One of the most important choices you make when starting a new business, is the type of legal structure you select for your business.
Your choice will impact:
- Formation cost and ongoing administration
- How much tax you end up paying
- The amount of record keeping which is required by your business
- The impact on your personal liability
- The effect it has on your ability to raise money
- Future needs
- Asset protection
To further illustrate the impact of your choice of appropriate business structure, read below a real case study from our files –
Mr Joe Block* was running his carpentry business as a sole trader. He has 3 employees and made a net profit in excess of $180 000.
Disadvantages for the current structure as follows:
- Personally liable for all debts of the business.
- Unlimited liability of the owner
- No legal separation between business and private assets (personal assets are available to creditors/banks to meet the debts of the business)
- Taxation – all business profits taxed in the hands of the owner at marginal tax rates (up to 47%)
After reviewing Mr Block’s situation, we set up a company for him and managed to roll over his sole trader business into a private company structure. Although there are initial costs and higher annual fees payable,
The advantages for Mr Block are as follows:
- Separate legal entity from that of directors and shareholders, therefore reduced responsibility of business debts and other liabilities.
- Because a company is legal “person”, there is more flexibility in managing business affairs.
- Profits can be retained and capped at the company rate of 28.5% for small business entities.
- There is the option to reinvest profits in company or to pay out as dividends to shareholders, therefore flexibility in distributing profits to shareholders.
- Dividends can be fully franked, so franking credits (tax already paid by company), will reduce the shareholders tax liability.
- Tax deduction is claimable for the director’s wages and other salary costs.
* name has been changed
On a final note:
The choice of business structure should only be made after due consideration of the advantages and disadvantages of various business entities and consultation with a business expert.