There are a number of alternative structures through which business can be conducted. Choosing the most appropriate structure for your business requires careful thought. Below we overview some of the most commonly asked questions and key matters to be considered.
Why does it matter what sort of entity I operate?
The operating structure determines a business’s legal, financial reporting, auditing and taxation status. To assist with the future growth and development of the business while meeting the various needs of its owner(s), the operating structure requires careful selection to avoid the need to amend it at a later date that may be difficult and expensive to implement due to legal costs and taxation implications.
What are the most common options?
- Self employment as a sole trader
- Partnership
- Company
- Trading Trust
What are the main advantages and disadvantages of these structures, and the rate of income tax applicable?
Self employment / Sole trader
| Advantages | Disadvantages | Income tax rate |
- Simple to set up, and at minimal cost
- Financial statements are not required but accounts are needed to calculate assessable income
- Any tax losses can be carried forward indefinitely
| - Unlimited liability. The individual will be personally liable for all debts if the business fails
- Not a separate legal entity
- Often difficult separating personal from business
- Can only sell business through sale of assets - GST and income tax consequences
| Individual marginal rates
Current annual rates:
19.5% $0 to $38,000 33% $38,001 - $60,000 39% Over $60,000 |
Partnership
| Advantages | Disadvantages | Income tax rate |
- Sharing of knowledge, skills and resources
- No limit on the number of partners
- Limited opportunity for income sharing
| - All partners have joint and several liability for any debts
- Not a separate legal entity
- Can only sell business through sale of assets – GST and income tax consequences
| Income distributed to partners and taxed at the individual’s marginal rates
(refer above) |
Company
| Advantages | Disadvantages | Income tax rate |
- Liability is limited to amount payable on shares (although personal guarantees may extend this liability)
- Can raise finance by selling shares
- Can sell investment by selling shares
| - Administrative requirements
- Directors may be held personally responsible
- Legal requirements – Companies Act 1993
- Tax losses retained by company (unless “Loss Attributing Qualifying Company” or LAQC)
- Increased level of taxation compliance requirements.
| 33% * |
Trading Trust
| Advantages | Disadvantages | Income tax rate |
- Opportunity for income splitting
- Asset protection and preservation
- Will appear commercially as a company if a company is appointed as the trustee
| - Trustees have unlimited liability (the trust deed may contain an indemnity)
- Can be costly to establish
- Requires ongoing administration
- Can only sell business through sale of assets – GST and income tax consequences
| 33% on trustee income *
Beneficiary income taxable at individuals marginal rates (refer above) |
* From 1 April 2000 there is a new tax avoidance rule that seeks to prevent the sheltering and splitting of personal services income by attributing income derived by an entity to the individual service provider. The attribution rule only applies where the interposed entity is associated with the individual service provider. Where 80% or more of the income is derived from one client (or associates) and through services personally performed by the individual service provider (or associates) the entity must attribute the income to the individual. To apply, the individual’s net income must be more than $60,000 after any attribution, and an exemption applies where substantial business assets are a necessary part of the business structure.
What should I think about when considering which entity is best to conduct my business activity through?
- Your present circumstances
- Your commercial objectives
- The risks of the venture
- The level of control you desire
- The taxation implications of holding the investment through that entity
- The taxation implications of profit and any future sale of the investment
- The funding arrangements
- Whether the business is new or already established
- The administration requirements and costs
- The expected continuity of the structure
- The internal structure ie, employees? who will manage the entity?
How easy is it to transfer from one structure to another?
This depends on the circumstances and can range from relatively simple (such as the sale of shares in a company) to more complex (such as the transfer or sale of assets). Each scenario has its own taxation implications, therefore you should consult your tax advisor or
David Dorrington at PricewaterhouseCoopers for detailed information.
