One of your most important decisions when you first started your business was the legal structure under which it would operate.
Your initial decision may have been weighed by factors such as costs, size, and possible longevity of the business. As your business matures, the question arises, is it still the most appropriate one?
As you know, three types of legal structures are commonly found in small businesses; namely sole proprietors, partnerships and proprietary limited companies. Often a family trust may also be involved in a company arrangement.
Many small businesses start as a sole trader. However, as your business and income grows, you may need to consider alternative business structures.
You should talk this over with your accountant. Each person’s tax liability, risk profile and business circumstances are different and need to be considered in detail. The following comments will guide you as to the most appropriate structure.
If you are a sole proprietor or in a partnership you may want to take a look at a new business structure when:
Your taxable profit increases beyond about $50,000 per year
You wish to borrow money for the business
You are concerned about personal liability
You want to make your business marketable.
Changing your business structure can be a complex matter, so you are strongly advised to consult your accountant. There are a myriad of legal, tax and commercial implications. However, sometimes, these decisions need to be made for the long term benefit of the business.
Pros and cons of business structures
Before deciding to make a change, consider the advantages and disadvantages of each alternative business structure as set out in this table. Note – a trust is not a legal entity, so commentary is provided following this table.
|Simple and low cost to set-up||Simple and inexpensive to set-up||Relatively complicated and expensive to form|
|Legal requirements are minimal||Legal requirements at a minimum||Highly regulated by government|
|Owner has total control||Control shared||Controlled by directors and ultimately, shareholders|
|Limited record-keeping and reporting required||Limited record-keeping and reporting required||Demanding record-keeping and reporting requirements|
|Easily discontinued||Can be difficult to dissolve||Can be difficult to dissolve|
|Owner retains all profits||Profits split between partners||Profits can be retained|
|Owner makes all decisions||Partners can disagree||Decisions made by board|
|Unlimited legal liability||Partners jointly and individually liable||Limited liability of shareholders|
|Ownership can be transferred (usually as a whole)||Transfer of ownership is somewhat complicated||Transfer of ownership simpler|
|Tax at marginal personal rate||Can have tax advantages by spreading income||Undistributed profits presently taxed at 30%|
|Limited range of expertise and advice required||Specialisation of partners is possible||May have wider range of expertise in-house|
|Inability to raise capital||Limited capital available||Easier to raise capital|
Many businesses are also organised to include a trust. The trust is normally a family or discretionary trust that ‘holds’ property on behalf of the beneficiaries (normally individuals).
This arrangement allows for tax efficient outcomes in terms of profit distribution and should the business be sold. The use of trusts is most suitable for medium-sized businesses.
A trust is normally set-up with a company acting as trustee. This is done so that the advantages of a company are available (see above) whilst full control is maintained as the family members become directors of the company and/or beneficiaries of the trust.
The main advantage of a trust structure is the ability to minimise taxation, whilst offering some flexibility in terms of privacy and limited liability.
In recent years the Federal Government has sought to remove or limit the tax advantages of trusts. Therefore, you need to consult your accountant to obtain the latest information. By its nature, a trust structure is a highly involved, legal process and professional advice is necessary.
The issues raised above need to be considered before deciding on the most appropriate business structure. You need to familiarise yourself with your options and choose the best mix of features that is suitable for your circumstances.
You should then discuss this with your accountant. The type of business you own makes little difference. Structure is mostly determined by legal and tax considerations.