Business Structures and Tax

As accounting professionals, we're commonly asked about the tax implication variations between different business structures. We take a high level overview of the tax obligations associated with the four main business structures in Australia and discuss the best structures for various business scenarios.

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The four primary business structures in Australia 

A business structure is the legal framework under which a business operates. Your choice of business structure will help define ownership and operational responsibilities, shape legal liabilities and commitments, and, of course, influence the tax and registration prerequisites. 

In Australia, there are four primary types of business structures:

1. Sole trader
2. Partnership
3. Company
4. Trust

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Sole Traders

A sole trader structure is perhaps one of the most straight-forward business structures. As a sole trader, you're the sole proprietor and manager of your business, therefore, you carry full legal responsibility for all aspects of the business. While this structure is considered straight-forward, it doesn't mean it's the best, and it's always a good idea to consider other business structures with your specific needs and goals in mind.

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Essential tax obligations for sole traders

As a sole trader, you must:

• Use your individual Tax File Number (TFN) when filing your income tax return.
• Report all income in your individual tax return, using the business items section to detail business income and expenses (sole traders don't file a separate business tax return, even if they're trading under a business name).
• Hold an Australian Business Number (ABN) and apply it to all business activities.
• Register for Goods and Services Tax (GST) if you meet the requirements. 

Additionally, if you're registered for GST, you may also need to lodge Business Activity Statements (BAS). If you have employees, you'll need to hold PAYG withholding and manage PAYG instalments. 

Sole traders can deduct salary, wages, and allowances paid to workers on their tax returns. However, deductions cannot be claimed for personal use of business funds or assets. For this reason, sole traders may benefit from keeping their business bank accounts separate from their personal finances. While there is no legal requirement to do so, it can greatly help with bookkeeping and reporting.

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Partnership Business Structure

When you jointly run a business, including sharing the business' income and losses, typically, that would be considered a partnership. Formal partnership agreements aren't necessarily obligatory, however, formalising the partnership can help provide transparency and fairness for everyone involved. A limited partnership is slightly different in that it includes partners with limited liability. This means their liability is limited to the amount of money they put into the partnership.

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Key tax responsibilities for partnerships

A partnership must:

• Obtain its own Tax File Number (TFN).
• Annually lodge a partnership return, detailing business income, deductions, and the distribution of income or losses among partners.
• Acquire an Australian Business Number (ABN) for all business operations.
• Register for GST if necessary.

Business partners individually report their share of the net partnership profit or losses in their tax returns and are personally liable for any associated tax. Money drawn from a partnership business structure isn't considered wages for taxation purposes, meaning it is not tax deductible for the partnership — the individual partner will be taxed on the drawings in their personal tax return.  

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Company Structure

A company business structure is a separate legal entity with separate tax and superannuation obligations, overseen by company directors and owned by shareholders.

Companies can distribute profits as dividends to shareholders and may attach franking credits to these dividends, allowing shareholders to receive tax credits for taxes already paid by the company on its profits.

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Company tax obligations: 

• A company is responsible for its own tax obligations. 
• Must apply for its own TFN. 
• Acquire an Australian Business Number (ABN) for all business operations when registered under the Corporations Act 2001.
• Register for GST if necessary.
• Pay tax at the company tax rate. 
• Any shareholders that the company pays a dividend to must have a distribution statement issued to them. 

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Trust Structure

A trust requires a person or entity to manage assets for the benefit of others (called beneficiaries). When a trust business structure is established for the purposes of operating a business, the trust deed usually defines the powers of the trustees and the interests of the beneficiaries.

Trust tax affairs are managed by the trustee, which can be an individual or a company. The trust's net income is commonly distributed among beneficiaries.

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The tax responsibilities of trusts 

Trusts must:

• Hold their own Tax File Number (TFN).
• Annually lodge a trust tax return, including a statement outlining income distribution.
• Acquire an Australian Business Number (ABN) for all business activities.
• Register for GST if necessary.
• Possibly file business activity statements, especially if registered for GST, with employer responsibilities like PAYG withholding or PAYG instalments.
• Pay super for eligible employees, which may encompass the trustee if employed by the trust.

