Sole Trader or Company? What business structure is best?
When starting or scaling a business in Australia, deciding whether to operate as a Sole Trader or a Company is important. Each structure has unique advantages and disadvantages, especially regarding tax implications, business growth, and asset protection. Here's a detailed guide to help small business owners navigate this choice.
Different Business Structures in Australia
Before jumping into the conversation on which business structure is best for your situation, you may want to familiarise yourself with the most common business structures in Australia. You can get a quick overview here.
1. Tax Implications
Sole Trader
PROS:
Simpler Tax Process: As a sole trader, your business income is treated as personal income. You report it on your personal tax return, simplifying tax administration.
Tax Offset: You can benefit from the small business income tax offset, which can reduce the tax payable on your business income by up to $1,000 per year.
CONS:
Higher Tax Rates on Higher Income: Sole traders are taxed at individual income tax rates. If your business income pushes you into a higher tax bracket, you could face tax rates of up to 45% (plus the Medicare levy).
Limited Deductions: Sole traders have fewer opportunities for tax planning and deductions compared to companies.
Example: If your business earns $120,000 annually, as a sole trader, your income is taxed at the personal marginal tax rate. This could mean paying a higher percentage in taxes than if the same income were earned through a company structure, where the tax rate might be lower.
Company
PROS:
Flat Tax Rate: Companies are taxed at a flat rate of 25% (for base rate entities under $50 million annual revenue). This can be advantageous for higher-income businesses as it may result in lower taxes compared to personal income tax rates.
Tax Planning Opportunities: Companies offer more avenues for tax planning, such as income splitting, deferring income, and accessing various business deductions and concessions.
CONS:
Complex Tax Obligations: Companies must comply with additional tax obligations, including GST, PAYG withholding, and fringe benefits tax (FBT). These add to the administrative requirements.
Retained Earnings Tax: While companies can retain earnings to reinvest, the interest gained on retained earnings is still subject to corporate tax and potentially further tax when distributed as salaries or dividends.
Read the full list of tax differences between a sole trader and a company here
2. Business Growth
Sole Trader
PROS:
Full Control: You have complete control over your business decisions without the need to consult directors or shareholders.
Low Compliance Costs: The cost of maintaining a sole trader business is generally lower, with less paperwork and fewer legal obligations.
CONS:
Limited Growth Potential: Sole traders may face challenges securing contracts or partnerships, as some clients prefer dealing with companies for credibility and legal security.
Difficulty Raising Capital: As a sole trader, it’s hard to raise significant capital for expansion since you cannot issue shares.
Example: A sole trader running a successful local café may struggle to expand into a franchise model due to the inability to attract investors or secure large loans without personal guarantees.
Company
PROS:
Scalability: Companies can issue shares, attract investors, and raise significant capital, making them better suited for rapid growth and expansion.
Credibility and Professionalism: Operating as a company can enhance your business's credibility, making it easier to attract large clients, partners, or contracts.
CONS:
Higher Compliance Costs: Companies must adhere to strict regulatory requirements, including annual financial reporting, audits, and ASIC compliance, which can be costly and time-consuming.
Dilution of Control: Bringing in shareholders or investors can dilute your control over the business, potentially leading to conflicts or differing visions.
3. Asset Protection
Sole Trader
PROS:
Simplicity: Asset management and business operations are straightforward since there’s no distinction between personal and business assets.
CONS:
Unlimited Liability: As a sole trader, you are personally liable for all business debts and obligations. This means your personal assets, like your home are at risk if the business incurs debt or is sued.
Example: If a sole trader is sued for a business-related issue, their personal savings and assets could be seized to satisfy the judgment, putting their personal financial stability at risk.
Company
PROS:
Limited Liability: One of the biggest advantages of a company is limited liability. Shareholders’ personal assets are generally protected, and they are only liable for the company’s debts up to the amount unpaid on their shares.
Separate Legal Entity: A company is a separate legal entity, meaning it can own assets, sue, and be sued in its name, providing a layer of protection for the owners.
CONS:
Complexity in Asset Management: Managing personal and business assets can become complex, especially if the company is family-owned or if personal guarantees are required for business loans.
Example: If a company goes into debt or is sued, only the company’s assets are typically at risk, protecting the personal assets of its directors and shareholders, barring any personal guarantees or illegal conduct.
4. Overlooked Implications
Sole Trader
Succession Planning: Sole trader businesses often face challenges in succession planning. If the owner retires or passes away, the business may struggle to continue, as it is heavily tied to the individual.
Insurance Costs: Sole traders may face higher insurance premiums since they are not protected by limited liability, and insurers may view them as a higher risk.
Example: A sole trader in the construction industry might pay more for liability insurance than a company due to the lack of limited liability protection.
Company
Director’s Legal Obligations: Company directors have strict legal obligations under Australian law. Failure to meet these obligations can result in personal liability or disqualification from managing companies.
Complex Exit Strategies: Selling or closing a company is more complex and involves legal procedures, tax considerations, and potential capital gains tax liabilities.
Let’s sum it all up
Choosing between operating as a Sole Trader or a Company in Australia depends on your business’s size, growth potential, and risk tolerance. Sole traders benefit from simplicity and lower costs but face higher personal risk and limited growth opportunities. Companies, on the other hand, offer scalability, credibility, and asset protection but come with greater complexity and costs.
Understanding these factors, along with overlooked implications like succession planning and director responsibilities, can help you make an informed decision that aligns with your business goals and personal circumstances. Consulting with a legal or financial advisor is always recommended to tailor this decision to your specific needs.
GO DEEPER …
The difference between a sole trader and a company
Sole traders and companies have different legal, tax and reporting obligations. See the business.gov.au website for a helpful overview of these key differences. In the article, they compare the costs, liability requirements and reporting obligations for both sole traders and companies.
Read the article here
Change your sole trader business to a company
Changing your business from a sole trader to a company structure will allow you to seek investment and also limit your personal liability. It will also change your reporting, tax and legal obligations.
You can learn how changing your business structure will affect your operations and how to do it on the business.gov.au website here.
Change your business structure
Read this article on the business.gov.au website to find out what you need to consider when changing your business structure and the common reasons for changing.
