Business Structure

Sole Trader

A sole trader is the simplest business structure.

A sole trader pays tax at their marginal rate, based on their taxable income. If a person is paid for their skill, knowledge or experience then the personal service income rules need to be considered. If there is a loss from a business venture then the non-commercial loss rules may apply.

One disadvantage of a sole trader is that all assets (except superannuation) are available to pay creditors.

The advantages of a sole trader include:

• Owner has complete control of the business
• Low cost to establish
• Can use a business name
• Access to the capital gains tax discount
• Access to the small business capital gains tax concessions (provided that the relevant conditions are satisfied)
• Access to the small business tax concessions (provided that the relevant conditions are satisfied)
• Easily understood
• Trading losses can be offset against other income, subject to the non-commercial loss rules
• Personal tax rate may be lower than the corporate tax rate
• Eligible for the small business tax offset of up to $1,000, on small business income

Disadvantages of a sole trader include:



• No income splitting
• Cannot salary package
• Unlimited liability (ie all assets are available to meet creditors, except superannuation)
• Need to satisfy the substantiation provisions
• The personal services rules may apply
• The non-commercial loss rules may apply

Company

A company is a separate legal entity and pays tax at 28.5% where it is a small business, otherwise 30%.

A company may also provide asset protection, expect where the company trades whilst insolvent. Directors are also liable for unpaid PAYG Withholding and superannuation obligations. A company structure provides limited liability as the liability of shareholders in limited to the amount paid for their shares.

A company pays tax on its taxable income. If these profits are distributed to shareholders in the form of dividends, then the shareholder will pay tax on the dividends received. The shareholder may also get a credit for tax paid by the company (a franked dividend).

If a company's income is characterised as personal services income, that income is taxable to the person whose skills and efforts it is rewarding even if it is paid to a company that the person controls.

A loan (or payment) to a shareholder or associate may be treated as an unfranked dividend. The loan either needs to be repaid prior to the lodgement of the company's tax return, or a loan agreement needs to be entered into. The loan agreement is usually for a term of seven years and requires annual repayments which include interest and principal. The Taxation Office publishes the interest rate each year. The private use of company assets may also be treated as an unfranked dividend.

A company is not able to access the 50% capital gains tax discount.



Losses made by a company are carried forward to be offset against future income, subject to certain tests.

The advantages of a company include:

• Taxation of income at a flat rate
• Profits can be retained, provided that it is not personal services income
• Limited liability
• Shareholders obtain the benefit of tax paid by the company where the company pays a franked dividend. The shareholder can obtain a refund of the tax paid by the company, depending upon their other income.
• Can utilise salary packaging
• Access to the research and development concessions
• Access to the small business capital gains tax concessions (provided that the relevant conditions are satisfied)
• Access to the small business tax concessions (provided that the relevant conditions are satisfied)
• A company has an unlimited life and can provide for succession planning

The disadvantages of a company include:

• The company is taxed at a flat rate of tax, even on low levels of income
• Distributions are treated as dividends and additional tax may be payable
• Cannot access the 50% capital gains tax discount
• More expensive to establish
• Higher administration costs
• Companies are regulated by the Corporations Act and ASIC
• Loans and payments to shareholders and associates may be taxed as unfranked dividends
• The private use of company assets may be taxed as an unfranked dividend
• Cannot stream franked and unfranked dividends
• Losses are retained in the company
• Benefits may be subject to fringe benefits tax
• Directors may be liable for the debts of the company, unpaid superannuation contributions and unpaid Pay As You Go Withholding
• The overall tax legislation that applies to companies is more complex
• Income may be subject to personal services income rules

Trusts

Trusts are advantageous from a structuring perspective as they can provide asset protection and also allow the streaming of income and capital to beneficiaries.



A trust is not a separate legal entity, but should be characterised as a documented relationship subject to trust law. The rules for the trust are documented in the trust deed, which is prepared by a lawyer. it documents the relationship between the person who created the trust by giving trust property (the settlor), the person(s) who operate the trust property (the trustee) and the person(s) who may benefit from the trust by receiving income and/or capital distributions (the beneficiaries). The beneficiaries can be individuals, trusts or companies. However, complex rules apply where distributions are made to trusts or companies.

A key feature of a trust is that there is a clear distinction between the legal ownership of the property, which is held by the trustee, and the equitable ownership of the property, which is held by the beneficiaries.

There are various types of trusts, but the most common tend to be discretionary trusts and unit trusts. A discretionary trust is one where the entitlements of the beneficiaries are not fixed. The trustee can resolve each financial year how the income will be distributed among the group of potential beneficiaries as set out in the trust deed. A unit trust is a trust where the entitlement to the income and capital of the trust are fixed in proportion to the number of units held by the beneficiary.

A discretionary trust is often used in family dealings. A unit trust tends to be used where unrelated parties are involved. A partnership of discretionary trusts is also often used by unrelated parties.

If a trust's income is characterised as personal services income, that income is taxable to the person whose skills and efforts it is rewarding, even if it is paid to a trust.

The advantages of a trust include:

• Limited liability (provided a corporate trustee is used)
• Flexibility as to the distribution of income, particularly for a discretionary trust
• Access to the capital gains tax discount
• Access to the small business capital gains tax concessions (provided that the relevant conditions are satisfied)
• Access to the small business tax concessions (provided that the small business tax concessions are satisfied)
• Each beneficiary eligible for the small business tax offset of up to $1,000, on small business income
• Can utilise salary packaging
• It is possible to change the control of the trust from one generation to the next without transferring the underlying asset

The disadvantages of a trust include:

• Accumulated income taxed at the top marginal rate
• Losses cannot be distributed and are subject to complex rules
• A trust usually has a life of 80 years
• Difficult to understand
• The trustee can be personally liable for the debts of the trust
• Distributions must be made in accordance with the deed
• Complex rules if distributions are made to a company
• Complex rules if the trust holds shares
• Depending upon the type of trust, it may be more difficult to satisfy the significant individual and CGT concession requirements
• Benefits may be subject to fringe benefits tax
• More expensive to establish
• Higher administration costs