Setting up in business? Which structure should you choose?
So, you’re setting up a new business and you need to decide how to structure the business. Do you form a company, or maybe a trust or do you simply set yourself up as a sole trader?
First, let’s consider the simplest of the various structures; starting a business as a sole trader or as part of a partnership (which is treated for tax purposes as basically a collection of individuals).
The main advantage of this structure is its simplicity; there’s less red-tape to negotiate to start your business and the associated legal and professional costs are minimal.
On the downside, once you start trading at a profit, you’ll pay income tax at your applicable marginal tax rate (which could be up to 49% for those earning more than $180,000 after 1 July 2014). The potential to split income between family members, which is often available where a trust is used as the business vehicle, does not exist.
A trust is a structure where a trustee (an individual or company) carries out the business on behalf of the members (or beneficiaries) of the trust.
Family businesses are often set up as a trust so that each family member can be made a beneficiary without having any involvement in how the business is run.
The major advantage of using a discretionary trust to run your business is that you are able to decide who benefits from the income of the trust. So, when you start trading profitably, the trust will be able to distribute its income in the most tax effective way permitted by the trust deed, typically to the beneficiaries with the lowest marginal tax rates.
The downside of investing through a trust is that tax losses will be trapped in the trust as the trust cannot distribute losses to beneficiaries. This will usually mean – subject to some complex anti-avoidance rules – that losses can only be rolled up and used against future income within the trust.
The other possible scenario is to set up your business through a company.
Shareholders own the company while directors run the company. In many cases company directors are also shareholders.
To become a company, an entity must:
- be incorporated under the Corporations Act 2001 (Commonwealth Act); and
- be registered with the Australian Securities and Investment Commission
The most common reason why people choose a corporate structure is that it provides limited liability to the shareholders, in other words the extent to which shareholders are liable for the debts of the company is limited to the amount they’ve invested as share capital.
Finally, there’s the advantage that the company will pay tax at the corporate rate of 28.5% (provided the company’s turnover is less than $2m), which is significantly lower than the top marginal rate for either individuals or trusts (which currently sits at 49% including the Medicare levy and the debt levy).
Many people opt for a mixed structure, often running their trade through a company, which is then owned by a discretionary trust. This provides both the asset protection and lower tax rate advantages of a company combined with the ability to stream income (in the form of dividends) to beneficiaries of the trust.
Click HERE for more details on these options
Source H&R Block Tax Accountants
For More General Information go to http://www.hrblock.com.au/tax-guides
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