Sole trader, partnership or company?

What the choice decides

business.gov.au lists what a structure can determine: the licences you need, how much tax you pay, whether you are considered an employee or the owner, your potential personal liability, how much control you have, and the ongoing costs and paperwork. The choice is not permanent. You can change structure as a business grows, though the ATO notes that a change can bring costs, tax implications and other obligations.

Here is a selection from business.gov.au’s own side-by-side comparison, which also covers cost, complexity and tax and legal obligations. The full comparison is on its page.

A sole trader

business.gov.au calls a sole trader the simplest form of business structure, relatively easy and inexpensive to set up. The sole trader is legally responsible for every part of the business, including its debts and losses. In its words, a sole trader “has unlimited liability and all your personal assets are at risk if things go wrong”.

For tax, a sole trader uses their individual tax file number and reports business income in their own tax return; there is no separate business return. A separate business bank account is not required, though business.gov.au recommends one, and records have to be kept for at least 5 years. The money a sole trader takes out of the business is a personal drawing, not a wage.

A partnership

A partnership is 2 or more people who manage a business and share its income or losses. It needs its own ABN and tax file number, and lodges a partnership tax return every year, while each partner pays income tax on their own share. The partnership itself does not pay tax.

In a general partnership, the most common type, every partner has unlimited liability for the partnership’s debts. Limited partnerships and incorporated limited partnerships also exist, and both are registered with a state or territory government. Each state and territory has its own partnership law.

A written partnership agreement is not compulsory. The ATO points out that without one, income and losses are shared equally between the partners.

A company

A company is a separate legal entity: business.gov.au says it “has the same rights as a natural person and can incur debt, sue and be sued.” As a member, your only financial obligation is to pay any amount unpaid on your shares if the company calls for it. Directors are another matter: if they are found to have breached their legal obligations, they may be held personally liable.

Three practical differences follow from the company being its own person.

• The money is the company’s. Even if you own all the shares, the money it earns belongs to it. The company may pay you, as a director, wages or directors’ fees, but you cannot take money out of it as personal drawings.
• Some debts can still reach a director. business.gov.au says directors are personally liable for pay as you go withholding and superannuation debts, and remain liable for the period they were a director even after they stop. The ATO calls these the director penalties rules.
• There is more to keep up. A company lodges its own annual tax return, completes an annual review with ASIC and pays a review fee, and every director needs a director ID.

business.gov.au describes companies as expensive and complicated to set up, and says they “generally suit people who expect their business income to be highly variable, and want the option to use losses to offset future profits.” The most common type for a small business is a proprietary company limited by shares, whose name ends in “Proprietary Limited” or “Pty Ltd”.

A trust

In a trust, a trustee holds the business for the benefit of others, the beneficiaries, and decides how profits are distributed. The trustee can be a person or a company. business.gov.au says trusts are expensive and complicated to set up, need a formal trust deed, and can be difficult to dissolve or change, and it suggests seeing a qualified, licensed professional first.

Starting small and becoming a company later

business.gov.au says that as a business grows you may decide to move to a different structure, and it sets out the move from sole trader to company in three steps: register the company, transfer licences and assets to it (including trade marks and other intellectual property), and deal with the old ABN. A sole trader’s ABN can’t be transferred to the new company. If you have been using it to run the business, it has to be cancelled, after you meet your lodgement, reporting and payment obligations, and cancelling it also cancels registrations such as GST.

Where to get help deciding

business.gov.au has a tool to work out your business registrations, which also helps match a structure to your needs. Before committing to a structure, it suggests advice from a professional business adviser, lawyer or accountant; the ATO adds a registered tax agent to that list.

If a company is the answer, the next step is registering it with ASIC.