If you want to start or purchase a business - or have an existing business - you may want to know the best ownership structure for you to use. We'll talk about the three main business structures in Australia and NZ - sole trader, partnership and company - over the next three articles and please email us if you want to know more.
The first is that you don't have to stick with the same structure - you don't have to form a company to buy a company, for example. A company can buy a partnership, a sole trader can buy a company and so on. Or, if you're currently a sole trader, you can turn it into a company; a company can be wound down and turned into a partnership. There is, of course, cost and hassle in making these changes so let's get it right, now, and have your money and effort directed at productively running a business.
Personal Liability
A sole trader is you, the owner and the person. Therefore a sole trader is a legal entity because the law recognises you - you can sign contracts, sue and be sued, own property, take out loans, have bank accounts and so on. Partnerships are not legal entities and cannot do this - we'll cover that next week.
So, you start or buy your business, paying from your personal bank account or a separate business account and, from whatever account you use, you make business purchases - assets and expenses. This is exactly like making private purchases.
If you don't repay your mortgage, the mortgagor can sell your house and then sue for any shortfall and you can lose other personal assets.
The same with your business: if your business spending is on credit and you don't pay, the creditor, lender, mortgagor or bank can sue you and get the court to take your personal and/or business assets. Because the business is you, the legal system doesn't see any difference between your business and your personal assets. Companies avoid this problem and you can read about that here in two weeks.
Taxation
As you are your business and it is you, legally, so the business income is yours. Whatever profit (or loss) you make from your business, it's added onto your other income. So, if you have interest and other income of $10,000 and your business makes a profit of $30,000, your taxable income is $40,000 (10,000 + 30,000 = 40,000). If your other income was $40,000 and your business made a $25,000 loss, your taxable income would be $15,000 (40,000 - 25,000 = 15,000). Simple maths.
The disadvantage of this is that all the business income (or loss) is yours - you cannot spread it to other members of your family to reduce tax, as you can with a partnership or company.
Your business's Tax File number will be your existing personal tax number.
Any business in Australia has to have an Australian Business Number (ABN) so you'll need to get that [not applicable in NZ]. You have to register for GST if your gross income is going to be over $75,000. You can do this on the ABN form.
You Trade Alone
When you die, the business ends, unless you provide for the assets to be passed on in a will. You can't pass on your shares in the business as you can with a company.
You can only borrow money against your personal assets. A company gives you more access to finance and we'll cover that in two weeks time.
Summary
As with every ownership structure, there are advantages and disadvantages. Above, we explained the three main issues and below is a summary of the advantages and disadvantages of a sole trader ownership structure.
Advantages of Sole Trader
- Low cost of entry - no company set-up costs.
- Easy to set up - it's only you.
- Few legal costs.
- Only one tax return required - cheaper accounting fees.
- No registration of name required (if trading under your own name).
Disadvantages of Sole Trader
- Personally liable for business debts.
- When you die, the business dies.
- Cannot split income out to other family members to reduce tax.
- Limited access to business finance.
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