Are you ready to step up from a sole trader to a company?
This is AMM's second guest post! I do not often allow guest posters, this means you know when there is one it is of quality. Today we touch more on the business side of AMM and discuss the move for entrepreneurs from sole trader to company!
Getting started in business usually means setting up a sole trader structure from day one. The simple and cost-effective nature of this business structure is what makes it so appealing to entrepreneurs across Australia, as well as the full control it gives the owner.
The downside to this, however, is that operating as a sole trader means you as the business owner are personally liable for every aspect of your business, including debts – meaning personal assets such as your home or car may be used to pay business debts.
If you’ve been in business for a while and are looking to grow, it may be worthwhile looking at changing up your business structure. This can limit your personal liabilities; allow you to bring in more employees; protect your business in the event of your illness or death; and even help you involve third parties willing to inject funds into your business to promote further expansion and growth.
Sole traders who switch their business structure often establish a company. Making the move will affect how your business operates and your legal obligations, and it’s important to ensure you understand the differences when deciding if operating your business in a company will meet your individual and ongoing objectives. Below is a summary of some of the key differences between the two:
Income from a sole trading business is treated as your individual income, therefore you have full access as the owner to draw on all funds in any business account. Holding a business bank account separate from your personal account is not compulsory for a sole trader (but is generally advisable). Also, maintaining complete and accurate receipts and records as required allows you to claim a tax deduction for any costs incurred in operating your sole trader business.
Conversely, any income earned by a company belongs to the company, and a separate bank account is mandatory when operating in this type of structure. The directors of a company may be paid a directors fee (or wages), but may not withdraw money from the company’s bank account as drawings. Similarly, shareholders in a company receive income in the form of dividends.
A common reason people get into business is to be their own boss – so it makes sense that sole traders make all the decisions and have full control over their business operations. However in a company, shareholders appoint directors to make those key decisions, and in situations where more than one director is appointed, all directors have a say in how the business is run. They will also be subject to the rules in the Corporations Act 2001. Shareholders may vote on major decisions about the company, usually in accordance with their shareholding amount. In private family companies, the directors and shareholders may be the same or associated persons, so a degree of control is still maintained.
As a sole trader, you are personally liable for all aspects of running the business, including financial and tax debts, and your liability is not limited in any way. Simply put, your business and personal assets are on the line if significant business debt builds up. A company, on the other hand, is treated as a legal entity, separated from its shareholders, and therefore liability is limited (generally to the extent of its assets). Shareholders liability is limited, and they are not responsible for debts incurred by the company (except for any unpaid capital on shares issued to them).
Directors also enjoy a degree of limited liability, unless they’ve signed any personal guarantees. Personal liability is only an issue if the directors allow trade to occur whilst their company is insolvent; or they act fraudulently or negligently. Directors may also be personally liable for certain tax debts incurred during the period of their directorship, and this liability continues even if they cease to be a director of the company.
Both sole traders and companies can employ staff members, and both are required to have workers’ compensation insurance; meet tax and super obligations; and fulfil employee entitlements.
Companies need to ensure they are lodging and paying Pay As You Go (PAYG) and Superannuation Guarantee Charge (SGC) on time, as the directors are personally liable for these and can be penalised for any unpaid or unreported amounts.
Here’s a tough question that many people avoid: If you were to pass away or be forced to stop work through disability or illness - what would happen to your business? For a sole trader, your business would simply cease upon your death and any assets (and liabilities) would be dealt with in accordance with your will, assuming you have one. Unfortunately, this may not provide your loved ones with the financial security you might have hoped for.
On the other hand, companies enjoy what is called ‘perpetual succession’. Even after directors and shareholders pass away, the company continues to operate, and shares in a company may form part of a will.
Other things to consider
There are costs involved in both forming and running a company. Companies are more closely regulated than a basic sole trader structure, requiring a higher level of record keeping and periodic bookkeeping/accounting to ensure continued compliance. The Australian Securities and Investment Commission (ASIC) also charges an annual fee to all registered companies.
These costs should be weighed up against the ongoing benefits a company structure could produce, even though they are greater than maintaining a sole trader structure. No matter which path you take now, be sure to take into account your goals over the coming years before taking the plunge.
Nigel Plowman, Director, McKinley Plowman
Prior to forming McKinley Plowman, Nigel specialised in management consulting and international accounting, enjoying success in Australia and in the United Kingdom.
His extensive experience in management consulting, international accounting and innovative tax structures has been a major driver in the success of McKinley Plowman as well as the many businesses he has steered towards new levels.
Nigel is dedicated to fast-tracking his client goals with cutting edge tax and business strategies. He is a member of the CPAs and the Taxation Institute of Australia and enjoys developing tax strategies that work well here and around the world.