If you’re thinking about opening a small business, one of the first things you need to do is decide what business entity is best for you. A business entity describes the legal structure of a business, and each business entity has different functions, responsibilities and purposes. You’ll need to know your business entity before applying for an Australian Business Number (ABN).
Types of business entity
There are several types of business entity, each differing in costs, structure, taxes, ownership and other factors. The right business entity for you will depend on your financial goals, how much ownership and liability you’re willing to take on, and how many people you’re opening the business with.
Each entity has its own advantages and disadvantages. If you’re clear on what it is you want to do and how you want to operate, it should be easy to identify which business entity suits you best.
Below are the four most common business entities. Other entities include incorporated associations and cooperatives.
Sole proprietorship/sole tradership
In a sole proprietorship, the business is owned and controlled by one individual. The sole proprietor is not considered a corporate entity, and therefore pays taxes and debts personally.
A sole trader entity is the easiest to set up and operate. The sole trader keeps full control over their assets and business decisions, with minimal reporting requirements. Losses incurred can be offset against the sole trader’s income, and the sole trader can use their individual tax file number (TFN) to lodge tax returns. It is easy to adjust your business structure from a sole tradership should you wish to expand or, conversely, choose to close your business.
The disadvantage of a sole tradership is that you must accept unlimited liability; risking all of your personal assets, and that there is limited opportunity for tax planning.
Income and losses are declared in the sole trader’s personal income tax return, and taxed at an individual rate. Should your annual turnover exceed $75,000, you will need to register your business for goods and services tax (GST).
A partnership is the same as a sole proprietorship, only with two or more individuals at the helm. Each partner files their own taxes for their share of the profits, and costs, debts and losses are shared by each partner.
A partnership is easy to establish, and has minimal requirements when it comes to reporting. Business tax losses can sometimes be offset against the personal income of a partner. Partners are not employees, so workers’ compensation insurance and superannuation contributions aren’t mandatory.
Personal liability is unlimited for each partner, and it’s important when entering a partnership to sign a formal agreement that outlines each partner’s responsibilities and authority, each partner’s financial investment, and the procedures you’d undertake to resolve disputes or end the partnership.
Without an agreement in place, each partner will own equal shares of each asset.
Partnerships do not pay tax on income, rather each partner pays tax on their share of the net income.
A company is a legal entity that is separate from its owners – meaning owners are not typically personally liable for the debts of the business. Registered companies require at least one director, who is responsible for managing the company’s operations.
Companies are advantageous as shareholders have limited liability. Companies are able to carry forward losses indefinitely to offset future profits, and it’s easy to sell or transfer ownership of a company. Profits of a company can be easily reinvested or distributed to shareholders as dividends.
On the other hand, companies are costly to set up and maintain, and require regular, complex reporting. Losses of a company cannot be distributed to shareholders.
Companies pay income tax on profits at the company tax rate. Tax is paid on every dollar earned, with no tax-free threshold.
A trust is an entity that carries out business and holds property or income on behalf of and in benefit of others. An individual or company can be a trustee, and a trustee is liable by law for the debts of the trust and may use the trust’s assets against those debts.
Assets of a trustee are protected, and asset and income distribution amongst trustees is flexible. Trusts are, however, expensive and complicated to establish, and difficult to dissolve. Any profits that are retained to be reinvested in the business are subject to penalty tax rates. Only profits can be distributed in a trust, not losses.
Trustees must lodge an annual trust return and apply for a tax file number (TFN). The trust isn’t liable to pay tax. Tax is assessed to the trustee or to the beneficiaries receiving the trust net income.
What are small business entity concessions?
Small businesses in Australia are entitled to small business entity concessions should they meet certain requirements. To be eligible, you must be a sole trader, partnership, company or trust that operates for all or part of the income year and has a turnover of less than $10 million. From July 2021, small businesses with turnover above $10 million but below $50 million may be eligible for certain concessions.
As a small business entity, ATO will offer access to concessions like simplified trading stock rules, PAYG instalment concessions, two-year amendment periods, and excise concessions.
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