Added by on 2012-09-25

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.

Sole ProprietorPartnershipCompany
Simple and low cost to set-upSimple and inexpensive to set-upRelatively complicated and expensive to form
Legal requirements are minimalLegal requirements at a minimumHighly regulated by government
Owner has total controlControl sharedControlled by directors and ultimately, shareholders
Limited record-keeping and reporting requiredLimited record-keeping and reporting requiredDemanding record-keeping and reporting requirements
Easily discontinuedCan be difficult to dissolveCan be difficult to dissolve
Owner retains all profitsProfits split between partnersProfits can be retained
Owner makes all decisionsPartners can disagreeDecisions made by board
Unlimited legal liabilityPartners jointly and individually liableLimited liability of shareholders
Ownership can be transferred (usually as a whole)Transfer of ownership is somewhat complicatedTransfer of ownership simpler
Tax at marginal personal rateCan have tax advantages by spreading incomeUndistributed profits presently taxed at 30%
Limited range of expertise and advice requiredSpecialisation of partners is possibleMay have wider range of expertise in-house
Inability to raise capitalLimited capital availableEasier to raise capital

Trusts

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.

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