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There are many things to consider when starting your own business. How will you attract customers? How will you ensure steady business growth? What type of business structure will you choose? This last question is an important one, as each business structure has different legal implications.
There are four business structures in Australia and the one you choose should be based on the nature of your business and how you plan to develop it over time.
The sole trader structure is generally suitable if you plan to work alone and trade in an environment with little risk. Your profits are taxed at personal income tax rates and the business structure has few legal formalities, so it is inexpensive to set up.
Lachlan McKnight, CEO of LegalVision, says a disadvantage of the sole trader structure is that you can be exposed to legal risk. “As a sole trader, you’re not a separate legal entity,” he points out, “so if things go wrong in the business and you owe money, you personally owe that money. Your personal risk is a lot higher.”
McKnight adds that while you may choose to purchase professional indemnity insurance as a sole trader, it’s important to remember that the business structure itself does not provide limited liability protection.
If you choose a company structure for your business, you form a legal entity, which is regulated by the Australian Securities and Investments Commission (ASIC). “It’s the structure that makes most sense if you’re running a reasonable-sized business or if you’re anticipating that it will grow to a point where you’ll need to employ people,” says McKnight.
Income tax is paid at the company tax rate, which is currently 30 per cent, and you must pay your employees’ superannuation. You can access money from your company by drawing a salary or paying dividends. “The company structure allows you to reinvest your profit into the company without paying the significant tax that you would have to pay if you were distributing it all to yourself,” explains McKnight.
A key benefit of a company structure is that is provides better protection from liability, as it is limited to the company’s assets and not your own. “If things go wrong for the company, you are not personally responsible for the debts of the company, and your assets are protected from potential liability,” says McKnight.
There are some instances, however, where company directors can be held personally liable for wrongdoing. This is often the case for fraudulent behaviour or wilful neglect of director duties.
A partnership is formed when two or more people enter into a business together to make a profit. It can have advantages, as there are more people sharing the risk and contributing to the business. This can be viewed favourably if you are looking to raise finance.
However, partnerships can create exposure to legal risks. Unlike a company structure, a partnership is not a separate legal entity to its partners. “Partners are jointly and severally liable for the debts and obligations of the partnership, irrespective of whether only one partner incurred the liability, ” says McKnight.
A formal partnership agreement can go some way in protecting you from liability; however, McKnight suggests that there are few benefits to the partnership structure.
A family trust, also known as a discretionary trust, can be costly and complex to set up; however, it provides greater flexibility for how income is distributed and this can bring tax benefits. For example, you may choose to split income with family members, who become beneficiaries, and they pay income tax on the money they receive from the trust.
A trust structure also limits personal liability, as the beneficiaries’ personal assets are not exposed to risk.
McKnight says that a drawback of a trust structure is that you must distribute profits each year. “You can’t hold profits in the trust itself – you have to distribute them, pay tax on them and then put them back into the trust,” he says. “If you’re planning on growing, it’s not an ideal structure.”
How you set up your business venture can have a significant impact on your future growth and finances. It’s therefore important to carefully consider the pros and cons of all these business structures in order to make an informed decision on the path that’s right for you.
You need to navigate a variety of legal issues when setting up or running an online business. That’s why we’ve teamed up with LegalVision to provide a one-stop solution for all your legal needs.