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Different business tax structures

When wanting to start a new business or take over an existing business, we need to consider the most appropriate business tax structure (ie a company, trust, partnership, or sole trader).

Sole trader or partnership

1. If you are just starting a small business where income maybe about $100k or less, or it may be like a part-time business or not sure you will still be running the business in two years time, we will usually set up a sole trader if it’s just yourself running the business (or a partnership if there’s two of you running the business).
2. The structure set up costs and time are a lot lower than compared to a company or trust.
3. Annual tax return costs are a lot lower than a company or trust.
4. Profits stay in that person‘s name and tax paid at personal tax rates.
5. The risk with sole trader or partnerships is that the business is your name, so you can personally be liable for any risks in the business (opposite to protection that a company or trust provides).

Trust

1. Normally, a trust a set up when it’s a bigger business that you believe will be longer-term and want better tax strategies and minimise any personal risk issues.
2. A trust doesn’t pay tax on profits, but allocates the profits to the family group, then those family individuals pay tax on the profit allocation. Which the advantage of this is that profit allocation can change from year to year, depending on what the person’s income position is for that year (ie – at uni, or time off for a baby, etc).
3. A trustee (like a manager) has to be noted for the trust, which can be a person, but to minimize personal risk , usually a company is set up as the trustee of the trust.  Which this company has no assets, doesn’t trade or have any income (so its still the Trust as your business tax structure).

Company

1. We would normally organise a company tax structure, when business profits are expected to be over $200k in profits each year (Note: profit = income less expenses).
2. As the company may be able to defer or minimize tax, by spreading out company dividends to the shareholder, over a number of years.
3. Company pays 25% tax on profits retained in the company.  If the director/owner takes money/profits from the company (outside of their wage), these profits get allocated out as a dividend to your personal tax return. Dividends come with the 25% company tax that the company has to initially pay, which you then personally have to pay ‘top-up tax’, being the difference between 25% tax and your personal tax rate. Example is when somebody’s tax rate if 32% – so company pays 25% and shareholder pays 7% top-up tax to get to 32%.
4. Companies can also be advantageous when business profits are retained by the company to help fund stock levels or equipment.  As the profits are taxed at 25%, so there is still 75% to retain and use by the company.
5. A company nominates who the shareholder is when company is set up, which we usually recommend a family trust, so the company profits can be paid as a dividend to the family trust, and then the dividend in the trust can be allocated and paid to family members how you choose to (depending on what people’s income levels are in that year), to help minimize tax.
6. Companies usually cost a bit more to have each year compared to trusts, but the potential tax savings can outweigh that when profits are high.

As you can see there is a lot to consider,  you really need to speak to your accountant before starting the business to make sure you are set up the right way from the beginning.  As time goes by your circumstances may change so you may need to reassess if that structure is still the best option for you.

By Patrick Hoey