Changing from a Sole Trader to a Company or Trust
When deciding on the most appropriate business structure we look at 4 main areas
1-asset protection (priority #1)
2-income tax minimisation
3-capital gains tax minimisation
4-succession planning
Asset Protection
Do you have assets that are worth protecting from creditors eg family home?
Lets say your home is owned 50:50 by you and your spouse and it's worth $1,000,000 and your loan is $400,000
Total equity is $1,000,000 - $400,000 = $600,000
Your 50% share = $300,000
I would argue that it is worth spending the money to add the extra layer of protection to protect your $300,000
Once off cost to setup a trust with company trustee is $3,300*
Once off cost to setup a company is $1,980*
Annual running costs include
- ASIC fee $320*
- Company management fee $220*
- Annual tax return fees from $2,200*
* Prices are subject to change
Running your business through a company OR family trust with a company trustee offers 'limited' asset protection in that the company is usually sued first. Assuming the company is unable to pay its debts then the creditor may be able to sue you personally but in most cases they can't.
Note that the ATO can issue director penalty notices (DPN) to the directors which makes them personally liable for the company / trust debts.
If the director gives a personal guarantee then they will be liable for the debt.
Income Tax Minimisation
Sole Traders
Sole traders are taxed on business profits at individual marginal tax rates. So the more you earn the more you pay.
Here are the ATO individual tax rates
Companies
Base rate entities (BRE) are taxed at 25%
All other companies are taxed at 30%
Wages are paid to the business owners / directors
If the shareholders want to take the after tax profits then they could pay themselves a dividend (the dividend will need to be grossed up for any tax paid but the shareholder will receive a credit for the company tax back so they don't end up paying tax twice)
Example:
Profit $100,000
Tax ($25,000)
Leaves $75,000 in the bank
$75,000 dividend paid to the shareholder is grossed back up to $100,000
Shareholder is taxed on the $100,000 at marginal rates but receives a credit of $25,000
Trusts
Generally trust income is distributed to family members per the trust deed
The ATO has changed the rules over the years
Business profits can only be distributed to the owners and not children or other family members unless in limited circumstances
Captial Gains Tax Minimisation
Sole Traders
Sole traders are taxed on capital gains at individual marginal tax rates
You may be entitled to reduce the capital gain by
- the 50% CGT General Discount provided the asset is held for more than 12mths
- the 50% active asset test (small business only)
For example- If you were to sell your business or client list for say $200,000 your would pay tax on the capital gain being $200,000 less cost of $0 (assuming you started the busines from scratch) less any discounts
Companies
Companies are taxed on capital gains at company tax rates
You may be entitled to reduce the capital gain by
- the 50% active asset test (small business only)
Companies are NOT entitled to the 50% CGT General Discount
Trusts
Capital gains are distributed to the beneficiaries and taxed in their tax returns less any discounts
Succession Planning
Sole Traders
Business sale - you can sell the assets (goodwill / customer list, plant & equiment, motor vehicles and stock)
Business Partners - you cannot add a business partner - you will need to change structures
Companies
Business sale - you can sell the assets (goodwill / customer list, plant & equiment, motor vehicles and stock)
You can sell the shares to another entity but there are risks so it's not normal practice
Business Partners - you CAN add a business partner
Trusts
Business sale - you can sell the assets (goodwill / customer list, plant & equiment, motor vehicles and stock)
Business Partners - you cannot add a business partner - you will need to change structures
Other Considerations
- protection against creditors
- appearance to potential customers
- some business will not deal with sole traders