability. This means that if there is an incident involving an injury or unpaid debt, the general partner with unlimited liability bears ultimate responsibility. In short, the buck stops with them.
Here are a few additional characteristics of partnerships:
- Unlike a sole trader, partnerships require applying for an Australian business number.
- Taxes are paid on an individualised basis, meaning the share of net income that each partner receives.
- Partnership tax returns must be lodged annually with the Australian Taxation Office.
The term "company" is often used interchangeably with the word "business," but it's actually something very specific. In the legal sense, owning a company means you have the same rights and responsibilities you do as a citizen. However, should you be sued, you're treated as a legal entity, separate and distinct from who you are as an individual.
There are more layers to setting up a company, which by its very nature makes the process more complex than the sole trader or partnership structures. Shareholders run the company, even though they may not be involved in day-to-day decisions. Those fall to directors, who (unlike shareholders) have liabilities to the company if there is reason to believe they're not living up to their legal obligations, per the terms of the business arrangement.
A few additional aspects about companies:
- Setup is more complex.
- Startup costs are more expensive.
- Requires review and compliance with the Corporations Act 2001.
A trust is perhaps the most distinct of the structures because most of the decisions are already made. The trustee is tasked with distributing the available assets to beneficiaries as directed by the owner of the trust. The trustee, which can be an individual or company, is responsible for the ongoing operation of the trust and living up to the obligations in place. These may include allocation of profits, assets or property.
A few additional aspects about trusts:
- Allow for the protection of assets that can eventually benefit others.
- Different types of trusts provide better options and greater flexibility.
- Help prevent legal disputes over the contents of the trust.
At WMC Accounting, we have extensive experience in advising clients on business structures and taxation. If you're having trouble figuring out which is best, we're happy to offer guidance. Please contact us today.