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Setting up a company in a sole trader business structure typically works for ventures that are small, not currently making a lot of turnover and have very little personal liability.
This may include self-employed tradesmen, musicians and specialty retail stores or manufacturers that don’t have a high turnover and require little to no staff.
A sole trader business structure is simple and cheap to set up but they can often be less flexible in terms of the tax benefits available to you and can stifle further growth plans.
How does a sole trader business structure work?
Is it the right structure for me?
It’s important to speak to a qualified financial professional as to whether a sole trader business structure is the right type of ownership you need for your company.
As a general rule, it’s an ownership structure that makes sense if you’re turning over around $50,000 or less in a single financial year and have limited liability.
Certainly, turnover of $75,000 or more will see you incur Goods and Services Tax (GST), so it’s something you should factor in.
In terms of the unlimited liability surrounding a sole trader business structure, it’s the type of ownership that would best suit very small operations like tradesmen, sellers of clothing or trinkets at the local market or entertainment providers, just to name a few.
It wouldn’t be advisable to run a medical practice as a sole trader, for instance, purely because of the liability involved i.e. malpractice.
Once you start growing beyond the $100,000 turnover mark, you’ve likely acquired more assets with the profits you’ve made and you may need more staff for your day-to-day operations.
It’s at this point you may want to consider switching from a sole proprietorship to a company business structure.
What are the advantages of a sole trader?
The tax advantages include:
- Simple and cheap to set up with the Australian Taxation Office (ATO) including no registration or annual administration fees.
- Fewer reporting requirements than a company meaning you just need to complete one tax return a year using your Tax File Number (TFN) if you’re operating in your name or an Australian Business Number (ABN) if you’re trading under a business name.
- You pay tax at the same rate as if you were an employee working for a company. This is typically only beneficial if you’re making nominal turnover (less than $100,000 as a general rule). Any more than this and you want to consider switch from a sole trader to a company structure to take advantage of the lower tax rates.
- You won’t need to pay payroll tax if you don’t employ anyone else in your business.
- It’s a lot easier to declare your business expenses such as car and travel costs.
- Personal superannuation contribution tax reductions available.
- Small business CGT concessions (50% discount) and there’s also a complete exemption if you run the business for at least 15 years (other conditions apply).
Other benefits of a sole trader business structure:
- From a business perspective you have more autonomy over business decision than when it comes to a partnership or company structure.
- Business licences are often lower for sole traders than for companies.
- You can still employ staff but keep in mind that you need to have workers’ compensation insurance, make superannuation contributions and adhere to the awards and entitlements of casual, part time and full time staff.
- Any losses you make in the business can be offset against other income you earn such as your wages or income from an investment property.
- You don’t need a business bank account although you’ll be required to keep financial records for at least 5 years.
- It’s easy to change to another business structure if you decide to operate as a partnership or if you get to the point in your growth where a company structure makes more sense.
What are the disadvantages?
Generally speaking, setting up a sole trader business structure for your business doesn’t really make sense if:
- You’re currently or expecting to turnover huge profits.
- There is a lot liability in the operation including the type of work you undertake and/or the products you sell or the services you deliver.
- You’re going to have a number of employees.
Large asset base and unlimited liability
As you earn more from the business, you’re likely going to be acquiring more assets like residential property, shares, cars and artwork.
Some of these assets are income-producing while some are more lifestyle-orientated.
Ultimately though, you’re essentially putting all of this at risk in a sole trader business structure should you be sued by a customer for goods you’ve sold or work you’ve provided.
In addition to this, you have complete responsibility for all debts in the business name.
This is known as ‘unlimited liability’ and it means your assets can be seized by creditors should you be unable to meet your obligations.
Accidents can and often do happen and many times they’re outside of your control.
Of course, banks have the same recourse should you default on a business loan.
Once you start growing beyond the $100,000 turnover mark, you’re likely at a point where you need more staff to help you run the business.
This in itself adds to your liability as a business owner because you’ll need to be in charge of superannuation contributions and set up workers compensation insurance.
Other drawbacks of a sole trader business structure include:
- Inability to do revenue splitting: Sole traders often try and pay a family member a wage for doing some kind of service such as administration work or bookkeeping to avoid paying tax on part of the income they derive from the business. However, they have to be an integral part of the business. You can’t just say they help out in the office a couple of days a week if there’s no employment paperwork to back it up.
- Inability to raise capital: Unlike a company, you can’t simply issue shares to raise capital to fund your next phase of business growth. Effectively, the only “capital” you can raise is debt from either your friends and family lending you money or by applying for a business loan with your bank. We can help you do this by refinancing your residential property and accessing equity to invest in your business.
- If you choose to operate your business under a name other than your own, you must register the business name with the Australian Securities and Investments Commission (ASIC). It’s not a drawback in itself but it just means you’re under more regulatory scrutiny.
- You can’t claim tax deductions on the money drawn from the business.
- You miss out on the advantages of collaborating and sharing ideas with a business partner.
- Limited options for planning and structuring your estate: Unlike a company ownership structure, it’s difficult to transfer business ownership to someone else after your death or in the event that you are forced to sell the business (due to illness or disability, for instance). You can specify your wishes in a Will but you can’t split the capital gain from the sale of the assets between family members. If there is a capital loss, the owner’s personal assets will be put at risk.
Tips on sole proprietorships
To protect yourself against the nature of unlimited liability with a sole trader business structure, it’s usually recommended that you apply for:
- Public liability insurance.
- Professional indemnity insurance.
- Income protection insurance (if you get injured or fall ill, there’s no one who can run the business).
How to get set up
The first step in setting up a sole trader business structure is to register for an ABN with the ATO.
Unless you’re operating under your own first name and surname, you’ll need to register a business name. This costs about $34 for a year or $79 for three years.
As explained previously, you’re not required to set up a separate business account for the business but you may want to consider it.
For example, by placing your business revenue into a high-interest savings account, you can earn extra income through interest.
You can find out more information about managing your business revenue and tax considerations on the ‘Self-employed people‘ page on the MoneySmart website.
Keep in mind that you’ll be expected pay quarterly Pay As You Go (PAYG) instalments if you have reported $4,000 or more in gross business income on your last tax return.
Note: It’s essential you speak to your accountant and a financial professional when making the decision to set up shop as a sole proprietor or if you believe it’s in your best interest to switch to a company business structure.
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