- Sole trader or a company? That is the question. Each business structure comes with its advantages and shortcomings.
- If you want to be a credible business and enjoy tax advantages then you should seriously consider forming a company.
- Unlike companies, sole traders don't have many operation costs, so for starters, sole trading is a convenient option.
When starting a business, you are faced with many choices. You will be deciding on what your business is going to do, what your target market will be, earnings & growth potential and how these are going to be achieved. Everything down to the design of your logo.
One of the most important aspects of setting up a business and one of the more complex areas is choice of business structure. There are several ways of setting up a business, ranging from the most simple structure as a sole trader to going down the path of incorporating and forming a company.
In the past, many businesses never started their life as companies – this became a consideration once the business started growing with the perception that incorporating occurred as a natural transition to an increasingly complex and larger business. Nowadays, more and more businesses are starting their life as a company. There is a range of reasons behind this, with several pros and cons to establishing a business this way.
The Pros of Incorporating
There are several advantages of setting up a business as a company:
1. Limited Liability
A corporation is a separate entity for legal purposes. The effect of being an entity in its own right means the owners and shareholders of the company bear no personal liability for the debts and obligations of the company.
As long as the company directors are meeting their regulatory requirements and acting in good faith, the directors’ personal assets cannot be used to meet any outstanding financial obligations borne by the company. Knowing this, lenders often ask the directors to personally guarantee the debts of the company.
1. Tax Advantages
Setting up a company can provide significant tax benefits. The company tax rate attracts a 30% flat tax rate, but this but this has been reduced in 2017-18 to 27.5% for smaller companies, called base rate entities with an aggregated turnover of less than 25 million. In the 2018-19 financial year, the threshold is increased to aggregated turnover of 50 million or less.
While no tax-free threshold is applicable, there is no tiered tax structure which simplifies tax calculations on business income. Also, the tax calculated is on the profits of the company (fewer expenses and deductions), which is separated out from the individual’s tax return.
Any income earned while operating as a sole trader adds to an individual’s personal tax return. Depending on the earnings, this can be taxed at a higher marginal rate than the company tax rate and may also increase the tax bracket under which the individual is taxed.
Registering your business as a company has a role to play in the perception of the business. A registered company can appear to generate a higher level of credibility for prospective customers and business partners.
Because it is a more complex and highly regulated structure, the efforts to manage this sort of business can be perceived as more significant than a simpler entity, which can thereby legitimise the business and contribute to an aura of scale in regards to business operations.
4. Access to capital
Capital can be contributed by the purchase of shares or equity in the company. Loans can also be made by the company. The options in a sole trader or partnership are limited by personal contributions or loans for which the individual remains personally liable. This creates a distinct advantage in being able to raise capital to be able to increase the scale of the business and generate growth potential.
5. Ownership is transferrable
Unlike a sole trader, the equity in a company can be transferred relatively easy by the purchase of shares in a company. If the managing director/s are no longer associated with the company, then the company will still continue to exist. In contrast, a sole trader business will cease to exist if the business owner no longer ceases to operate the business, retires or even passes away. The advantage of the company is, therefore, a continuation of operations, providing more certainty for investors, creditors and customers.
The Cons of Incorporating
While incorporating your business can have distinct advantages, the increased complexity of forming a company comes with additional regulatory burdens and considerations:
While a sole trader or partnership can be established relatively cheaply, forming a company involves higher start-up costs and increased costs throughout the life of the business.
To form a company, you must register for an Australian Company Number (ACN) which is obtained through the Australian Securities and Investment Commission (ASIC) at a cost of $479. Choosing a company name, as well as business name registration also come with costs. A sole trader operation may only have to set up a business name, which is relatively cheap.
Given the increased complexity of a company structure, it may also be advisable to consult an accountant or financial advisor to assist. The fees for a company setup vary from firm to firm. I form companies for around $2,000 – this cost involves a complete setup, registrations and training.
Ongoing costs remain higher for a company than a sole trader. Companies are subject to an annual review fee of $254 (which increases once publicly listed). Companies must also have a separate bank account in the name of the company, incurring business banking fees which are generally higher than personal accounts.
While it is recommended, a sole trader does not have to open a separate bank account. Other obligations associated with running a company will also be generally higher, including insurance premiums, lending rates and professional fees.
Running a company is subject to government regulation via Australian Securities and Investments Commission (ASIC). There are increased obligations around governance and disclosure. A company must lodge its own tax returns and keep financial records for a minimum of 7 years under the Corporations Act 2001.
In addition, a company must have a registered office and a principal place of business. Directors’ personal details must be supplied to ASIC and any changes to the company must be lodged with ASIC, including any changes to company details, change of company name or the appointment of alternate directors. Resolutions must also be formally recorded in minutes, even if under the control of a sole director.
The company must also comply by rules that are set out internally in a constitution or otherwise prescribed in the ‘replaceable rules’ of the Corporations Act which can substitute as default rules in the absence of a specific internal rule.
Because of the more complex structure and requirements, the establishment of a company can seem overwhelming or onerous. For new businesses, forming a company can seem like a minefield of legalese and red-tape, with the required legwork to understand the nature of the company seeming prohibitive to setting it up.
The necessity of Forming a Company
Sometimes under specific employment arrangements, forming a company can become a necessity. Firstly, it is important to distinguish between an employee or a contractor. When a business employs someone to complete a specific task they enter into an arrangement with them either as a direct hire or contractor.
Determining which applies can generally be deemed by the level of control and concomitant obligations the employer has towards the worker. Independent contractors commonly have a good deal of control over the terms of employment, nominating specific hours and prices for their labour, but also bearing responsibility for their own taxes, insurances, super and income.
In the case of independent contractors, who have a specific work agreement and contract with a business, when the terms of the contract expire and a new contract commences, the business may require that the contractor operates as a company. This can also be true of franchise arrangements which specify that a business must be trading in a company name to assume the franchise.
Summation – To Incorporate or Not?
There is no easy answer - there are several things to consider when setting up and structuring your business. Whether or not to incorporate your business operations at the outset involves a good understanding of the obligations involved and what aligns best with your business objectives.
While incorporating comes involves increased costs, regulation and reporting, structuring a business as a company provides many advantages in terms of liability, tax and equity arrangements. The increased complexity of a company is offset by greater flexibility, access and scale which may not only be beneficial at the outset of the business, but prove necessary for long-term planning and growth.
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