In the second installment of this series we looked at Sole Traders, where the individual is the business. Now its time to explore the other end of the spectrum. A company is a completely separate legal entity from those who own and operate the business. A company has directors who run the business and are responsible for the day-to-day administration of the company. The ownership of the company sits with the shareholders. Anyone who has ever purchased a share on the ASX would be familiar with this concept.
When small business owners start to consider restructuring their operations the most commonly visited option is a company. They’re familiar and most business owners are aware that they offer significantly improved asset protection for business owners over the sole trader option. While asset protection is certainly on the checklist of things to think about when choosing your business structure, it is not the only consideration.The Pros and Cons of using a company are briefly outlined below.
Advantages & Disadvantages
- A company can be owned and run by one person;
- Shareholders are not responsible for company debts unless they sign a personal guarantee;
- Easier to attract capital because of limited liability;
- Companies can operate globally and own properties;
- Companies pay a flat 30% tax on every dollar of profit regardless of home much money is earned. This rate falls to 28% for small businesses;
- Relatively expensive to establish and register;
- Record keeping requirements and compliance costs are generally higher;
- Shareholders may have difficulties in recovering their investment because of limitations on who can buy shares;
- Funds taken out of the company by the owners that are treated as wages attract the usual PAYG withholding and superannuation obligations imposed on any employee;
- Companies that hold Capital Gains Tax assets do not receive the 50% tax discount for holding the asset for more than 12 months that an individual would be entitled to.
Business owners who are considering operating through a company structure must consideration Division 7A. Division 7A essentially seeks to prevent directors and shareholders of private companies from taking the company’s profits for personal use. Individuals who take ‘Drawings’ from a private company have until the lodgment date of the company’s income tax return to either repay the funds in full or enter into a loan agreement with the company. If you fail to do so you will have to pay tax on the full amount taken in the current financial year in your own name. This could mean paying in excess of 40% tax on income that the company may have already paid up to 30% on. As you can imagine if the sum taken from the company is significant this can result is a substantial tax bill.
Where to from here?
Business owners looking to shift their business operation from a sole trader into a private company can experience a number of benefits. However, there are also a number of key differences and potential issues that must be carefully managed. I’d never recommend any small business owners work through this process without seeking some sort of professional advice. Panic Atax works closely with every client we have that operate through a private company to ensure all the risks are managed and any potential issues are identified early enough to correct them.
I would encourage you to read the rest of the articles in this series. Each article explores a different structuring option and its important to understand all of them to make an informed decision.