Before the commencement of any business venture one of the first fundamental questions is what business structure you will operate under. If this is not considered carefully & the correct decision made, this can be costly in the future if you need to restructure your business.

Your choice of structure will depend on the size and type of business and how you want to run it. Each structure may have an impact on key areas such as tax you’re liable to pay, asset protection and costs to set up. There are a number of structures that you can choose from when starting or expanding your business.

The 4 most common types of business structures in Australia are:

  • Sole trader – the simplest structure, gives you full control
  • Company – more complex, limits your liability because it’s a separate legal entity
  • Partnership – made up of 2 or more people who distribute income or losses
  • Trust – where a trustee is responsible for business operations

Sole trader

A sole trader is the simplest form of business structure and is relatively easy and inexpensive to set up.

As a sole trader you are legally responsible for all aspects of your business including any debts and losses and day-to-day business decisions.

If you are looking at starting your business as a sole trader, consider the following key elements. A sole trader business structure:

Pros

  • is simple to set up and operate
  • gives you full control of your assets and business decisions
  • requires fewer reporting requirements and is generally a low-cost structure
  • allows you to use your individual tax file number (TFN) to lodge tax returns
  • doesn’t require a separate business bank account, although this is recommended to make it easier to keep track of your business income and expenses

Cons

  • has unlimited liability and all your personal assets are at risk if things go wrong
  • doesn’t allow you to split business profits or losses made with family members 
  • makes you personally liable to pay tax on all the income derived, at your personal marginal tax rate (top marginal rate is currently 45% for income over $180,000)
  • not suitable for expanding to include new “partners”

Partnership

A partnership is a business structure made up of 2 or more people who distribute income or losses between themselves.

If you’re looking at setting up a partnership structure, consider the following key elements. Partnerships:

Pros

  • are relatively easy and inexpensive to set up
  • have minimal reporting requirements
  • share control and management of the business

Cons

  • don’t pay income tax on the income earned — each partner pays tax on the share of the net partnership income each receives, at the partners marginal tax rate (top marginal rate is currently 45% for income over $180,000)
  • require a partnership tax return to be lodged with the Australian Taxation Office (ATO) each year
  • has unlimited liability and all your personal assets are at risk if things go wrong
  • doesn’t allow you to split business profits or losses made with family members
  • addition or cessation of partners requires the formation of a new partnership

Individual states and territories govern partnership laws.

Company

A company business structure is a separate legal entity, unlike a sole trader or a partnership structure. This means the company has the same rights as a natural person and can incur debt, sue and be sued.

As a member you’re not liable (in your capacity as a member) for the company’s debts. Your only financial obligation is to pay the company any amount unpaid on your shares if you are called on to do so. However, directors of the company may be held personally liable if found to be in breach of their legal obligations.

Companies are expensive and complicated to set up, and generally suit people who expect their business income to be highly variable and want the option to use losses to offset future profits.

Company officers and directors must comply with legal obligations under the Corporations Act 2001.

There are key features you should know if you are looking at starting your business as a company.

A company:

Pros

  • means company members have limited liability
  • for asset protection purposes a company is a separate legal entity
  • requires an annual company tax return to be lodged with the ATO with tax payable capped at the corporate tax rate (either 27.5% or 30%)
  • means wider access to capital
  • easier to introduce new equity partners

Cons

  • is a more complex business structure to start and run
  • involves higher set up and running costs than other structures
  • requires you to understand and comply with all obligations under the Corporations Act 2001 & understand all your obligations as a director
  • means the money the business earns belongs to the company & payout of monies to shareholders may require additional tax being payable by the shareholders at their marginal tax rate

Trust

A trust is an obligation imposed on a person (a trustee) to hold property or assets (such as business assets) for the benefit of others, known as beneficiaries.

If you want to set up a trust, keep in mind that trust structures:

  • can be expensive to set-up and operate
  • require a formal trust deed that outlines how the trust operates
  • require the trustee to undertake formal yearly administrative tasks

If you operate your business as a trust, the trustee is legally responsible for its operations. A trustee of a trust can be a company, providing some asset protection.

Profits from the trust go to beneficiaries.

Key features
If you use a trust for your business structure, the trust:

Pros

  • may be liable to pay tax depending on the wording of its deed and whether any income the trust earns is distributed to its beneficiaries
  • in certain circumstances a trust can offer similar asset protection benefits as a company can
  • flexibility to distribute profits to eligible beneficiaries under the trust deed & the beneficiaries will pay tax at their marginal tax rate

Cons

  • is a more complex business structure to start and run
  • involves higher set up and running costs than other structures
  • where the trust accumulates net trust income (does not distribute it), the trustee is assessed on that accumulated income at the highest individual tax rate
  • due to the nature of a trust there can be additional state and federal taxes to consider