7th August, 2021
Ready to go out on your own but not sure which business structure to choose? This sole trader vs company cheat sheet explains the major differences between two of the most common business structures.
From the legal implications to your reporting requirements, ongoing costs and how you’ll be taxed, here are some key things you should know before you decide whether to start a business as a sole trader or as a company.
A sole trader is the simplest business structure, and therefore the easiest and quickest to set up. When you own and operate a business as a sole trader, you and your business are considered a single entity.
A company, on the other hand, is a separate legal entity. Requiring at least one shareholder (owner) and one or more directors to make management decisions, it’s a significantly more complex business structure. Even if you’re the sole shareholder and director.
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Understanding the differences between operating as a sole trader and operating as a company will help you decide which one is right for your business. Your accountant or business advisor can help you with this, too.
To get started as a sole trader, you first need to obtain an Australian Business Number (ABN). Then, unless you plan to trade under your own name, you’ll need to register a business name.
Setting up a company, on the other hand, requires an Australian Company Number (ACN) as well as an ABN. To receive your ACN, you must register your company with the Australian Securities and Investments Commission (ASIC).
A registered business name is also necessary if you don’t wish to trade under your company’s legal name.
While separate business bank accounts are advised – but not required – for sole traders, they’re mandatory for companies.
Any sole trader or company expecting to make total revenue of $75,000+ in the first year in business should also register for Goods and Services Tax (GST).
With more complex business structures come higher set-up costs, and most of the registrations above require an initial outlay.
Sole trader and company set-up fees:
Once established, a company is more costly to run.
With greater compliance requirements and more paperwork, accounting fees are higher. Subject to annual review by ASIC, you’ll also pay an annual review fee of $276 (as a proprietary company).
Closing a company is also more involved. As a sole trader, you’re required to cancel your ABN and business name within 28 days of ceasing trading.
If winding up a company, you must pay a small fee ($42) to formally deregister. You’ll also need to clear any outstanding amounts with ASIC before applying.
As a sole trader, you’re single-handedly responsible for making day-to-day business decisions. You can also withdraw money from the business for any reason at any time.
On the flip side, you’re legally responsible for any debts or losses incurred. If the business is in trouble, your personal assets may come under threat.
In a company, your degree of control depends on the structure in place, and whether you’re the sole director. Additionally, under the Corporations Act of 2001, certain decisions can only be made by passing a company resolution.
The business’s income belongs to the company. Therefore, while they may receive wages, a salary or dividends, no individual can take money from the business as ‘personal drawings’.
There is a division between personal and business assets and, as a rule, the company is liable for business debts. In some cases, however, directors can be personally liable.
A big difference between sole trader and company arrangements lies in taxation. As a sole trader, you’re taxed as an individual, meaning you report your business income in your personal tax return.
You use your individual tax file number (TFN) to lodge a single tax return each year, and are taxed at personal income tax rates.
Companies must lodge an annual company tax return. They pay tax on any profits at the full rate of 30 percent, or lower company tax rate of 27.5 percent. Shareholders and directors also lodge a personal return and pay tax on dividends/earnings at the individual tax rate.
There are a few circumstances under which a sole trader would consider trading under a company structure.
Sole traders are taxed as individuals and individual marginal tax rates can go as high as 49 percent. However the full company tax rate (as at 5 May 2021) is 30 percent. So in instances where you could pay less tax by operating as a company, your business advisor may recommend that you do so.
Other tax benefits afforded to companies but not sole traders are travel allowances and research and development tax offsets.
There may also be commercial or legal reasons that trading as a company would be advantageous. If you’re planning to scale your business, taking on investors or large clients will be easier if your business is a company.
And while you’re scaling, a company structure can provide some legal protection – sole traders are one with their business, but companies are completely separate legal entities. Your legal advisor will help you weigh up the pros and cons.
Both sole traders and companies can have employees, and there are pros and cons for each structure. The structure most suitable for you will depend on the kind and size of business you’re building.
Still unsure? Seek advice from an expert. Here’s a guide to finding the right accountant for your needs.