One of the most common questions asked by small businesses and entrepreneurs everyday, is whether to trade as a company or as a sole trader. This decision impacts on business relations, tax, legal and financial aspects of the business and deciding between the two will depend on your own personal situation and the future plans for the business.
To help you make the right decision, below is some general information outlining the most important differences. First, lets define the two structures;
- A sole trader is defined as an individual trading on their own, where you can either trade under your own name or register a business name.
- A company is defined as a legal entity that is separate from its shareholders (owners) and directors of the company.
Setting up as a sole trader is very easy, with zero to minimal setup costs. You simply register an Australian Business Number (ABN) and you trade under your own name, ie John Smith. If you want a business name with a little more pizzazz you can register a business name with the Australian Securities and Investments Commission (ASIC) so you can trade as something like ‘John’s Fantastic Web Design’.
To setup a company you lodge the company with ASIC. They currently charge $457 to register a company and will provide you with an Australian Company Number (ACN). To help make the process simpler, you would typically use a company registration service that allows you to register your company online and also completes all your required legal documentation, which ASIC don’t provide. A company must also have its own ABN and tax file number (TFN) to trade.
Sole traders have unlimited liability. This means the law can’t distinguish between yourself and your business, so if your business is in trouble you will be held personally responsible for any outstanding legal and financial costs, potentially putting your personal assets at risk.
A PTY LTD company (the most common type) restricts the liability of shareholders for the debts of the company to the price paid for their shares. In most cases, shares are fully paid which means the liability of a shareholder is zero. Directors for the most part, also have zero liability unless they continue to let the company trade while insolvent.
Income & Tax
Any profit or income earned as a sole trader is treated as your own personal income and the tax paid will depend on the individual’s marginal tax rate. As a sole trader you are also allowed to offset any losses from another source of assessable income that you may have (restrictions apply).
As a company requires it’s own ABN and TFN, a separate tax return must be lodged. A company is subject to a flat 30% company tax and doesn’t enjoy a tax free threshold like an individual. However a company can be much more flexible in structuring how profits are distributed or retained, which could result in tax advantages. A company is also much more flexible in obtaining investment from outside parties by offering shares.
Generally, if its just you and you want to minimise your upfront costs while proving your business idea, you would begin operations as a sole trader and change to a company later on if you need to. If you’re pretty sure that you will be bringing on partners or expanding in the future, then it would be worth the bit of extra effort upfront to register a company from the get go.
Either way, you should always seek professional advice from an accountant or lawyer to help you decide on the best business structure for your business.