Business Structure Basics
Posted by Tom Nunan, Manager, Carter Connell
Whether your hobby has turned into a profitable side gig, or you are merely considering going out on your own, it is important to think about how you are going to structure your business. When we talk about the “structure” – what we really mean is, who owns the business you operate? We often see clients who have given little thought to this. Failure to get the structure right can result in a surprise tax bill, or inadvertently exposing personal assets to business risk. In this article we provide an overview of the three basic structures available to individually operated SMEs.
1. SOLE PROPRIETOR
This is the default structure if you have not set anything else up. You are the business – that is to say:
a. All your supply or service contracts for your business are entered into in your own name (even though you may be using a trading name).
b. You directly receive all the revenue from the business, which forms part of your income on your personal tax return.
c. If someone wants to start legal proceedings relating to the business, they will be commenced against you and you could be personally liable.
The key advantage of this structure is minimal set-up and ongoing administration costs – no need to prepare a separate tax return for your business or pay for company registration costs. You just register your business name to get an ABN and away you go.
The key disadvantages are greater personal exposure and potentially paying excess tax. If someone goes after your business, they are going after you as an individual so your personal assets could be on the line. In addition, the lack of separation between you and your business limits the options available to manage tax exposure.
Example 1: Sole proprietor
Henry Applebee has started selling homemade sauces (“Applebee Sauces”) at his local market on the weekends. He has not given any thought to the structure of his business. He completes his individual tax return at the end of the year and realises he needs to pay $20,000 in tax relating to Applebee Sauces. This is because the profit from Applebee Sauces is included on top of Henry’s income from his day job and taxed at the applicable marginal rate.
2. COMPANY
A company is a separate legal entity that can enter into contracts and sue and be sued in its own name. A company has at least one director (with decision-making authority and responsibilities) and one shareholder (who owns shares in the company). All companies in Australia must be registered with ASIC and have an ACN. There are yearly ongoing administration fees even if the company is inactive.
Example 2: Company
The next year Henry registers a company, Applebee Sauces Pty Ltd, to own the business. He makes himself the sole director and shareholder of that company. Some practical impacts of this structure are:
Rather than Henry entering into contracts in his own name for the business, he will now be executing contracts and signing off on financials in his capacity as director of the company.
Henry will oversee the lodgement of the company’s tax returns.
Henry will decide on any dividends to be paid to the shareholders.
Henry needs to be careful not to treat the company’s money as his own, as this could create a host of issues for him including landing himself in the same tax situation as Example 1.
3. TRUST
A trust itself is not a separate legal entity – a trust just describes a relationship between a trustee and the trust’s beneficiaries. A trustee:
Can either be an individual or a company (a “corporate trustee”)
Holds the trust assets on behalf of the trust
Enters into transactions on behalf of the trust; and
Has decision-making authority and obligations to the beneficiaries (like a director of a company).
The key advantages are:
Asset protection - the beneficiaries do not own the trust’s assets, so it is much harder for a beneficiary’s creditors to go after those assets
Tax effectiveness – the trustee usually has the discretion to distribute income or capital to any of the beneficiaries, so can distribute in the most tax effective manner
Eligibility for Capital Gains Tax discount - not available to a company
Less ongoing administration than a company – although there’s some initial set-up in having a trust deed drawn up by a lawyer and opening a bank account for the trust, once it has been set up there are no ongoing administration fees like with a company.
Example 3: Trust
Henry decides to set up a trust (The Applebee Trust) for the business. He has a trust deed drawn up by a lawyer, which appoints him as the trustee and the primary beneficiary of the trust. The trust also includes a list of family members and related entities as secondary beneficiaries. Some practical impacts of this are:
Henry will execute contracts in his capacity as trustee of the trust.
Henry will need to ensure tax returns are lodged on behalf of the trust.
Before 30 June each year, Henry, as trustee of The Applebee Trust, will need to decide how to distribute the profit of the trust among the beneficiaries.
Although the trust will achieve some separation for Henry from his business, he will need to be aware of his personal exposure in his capacity as trustee. Bennett & Philp have written an excellent article discussing this issue here – https://www.bennettphilp.com.au/blog/should-the-trustee-of-a-family-trust-be-an-individual-or-a-company
It is important to realise that structuring is not a “set and forget” exercise - the suitability of your structure should be periodically reviewed as your business grows and changes. Whatever structure your circumstances require, the specialists at Carter Connell will provide ongoing support to ensure the best outcome for you and your business.
Contact us today to discuss your structuring needs.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Carter Connell accepts no responsibility for any loss suffered as a result of any party using or relying on this article.