Business Legal Structures
A business can be legally structured in 4 main ways. Choosing the best legal structure to suit your business circumstances is one of the first and most important decisions to be made in starting your business.
Below, we detail the 4 main legal structures that you should consider for your business. We recommend that you contact us for further information or to ensure that you are currently running an optimal business structure.
If you are planning to operate your business alone (without any business partners), a sole trader may be the simplest & most appropriate structure.
- You have complete control over the management and direction of your business.
- You own all your business´s profits and assets.
- Cheap & simple to set-up and easy to maintain.
- Minimal statutory provisions and government regulations govern how you operate your business.
- Disbanding is relatively easy. You keep any after-tax gains if you sell the business.
- Unlike companies, you do not need to disclose your profits to the public in order to obtain funding etc (i.e. greater privacy).
- You are fully liable for your business debts, so you risk losing personal assets (home, vehicles, etc.) if you cannot repay your debts. Similarly, any intellectual property may be at risk if the business fails.
- You are likely to be limited as to how long you can stay away from your business as technically, if you are sick or take holidays, you don’t generally get paid.
- You pay tax on profits at your marginal rate of tax, which may be higher than the company tax rate of 30%.
- You must put money aside to pay your tax; otherwise, you may have cash-flow problems when you lodge your annual tax-return.
- Few tax concessions are available.
- The business structure limits opportunities for expansion.
A Partnership is a common, simple & inexpensive way to set up or structure a business for 2 or more owners to work together and share profits. A Partnership requires the intention that all owners act on behalf of each other and the business.
Partners must have a clear understanding of their rights, responsibilities & obligations, and must keep their co-owners properly informed. A written partnership agreement must be established.
- Partnerships are easier and less expensive than companies to set up.
- Partnerships are simple to administer. Profits and losses are shared between partners according to his/her share (as specified in the ´partnership agreement´).
- Partners may carry on business under a trading name.
- Partnerships combine the resources and expertise of a number of people.
- Unlike the sole trader structure, partnerships allow for greater flexibility in holidays and sick leave.
- Unlike companies, partnerships do not have to disclose their profits to the public (i.e. greater privacy).
- Changing the legal structure is relatively simple (i.e. changing from a partnership into a company at a later stage).
- Personal differences may interfere with business.
- All partners together are personally responsible for business debts. Each partner is individually liable for debts incurred by the other partners. This is known as being ´jointly and severally´ liable.
- All partners have a right to participate in the management of the partnership (unless otherwise agreed).
- Tax is charged at the personal (marginal) tax rate. As business earnings increase, so does the tax rate.
- Partners cannot transfer their ownership to someone outside the partnership unless the other partner(s)agree.
A company is a distinct legal entity separate from its shareholders or officers.
In Australia, the most common types of company are:
- ´Public´ companies (usually formed to raise or borrow public money by listing the company´s shares for trading on a stock exchange)´
- Proprietary limited´ companies (cannot raise money from the general public through share issues).
All companies are governed by the Australian Securities and Investments Commission (ASIC), which administers the Corporations Act 2001 (Commonwealth) and other legislation. Public companies must also comply with the rules of the Australian Stock Exchange.
- Ability to draw a wage from your company means that directors can take sick & holiday pay (unlike a Sole Trader).
- Legal arrangements are in the company´s name, and not in the name of its directors and managers.
- In most cases, shareholders can only lose the value of their shares and are not liable for the company´s debts.
- Company shares can be transferred which means that the business structure ensures continuity of management and ownership in the event of the death or disability of key people.
- The tax rate for companies is less than the highest rate for individuals (currently a flat rate of 30%).
- Profits distributed by companies to shareholders are taxable at their marginal rate of tax.
- Companies are more regulated than other business structures.
- The rules for establishing and running a company are more complex and costly than other business structures.
- Lessors, suppliers and lenders are reluctant to lend money or enter into contracts or leases with proprietary limited companies unless directors or shareholders provide personal guarantees.
- If directors fail to meet their legal obligations, they may be held personally liable for the company´s debts.
A trust is a relationship where a trustee (an individual or a company) carries on business for the benefit of others (the beneficiaries).
A trustee may carry on a business for the benefit of a particular family and distribute the yearly profit to them. A trust is not a separate legal entity.
A trust may be discretionary (i.e. the trustee decides how profit will be distributed among beneficiaries) or
have fixed interests (i.e. it will benefit certain people in predetermined proportions). Commonly, the trustee is a company (a corporate trustee); often this business structure is more tax effective.
- A trust provides asset protection and limits liability in relation to the business.Trusts separate the control of an asset from the owner of the asset and so may be useful for protecting the income or assets of a young person or a family unit.
- Trusts are very flexible for tax purposes. A discretionary trust provides flexibility in the distribution of income and capital gains among beneficiaries.
- Beneficiaries of a trust are generally not liable for the trust debts, unlike sole traders or partnerships.
- Beneficiaries of a trust pay tax on income they receive from a trust at their own marginal rates.
- Trusts receive a discount on the amount of capital gains tax payable on capital assets held for more than 12 months.
- Establishing a trust costs significantly more than establishing sole traders and partnerships.
- A trust is a complex legal structure, which must be set up by a solicitor or accountant.
- The trustee has a strict obligation to hold and manage the property for the exclusive benefit of the beneficiaries.
- Operation of the business is limited to the conditions outlined in the trust deed.
- As with companies, there are extensive regulations that trusts must comply with.
- Losses derived in a trust cannot be distributed and cannot be offset by beneficiaries against other income they may have.
- Unlike a company, a trust cannot retain profits for expansion without being subject to penalty rates of tax.
For further information, don’t hesitate to contact Freshwater Taxation.