Business is no longer a case of go big or go home. There are now over 2 million small businesses in Australia, and the rise of social media and digital marketing means you can go from zero to business-owning hero in a matter of hours. Yay!
But how does this look from a tax perspective, and how do you go about setting up your shiny new business idea with the ATO? With more and more people deciding to give their own business a crack, it’s time we broke down the business tax and setup essentials you need to know.
When you need to register as a business
Knowing when you’re operating as a business can be difficult if your activity initially began as a hobby. If you started making scrunchies for your kids and now your velvet masterpieces have become the talk of the town, you may be responsible for setting yourself up as a business.
Essentially, if you intend to make a profit from your activities and you’re operating in a commercial manner, you’ll need to register as a business and pay taxes on your profits. It sounds super boring, but paying tax means you made a profit – go you!
Getting an ABN and registering a business name
The first step in setting up a business in Australia is to obtain an Australian Business Number (ABN). You’ll also need a Tax File Number (TFN) if you don’t already have one. You can find out through your MyGov account. Your ABN is your business’ unique identification number, and is how the ATO keeps a record of your business’ income.
Choosing a business structure
When setting up a business, you need to choose a business structure. Your business structure will determine how and when you pay taxes, and certain entitlements you can access. Don’t stress, you can change your structure if you need to but getting it right and choosing an appropriate structure for your first couple of years in business will save you time and a ton of stress!
Option 1: Sole Trader
A sole trader is the simplest and lowest cost business structure to set up, and is a common choice for small businesses starting out. As a sole trader, you’re an individual running a business by yourself, and you pay tax at your individual marginal tax rate, which is the rate you’d pay if you earned the income through employment.
Pros of being a sole trader
There are many benefits to being a sole trader, including:
- You don’t have to register for and collect Goods and Services Tax (GST) until you’re earning over $75,000
- There are generally fewer reporting requirements
- All your tax is reported on an individual tax return – so you only need to file one, phew
- It’s generally the cheapest business structure to operate
- You can employ people within your business
- You’re not required to set up a separate business bank account (though it’s recommended)
Cons of being a sole trader
There are some important considerations to being a sole trader, including:
- As a sole trader you are individually responsible for paying the tax owed on your business profits
- There is unlimited liability against your personal assets – that means if your sole trader business was sued or went bankrupt, your personal assets like your home and savings could be used to pay the debts
- Once you earn over a certain amount (usually around $110,000), you may be paying far more tax as a sole trader than another business structure.
The bottom line: many small businesses start out as sole trader business structures and eventually become a company once the business is more established. Sole trader structures are a simple and easy way to get started in business with relatively low costs, providing you’re aware of the risks associated with your personal asset liability.
Option 2: partnership
A partnership structure operates with similar rules to sole trader structures, but allow multiple owners to run the business together. Partnership business structures are relatively simple and inexpensive to set up, and can be well suited to family members, friends or colleagues going into business together. Got some mates and a business idea? Listen up.
A partnership can be a general partnership, limited partnership or an incorporated limited partnership. General partnerships are popular among business owners who want to run the business together on an equal basis and share the responsibilities and the unlimited liability equally between them. Limited partnerships or incorporated limited partnerships allow for different people to have different levels of responsibility within the business, and load all of the unlimited liability onto individual partners.
Pros of setting up a partnership
There are many pros to setting up a business as a partnership:
- Partnership structures don’t have extensive reporting requirements
- Low setup and running costs
- Income and losses are split between partners as individuals
- You don’t have to register for GST until the partnership earns over $75,000
- The partnership itself doesn’t pay tax. All tax is paid by the partners as individuals at their marginal tax rate, depending on the net income they receive.
Cons of setting up a partnership
There are some drawbacks to setting up a partnership:
- Like a sole trader structure, there must be at least one partner responsible for the unlimited liability against the business. This means that one or all of the partners could be held responsible for debts or owings that the business incurs
- Partners must decide and agree on how unlimited liability will be distributed.
- The complexities of running a business with other people can interfere with personal relationships
- Partnerships are governed on a state level, which may be confusing for partnerships run by individuals in different states
The bottom line: setting up a partnership business is a great way for multiple people to run a business together with very low setup costs and minimal reporting. Much like a sole trader structure, some businesses may begin as a partnership and eventually evolve to become a company in the future.
Option 3: company
A company is a more complex and expensive way to set up a business in Australia. When you set up a company, you and your business are separate entities, which means all income earned through the business belongs to the business, and not immediately to you. But, that brings some attractive tax benefits!
Pros of setting up a company
There are a few reasons why setting up a company may be a more favourable option for your business. These include:
- Company directors have limited liability, which means unlike sole traders, you as an individual cannot be held personally responsible for paying the company’s debts. This is often appealing to businesses that may take out loans, or for business owners who own assets that they want to protect.
- Tax is paid at the company tax rate (which is currently being reduced year-by-year to reach 25%). This means that high-earning businesses can pay less tax than if that income was earned by an individual, as you’ll pay a flat rate of tax rather than individual marginal rates, which are as high as 45%. Ouch.
- Company structures are often well suited to businesses that plan to scale and grow. Being a company may make it easier for you to obtain the funding you need to expand your operations.
Cons of setting up a company
As with all tax structures, there are some important factors to be wary of before you set up a company:
- The setup and running costs are substantially higher than for sole traders or partnerships, and require the input of an experienced accountant
- Your reporting requirements are more labour intensive than other structures
- As a company director, you must comply with the Corporations Act (2001) and keep on top of the compliance associated with running a company. Fear not, a great accountant can help you with everything!
The bottom line: in many cases, companies are set up following a period of time spent operating as a sole trader or partnership, though it’s not uncommon for businesses to go straight for a company structure. Starting a business in Australia as a company structure tends to be better suited to businesses that require lending or investment, and that plan to grow and scale very quickly.
Option 4: trust
Trusts are complicated, but essentially they’re a way for you as a business owner to own the shares of your company. Owning them through a trust can affect the way you pay tax. Setting up a trust in Australia involves a trustee becoming a legal entity for the purpose of controlling and distributing assets to beneficiaries.
Pros of setting up a trust
There are many reasons why a trust may work for you. These include:
- Trusts can deliver tax benefits by reducing a business owner’s tax obligations as an individual, for example when dividends are paid through the trust. Families or couples may use trust structures as part of their tax planning
- Trusts can work well for business partners to manage their ownership of their shares
- A trust may also be able to limit liability and protect your shares if you breach the company director duties and become liable for a company debt
Cons of setting up a trust
Trust structures are very complex, and require considerations like:
- Trusts require complex legal compliance, which can be costly and time consuming
- Setup can be expensive
- There are annual administrative tasks that the trustee must carry out
The bottom line: trusts are a very specific structure that aren’t right for every business owner. If you think a trust may be appropriate for your business, speak to your accountant for dedicated support tailored to your own circumstances. If you’re looking for support in setting up your business and help with knowing your GSTs from your TFNs, contact us. We can assist you with everything from getting started to ongoing tax compliance for your business, and help you get the most out of your new business. For us, it all starts with you.