Choosing a business structure is hard enough. So, why change it? Most entrepreneurs start with a sole trader structure but, as the business develops, see the benefit in becoming a limited company. Making the move will affect how you run your business and your obligations as an owner, so making the switch at the right time and for the right reasons is critical. Here’s what you need to know.
What is a sole trader?
A sole trader business structure is the simplest and cheapest to set up. As a sole trader, you have full control over your assets and business decisions, and fewer financial and tax obligations than if you own a company. However, you’re also legally responsible for all financial aspects of your business. That means your personal assets – such as your house or your car – can be seized to pay off any debts if the business runs into financial trouble.
What is a company?
Unlike a sole trader, companies are considered to be separate legality entities. So, as a company director, you can limit your personal liability when it comes to paying off debts, but you’ll double the number of legal, tax, and compliance responsibilities you have to adhere to. And, while you may save money on tax – a company pays tax at a different rate – you’ll have to cover the initial set-up and ongoing administrative costs of operating a company. What are the differences? There are some important differences between sole trader and company structures. For example:
- Companies are subject to an annual review by the Australian Securities Investment Commission (ASIC); sole traders aren’t.
- Companies must maintain financial records that comply with the Corporations Act 2001.
- Company directors have to lodge two tax returns – their own and a company tax return. Sole traders only lodge an individual tax return.
- Sole traders don’t pay income tax on the first $18,200 they earn. For companies, there is no tax-free threshold.
- Sole traders pay the individual tax rate that corresponds to their income. Companies pay the standard company tax rate of 27.5%.
- Sole traders may qualify for a discount on Capital Gains Tax (CGT); companies won’t.
Why change to a company structure?
You might consider changing to a company structure to:
- Limit your personal liability.
- Lower your tax liability by accessing company tax rates, as opposed to individual tax rates.
- Position your business for growth, or to attract investors.
- Access greater legal protection between yourself and third parties, such as employees or suppliers.
How to change to a company structure?
If you’ve decided that a company structure is the right move for your small business, and you understand your new role, responsibilities, and potential liabilities as a director, here’s what you need to do:
1. Cancel your existing Australian Business Number (ABN).
2. Apply for a new ABN and register for taxes via the Business Registration Service.
3. Fill out and submit a 201 Application form on the ASIC website. You’ll also need to pay a $479 application fee.
Changing from a sole trader to a company isn’t a small decision. Always seek legal and professional financial advice first, and carefully weigh up the pros and cons of each structure before you take the leap.
For more advice about how to grow your business, check out these resources.