Income tax payment responsibility is determined by how trust income is distributed and to whom. Generally, beneficiaries are liable for taxes on distributed trust net income. Trustees might pay taxes on undistributed income and potentially for specific beneficiaries (like non-residents or minors).

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Best Structure for a Family Business: What to Consider

Choosing the best structure for your family business involves assessing several key factors that will influence the long-term success and sustainability of the business. Here are some important considerations:

1. Size and Complexity of the Business:

If your family business is small or just starting out, a simpler structure like a sole trader or partnership might be more appropriate due to lower costs and fewer administrative requirements. As the business grows, transitioning to a company or trust structure can offer more protection and flexibility.

2. Tax Efficiency:

Different structures have varying tax implications. A sole trader or partnership might offer straightforward tax reporting, but profits are taxed at individual rates — ranging from nil up to 45% (excluding the 2% Medicare levy). Trusts and companies may provide more tax planning options, such as income splitting or retaining earnings within the business, which can lower the overall tax burden. The company tax rate is 30% or 25% for eligible companies. 

Check out our article on tax tips for trusts to see an example of how a family business uses a trust to tax-effectively distribute income. 

3. Liability Protection:

Limited liability is a significant factor for families wishing to protect their personal assets. A company structure provides this shield, ensuring that business debts don’t directly impact the family’s personal wealth. Similarly, trust structures can offer asset protection by holding assets separately from individual family members.

Learn more about how companies can be used to protect personal assets, like the family home!

4. Succession and Generational Planning:

A significant concern for family businesses is ensuring a smooth transition from one generation to the next. Trusts are sometimes favoured for this reason, as they allow for long-term planning and controlled asset transfers. Trust deeds can stipulate how and when beneficiaries will inherit assets, providing structure to the succession process.

5. Decision-Making and Control:

If maintaining control within the family is important, the structure should reflect this. In a sole trader or family-controlled company, decisions rest with a single individual or board, while a partnership requires collaboration among all partners. Trust structures, especially discretionary trusts, allow for centralised control by trustees, who manage the assets and distributions to beneficiaries.

6. Capital Requirements and Growth Plans:

If the business has significant capital needs or plans to expand rapidly, a company structure allows for raising funds through the sale of shares. Partnerships and sole traders can be more limited in terms of raising capital, while trusts may require a more complex arrangement to bring in outside investors.

Find more information on how to finance business expansion with debt and equity financing. 

7. Regulatory and Legal Obligations:

Company structures come with higher compliance obligations, including financial reporting and corporate governance. Trusts also require legal and financial oversight. Weighing the administrative burden against the business’s complexity and size is crucial when determining the right structure.

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Consulting a Professional

Given the complexities of family business structures, seeking professional advice is essential when looking for the right business structure. The right structure can provide the necessary foundation for growth, succession, and protecting family wealth, while the wrong choice could expose the business and family to unnecessary risk.

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What is the best structure for a business turning over more than $1,000,000 a year?

For a business turning over $1,000,000 a year, selecting the right structure is crucial for managing tax efficiency, liability, and growth potential. A company structure is often a strong choice for businesses of this size, as it provides protection via limited liability, protecting personal assets from business debts. It also allows for greater flexibility in raising capital and attracting investors, which can be important for future expansion. Additionally, the company structure offers tax advantages, such as income retention within the business, which can be taxed at the corporate rate rather than higher individual rates. A discretionary trust might also be considered, as it allows for strategic income distribution to family members, potentially reducing the overall tax burden while protecting business assets. Consulting with an accountant is essential to tailor the structure to the business’s specific needs and future goals.

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How to choose the right legal structure for your business 

As you can see, there is more to consider than purely tax consequences when it comes to establishing the correct business structure for your operation. We are happy to help you understand the different tax consequences and other implications of the different structures to find the best fit for your business. 

If you need assistance in understanding your tax obligations or want to assess if your current structure is right for you, talk to the team at Bonerath & Co. today!

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