Choosing a business structure is important for asset protection, taxation, and entry and exit of owners. If the wrong structure is chosen, this may require a costly restructure at a later date. The most common types of structures are sole traders, companies, partnerships and trusts.
A sole trader structure is the simplest, with the business owner trading in their capacity as an individual. A partnership involves multiple business owners. In contrast to each of these structures, a company creates a separate legal identity to the business owners. Trusts can take various forms, and can be used for income splitting.
There are five key factors that you must consider when choosing a business structure, or deciding to restructure.
- Is asset protection a priority?
Your asset protection needs will depend on the risk profile of the business and the owners. Identify who the ‘at risk’ individuals are in your structure. In professional practices, this will usually be the professionals running the business. In other businesses, this will be whoever is taking on the risks. What will happen to their assets if the business cannot pay its debts?
- Will you be working alone, or will the business have multiple owners?
You need to consider how other individuals can enter and exit the business. Maybe you might start out on your own and add other investors or partners to the business later. Maybe you have a group of people already that you want to set up a business with. It is important that you choose a structure that suits the number of owners of the business, and can flex and adapt to later changes. Some structures are only appropriate for individuals, such as a sole trader or discretionary trust structure. Other structures, such as partnerships or companies, will be able to facilitate multiple members.
- What are the taxation implications?
Income tax, Capital Gains Tax, and Stamp Duty are high priorities when choosing an appropriate structure for a business. Each structure has distinct tax implications. Capital Gains Tax is a significant consideration in restructuring.
While it is important to choose a structure that optimises taxation implications, you need to ensure that the choice of structure is not purely motivated by tax avoidance. Tax laws prohibit structures which are only devised for tax avoidance purposes. To ensure that your chosen structure is upheld by the courts, it must be able to be justified by other reasons, such as asset protection.
- Do you need to split income?
Some structures allow you to split income. This is particularly useful if an owner’s partner earns less income, attracting less tax liability. However, if you are providing a personal or professional service, you will need to be mindful of the anti-avoidance personal services income rules. In particular, the ATO have issued warnings regarding the application of the rules to professional firms.
- Do any regulations in your industry or profession affect the structures you can choose?
Some industries can only use particular structures. For example, only a natural person may become a liquidator. The laws that regulate your industry or profession should be the starting point in choosing an appropriate structure for your business.