Which Business Structure is right for me?
There are many types of business structures under which your business can be operated. The choice of one over the other depends on a variety of issues as well as your particular requirements. Here, we take a detailed look at the four most common business structures:
Sole Proprietorship
This type of business is operated by an individual without partners or company set-up and with minimal reporting requirements. If you welcome the lack of formalities in owning and operating your business while maintaining total control of it, then sole proprietorship may be for you. A sole proprietor is taxed at a personal rate and tax losses can be offset against other income. If and when the time comes to sell up, there is much less red tape. If you have held your asset for at least 12 months before selling, you can claim the 50% Capital Gains Tax discount. This means that you will pay only half of the CGT you would have to pay if you held the asset for only a few months before selling. There are no superannuation contributions to worry about as a sole proprietor because you are not an “employee” of your business.
Disadvantages
The main disadvantages to this type of structure are:
Unlimited liability - business debts are combined with personal assets
The sole proprietorship comes to an end when the person running the business dies – there is no perpetual succession
Potential lack of resources, for example, finances and skills
Limited access to finance if the business grows – you cannot raise capital from the public
No flexibility in tax planning – e.g., to vary the income of family members from year to year.
Partnership
A partnership structure involves two or more persons carrying on a business in common with a view to profit. It is relatively inexpensive to establish and can actually be established by the part’s conduct, although it is advisable to have a partnership agreement.The legislative regulation for partnerships is relatively minimal, and partners are not required to make public disclosures. Partners can, in fact, regulate themselves and resolve problems together.
Tax losses can be used immediately by the partners against income from other sources. This is useful for start-ups when the business loses money because partners can deduct losses from their personal income. The partnership can be set up to vary profits or losses between partners on an annual basis. Partners hold an interest in each partnership asset as an individual and so are able to access the 50% CGT discount.
Disadvantages
Partnership may exist at law as a result of the parties’ behavior, even if that was not the plan.
Unlimited liability – the partners are all jointly and severally liable for the debts of the firm
You need to amend the partnership agreement to add or remove partners
Difficult to transfer a partner’s personal share in a partnership
Taxable income flows through to partners, so they pay high tax rates when the business makes money
The maximum number of partners is set at 20, so growth may be restricted
Different Partnership Acts exist in different States, which may hinder interstate partnerships
One partner’s actions can bind the others
Partners hold an interest in each partnership asset as an individual. If a partnership asset is sold then each partner is treated as having disposed of an asset for CGT purposes represented by that partner’s percentage interest.
Joint venture
Sometimes, entities form a business relationship for a specific purpose–a joint venture (which may be incorporated or unincorporated). It is always preferable to enter into a written agreement so that each party understands the nature and goals of the venture. Participants are not usually responsible for the acts of other participants. Unless stated otherwise, transfer or assignment of each participant’s rights may be able to take place without the consent of other participants. A joint venture cannot be sued in its own name, although individual participants in unincorporated joint ventures. Participants may be able to compete with each other in areas not relating to the joint venture.
Disadvantages
It exists only for as long as the joint business is operated
The JV may come to an end if one participant retires unless reconstituted with new members
Participants are liable for debts of joint venture on a several liability basis
Remit of the business venture is restricted, and the agreement would need to be amended to proceed with other business ideas
The ability to sell the entire joint venture is restricted
Company
A company is a separate legal entity that is able to enter into contracts in its own name. Your company can be limited by shares, limited by guarantee, unlimited, or a no liability company. It can be incorporated as a private company or a public company. Company shareholders enjoy limited liability, although there are some exceptions for directors.
The company tax imputation system prevents their being taxed at a shareholder level and at the company level. Contributions made by your company to a superannuation fund on behalf of employees can be claimed by the company as a tax deduction. If you are in a group of companies, any losses can be transferred from one company to another in the group, provided there is full common ownership. Your company tax rate is set at a much lower rate than the highest individual tax rate, and you do not have to distribute profits. After your death or retirement, the company will continue. It is quite easy to issue new shares and bring in new ownership without creating a new entity.
Disadvantages
It is more expensive to establish a company.
Costs (annual filing fees and accounting fees). In general, greater accountability has increased complexity and costs.
Compliance can be onerous - governed by ASIC rules and Corporations Act
Where a company undertakes negative gearing, the tax losses are trapped within the company
A company cannot claim the CGT 50% discount concession, which is available to individuals and superannuation funds
What should I do next?
If you are thinking about starting a new business and are unsure of which structure to choose, or if you are planning on changing your current business structure, our lawyers at You Legal will be happy to advise you.
* This blog is for general guidance only. Legal advice should be sought before taking action in relation to any specific issues.