Structuring your business for success
Before you even open your doors for business, there’s a pressing issue you need to address: which business structure will work best for you.
Starting a business is full of momentous decisions, from quitting your job right through to registering a business name.
Like any of these big moments, choosing a business structure shouldn’t be rushed. Businesses in Australia mostly fit within four categories – sole trader, partnership, discretionary trust, and company – and can even use a combination of them at once.
BDO Australia tax advisor Cheryl Overlack said an accountant was best placed to talk business owners through the implications of each.
“They'll help you decide on the best structure for your business, and will hopefully help you avoid future difficulty with income tax, capital gains tax, and accounting in general,” she said. “Bear in mind that what is best for your business right now might not work so well in the future.
“However, your accountant should be able to guide you through the pros and cons of each scenario, and together you can decide on the most appropriate structure.”
Here’s the four structures, in a nutshell.
A sole trader business has the simplest structure.
“If you’re a sole trader, business profits are treated as personal income and you pay tax in your own name,” Cheryl said. “Your trading name can be your own name, unless you choose to use a registered business name.”
A partnership is not a legal entity from an income tax perspective. Instead, profits are distributed to the partners based on their share. The partnership still needs its own tax file number and must lodge an income tax return.
Cheryl said partnership agreements should be drawn up with a solicitor to govern each partner’s rights in line with the Partnership Act. She said she knew of two partners who’d built a successful business from the ground up from equal effort – but without a partnership agreement.
“Unfortunately, one of the men suffered a massive heart attack and died instantly,” she said. “They’d never discussed what would happen to the business should something happen to one of them.
“Suddenly, the deceased man’s wife was a 50% partner but knew nothing about the business and had no interest in being involved in the business, either.
“The options available to them at that point in time were 1. Continue running the business with the remaining man and the deceased man’s wife, or 2. For the remaining man to buy out the wife’s share.
“Neither option was particularly satisfying to either party, but after lengthy discussions and large legal fees, settlement was obtained. “This situation could have been avoided with both a partnership agreement and a buy/sell agreement.”
Under a discretionary trust, the trustee runs the business for the benefit of the trust’s beneficiaries and is responsible for debts. Solicitors need to draw up trust deeds, which set out, among other information, the trustee and the beneficiaries.
“For this reason, trusts are more expensive to set up than a partnership or sole trader,” Cheryl said.
“Generally, a trust does not pay income tax – instead, profits are distributed to beneficiaries, who then pay tax on the amount distributed to them.”
However, trusts still need to have tax file numbers and lodge tax returns.
A company pays a flat rate of tax. The current rate is 30% but eligible small businesses pay only 28.5%. Companies are more costly to set up and pay annual ASIC fees. As well as lodging income tax returns, companies must prepare financial statements – which means higher accounting fees every year.
Again, Cheryl recommends a shareholders’ agreement for company owners.
“Think of it as your business pre-nup,” she said. “A well-drafted shareholders agreement will cover what decisions directors can make, what decisions shareholders can make, dividend payments, and what will happen if any of the shareholders/directors want to exit.”