Which Business Structure is Right for Your Business?
When you start a business, you need to make hundreds of decisions; everything from your brand name to your desired business location. One of the most important decisions you'll need to make is determining the business structure you want to adopt, with the two most common types being a sole trader or company. This guide provides insight into the differences between these two business structures and helps you decide on the one that suits your business goals.
Sole Trader or Company: Registration Fees
Starting a business as a sole trader is relatively inexpensive, requiring only registration for an Australian Business Number (ABN), which is free. Registering a business name costs $39 per year or $92 for three years. If you expect to earn over $75,000 per annum, you will also need to register for GST, which is also free.
Setting up a company involves higher upfront costs, ranging from $443 to $538. You may also need to register your business name, and the cost varies. When registering a company, you should also consult a lawyer to prepare your incorporation documents. Legal fees can vary depending on the complexity of the company structure and the lawyer's hourly rate, but you should expect this to cost $2,000 - $5,000 in most cases.
According to the Australian Securities and Investments Commission (ASIC), there are other fees associated with setting up a company, and it is advisable to seek professional guidance when setting up a company to avoid future costs. You can see the list of fees in the below table:
Sole Trader or Company: Liability and Debt
One of the key differences between a sole trader and a company is liability. Sole traders are personally liable for all financial and tax debts incurred by their business, including personal assets like their home and car, which can be used to repay any outstanding debt. Examples of debts that a sole trader may be liable for include:
- Loans: If you take out a loan in your name to finance your business, you are personally responsible for repaying that loan.
- Credit card debts: If you use a personal credit card to make business purchases, you will be liable for any debts incurred.
- Taxes: As a sole trader, you are responsible for paying all of your taxes, including income tax, GST (Goods and Services Tax), and any other relevant taxes.
- Trade debts: If you owe money to suppliers or other businesses, you will be personally liable for those debts.
- Legal judgments: If your business is sued and a judgment is entered against you, you may be personally responsible for paying any damages awarded.
This lack of legal protection for personal assets is often considered the main disadvantage of being a sole trader, which is why some business owners opt to register a company where personal liability is limited.
On the other hand, setting up a company creates a separate legal entity distinct from the business owners or shareholders. As a result, the company's shareholders are not personally liable for the debts and obligations of the company beyond the amount of their investment in the company.
This means that if the company incurs debts or obligations, such as loans or legal claims, the shareholders are not personally responsible for those debts beyond the amount they have invested in the company. The liability of the shareholders is limited to the amount of their share capital in the company.
In other words, the company's assets and liabilities are separate from the personal assets and liabilities of the shareholders, and this separation limits the shareholders' liability. This is why setting up a company can be an excellent way to protect personal assets from business debts and obligations. You can set up a company and still own 100% of the shares in the company. So, to this effect, you can run the business in the same way as you would as a sole trader, but your liability for any losses is reduced.
Sole Trader or Company: Tax Considerations
Sole traders are taxed at the same rate as individuals, and their tax rates depend on their earnings for the year, starting at $18,200. Sole traders enjoy a tax-free threshold on earnings under this amount. On the other hand, companies are taxed at a flat rate of 30% on their taxable income, and the rate reduces to 25% for small businesses with an annual turnover of less than $50 million.
Let's give an example to see how a sole trader versus a company would be taxed. Let's imagine a business earning $100,000 a year in taxable income. Let's see how it would be taxed.
As a sole trader, the business owner would be taxed on their income tax return, and the business profits would be included in their taxable income. For the 2022-2023 financial year, the tax rates for Australian residents are as follows:
- 0 – $18,200: Nil
- $18,201 – $45,000: 19 cents for each $1 over $18,200
- $45,001 – $120,000: $5,092 plus 32.5 cents for each $1 over $45,000
- $120,001 – $180,000: $29,467 plus 37 cents for each $1 over $120,000
- $180,001 and over $51,667 plus 45 cents for each $1 over $180,000
Assuming the business owner has no other income, the taxable income of $100,000 would result in a tax liability of $24,947.
As a company, the business would be taxed separately from the business owner at the company tax rate. For the 2022-2023 financial year, the company tax rate is 25% (if your turnover is less than $50 million).
Assuming the business is structured as a company, the taxable income of $100,000 would result in a tax liability of $25,000.
However, if the business owner wanted to extract the after-tax profits from the company as personal income, they would be subject to personal income tax on that income. Dividends paid to Australian resident shareholders are generally taxed lower than personal income due to the dividend imputation system.
Operating as a company structure in Australia is often more tax-effective if your business makes a lot of money because of the different tax rates and rules that apply to companies versus sole traders. Here are a few reasons why:
- Lower tax rates for companies: The corporate tax rate for Australian companies is 25% to 30%, lower than the highest personal income tax rate of 45%. If your business is structured as a company, you will likely pay less tax on your profits.
