You have a concept and a passion for your business, but which business structure should you choose and why? This post will explain the distinctions between the business forms of sole trader and corporation and offer advice to entrepreneurs who are unsure which structure is best for them.
In short, many business owners opt to be sole traders since it is an easy way to start a firm. There is less administration; for instance, you don’t need to complete corporate tax returns. However, being a sole trader has a lot of drawbacks, such as personal liability and the inability to bring in investors because you don’t have any business shares to offer.
Most growing organisations chose a company structure because of the limited liability, potential tax benefits, ability to incentivise employees with shares, and opportunity to bring in investor shareholders.
The Main Distinctions Between a Sole Trader and a Registered Company
Being a sole trader comes with only a few costs. Sole traders can apply for an Australian Business Number, and many do so in addition to purchasing a business name.
The ASIC registration fee (currently $497) and the annual renewal fee (currently $243) are two of the fees associated with forming a business.
Businesses that require particular licences, such as a liquor licence for an alcohol-related business, must pay a variety of fees.
Liability
The fact that a business structure has restricted liability is a significant benefit. Shareholders are only liable to a limited extent; they are not liable for the company’s obligations.
Unless they made a personal guarantee, were dishonest or negligent, or breached their directors’ obligations, such as managing the firm when it was insolvent, directors have little accountability.
Sole traders have no limit on their culpability; they are personally liable for the company’s debts. This means that both corporate and personal assets, such as a home or car, are in danger.
It is for this reason that sole traders are advised to ensure they have adequate sole trader insurance in place.
Investments and Fundraising
A corporation can attract investors by selling shares, allowing shareholders to own a piece of the business. The corporation can either issue shares directly or options over shares, as well as convertible notes that convert to shares.
Shares cannot be offered by sole dealers. They usually take out a loan to raise finances. Because banks and financiers have limits on how much money they will lend, obtaining finance for a sole trader may be challenging. The repayment of interest on a loan is usually required on a monthly basis, which can have an impact on cash flow.
Business Decisions
Sole traders are responsible for making their own business decisions.
Shareholders appoint directors to make critical business decisions in a corporation. Directors have responsibilities outlined in the company’s constitution (or, if no constitution exists, by the equivalent rules in the Corporations Act), as well as responsibilities outlined in the Corporations Act and general law.
Rates and Conditions for Taxes
The tax payable by a lone trader vs a corporation differs. Companies pay 30% tax on their earnings, whereas lone traders pay personal income tax; thus, their tax rate is determined by the amount they make, which includes the revenue from their firm. For income of $180,000 or more, the highest personal tax rate is now 45c in the dollar.
Sole traders are required to file individual tax returns. Both personal and business tax returns must be filed by business owners.
Companies must keep financial records and keep their books up to date in order to comply with the Australia Securities Investment Commission’s reporting requirements.
Retained Profits
All earnings secured by lone traders are taxed at the applicable marginal tax rate. A sole trader must also pay personal tax on money used or retained in the firm.
Companies might choose to give profits to shareholders as dividends or to keep profits and use them for the business, such as to accelerate expansion. Retained earnings, or profits that are used for reinvestment, are taxed at the corporation tax rate of 30%.
Tax Loses
If a firm owns multiple businesses, it can use the gains (or income) from one to offset the losses of another.
If a sole trader loses money from one source of taxable income, such as a rental property, they can deduct it from another, such as company income.
Succession
When the owner of a sole trader entity dies, the business ceases to exist. The business’s assets are distributed according to the will or estate laws.
The term “perpetual succession” refers to a company’s ability to continue to exist and operate even after its directors/founders have died away. This is principally due to the fact that a corporation is treated as a separate legal entity under the law. Under the will or estate legislation, the shares of a deceased shareholder pass to the heir.