- Ability to retain earnings: As a company, you can retain earnings within the business and reinvest them rather than paying them out as personal income. This can be particularly useful for businesses looking to grow and expand, as it allows them to invest more money back into the business.
- Access to tax deductions and incentives: Companies can also access a range of tax deductions and incentives that may not be available to sole traders. For example, a company can claim deductions for expenses such as research and development, capital investment, and employee share schemes.
Sole Trader or Company: Administration
Operating a business requires some administrative responsibilities and financial costs. Choosing the right business structure can reduce the complexity and costs of these obligations.
Simpler business structures like a sole trader have less demanding paperwork, reporting, and ongoing costs. The primary reports required to be lodged with the Australian Taxation Office (ATO) for a sole trader are an individual tax return and a business activity statement (BAS). It's essential to note that lodging a BAS is not always necessary if the business is not registered for GST. For further information on GST and if your business should register, check out the guide "Should you register your business for GST?" on our website.
Records must be kept for at least five years to keep the ATO happy, either in paper or electronic format. Accounting software like Thriday can simplify and automate financial admin for small businesses. Thriday is free to join, and the platform uses AI to automate banking, accounting and tax.
Furthermore, the ongoing costs for a sole trader are minimal, with registering a business name costing only $39 per year.
In contrast, a company structure is generally more complex and requires more paperwork. A company must lodge an independent tax return in addition to the individual return and keep financial records for at least seven years. Companies must also have a separate bank account, and the fees and level of paperwork will vary by institution. For more information, refer to our guide to business bank accounts.
Companies are subject to an annual review by ASIC, which comes with a $290 fee. Despite the additional requirements and costs, setting up a company structure can help limit personal liability and provide more tax-effective options for businesses making a significant profit.
Sole Trader of Company Quiz
Deciding whether to go with a sole trader or company business structure is hard. To help you make the right choice, we created this simple business structure quiz. Just answer a few questions, and you'll get notified of what will work best for you based on your answers.
Sole Trader or Company: FAQs
What is the difference between a sole trader and a company?
The main difference between a sole trader and a company is that a sole trader is an individual who runs and owns a business. In contrast, a company is a separate legal entity that shareholders own. A sole trader has unlimited liability, meaning that they are personally responsible for all the debts and obligations of the business, while a company has limited liability, meaning that the shareholders are only liable for the company's debts up to the amount of their investment.
What are the costs of registering as a sole trader or a company in Australia?
Generally, registering as a sole trader is less expensive than registering a company. In Australia, registering a company involves paying a registration fee and ongoing annual fees, while registering as a sole trader involves only minimal costs.
What is the liability difference between a sole trader and a company?
A sole trader has unlimited liability, meaning they are personally responsible for all the debts and obligations of the business. On the other hand, a company has limited liability, meaning that the shareholders are only liable for the company's debts up to the amount of their investment.
What are some examples of debts that a sole trader may be personally liable for?
A sole trader may be personally liable for debts such as unpaid taxes, employee superannuation, and bills for goods and services.
What is the tax rate for sole traders and companies in Australia?
The tax rate for sole traders and companies in Australia varies depending on the business's profit. As of 2022-2023, the tax rate for companies is 25% to 30%, while the tax rate for sole traders ranges from 0% to 45%, depending on their income.
What is the tax rate for small businesses with an annual turnover of less than $50 million?
Small businesses with an annual turnover of less than $50 million can access a lower tax rate of 25% as of the 2022-2023 financial year.
What are the tax considerations for a sole trader versus a company in Australia?
Regarding tax considerations, there are some differences between a sole trader and a company. For example, a company can claim tax deductions on expenses such as salaries and superannuation payments to employees, while a sole trader cannot. However, a sole trader may be able to claim tax deductions on expenses related to running the business from their home.
What is the main disadvantage of being a sole trader?
The main disadvantage of being a sole trader is unlimited liability, which means that the business owner is personally responsible for all the debts and obligations of the business. This can put the owner's personal assets at risk if the business runs into financial trouble.
Can a business owner still own 100% of the shares in a company they set up?
Yes, a business owner can still own 100% of the shares in a company they set up. The number of shareholders a company can have is generally unlimited, and the shares can be divided among the owners as they see fit.
What should one do when setting up a company to avoid future costs?
When setting up a company, you must seek professional advice to ensure that all legal requirements are met and avoid future costs. This may include registering for taxes, obtaining necessary licenses and permits, and complying with employment laws and regulations. Having a clear business plan and understanding the financial and legal risks involved in running a company is also essential.
Choosing a business structure can significantly impact your business, and it is important to consider your circumstances before deciding. While the costs and fees associated with registering as a sole trader are relatively low, it is vital to understand the personal liability that comes with it. On the other hand, setting up a company can limit your personal liability, but it involves higher upfront costs. Seeking the advice of a professional when starting a business can help you make informed decisions that can save you future costs.