There are many reasons that businesses choose to change their trading structure from a sole trader to a company. The tax benefit is the obvious one. If your business is steadily growing and has had a good financial year, it may be time to consider the switch. However, there are other factors to consider.
If you are a ‘Small Business entity (SBE)’ – that is a business with turnover (gross sales) less than $10 million in a financial year – when does it make sense to change your business structure?
Tax benefits of changing to a company structure
With a sole trader structure, ‘the magic taxable income number’ is $107,550. Once your taxable income (profit with tax adjustments) reaches this figure, you’ll start to pay more tax than a company would. This is because sole traders are taxed as individuals at marginal rates on a sliding scale.
With a company structure, your business would qualify for a flat company tax rate of 27.5% and your profits would not be taxed at a rate higher than this, hence you will pay less tax above $107,550.
Other reasons to change from a sole trader to company
You may want to change to a company structure even before hitting this magic taxable income number for these reasons:
- A company structure protects your personal assets
Sole traders are personally liable for financial or tax debts as there is no division between business and personal assets (including joint assets such as cars and houses). With a company structure, your family assets are separate from your business and cannot be touched by creditors. For this reason, many businesses, especially ‘riskier’ ones, are established with a company structure from startup.
- Contracts require a company structure
If your business contracts to another business, sometimes it will be a requirement in your contracts that you operate as a company structure.
- Your management or ownership changes
If you are taking on a business partner or wanting to bring on investors, you will want to separate your ownership interests. A company structure allows you to do this.
- Your business is expanding or changing operationally
If you are looking to expand overseas and change your market focus or operations, a company structure can be preferable.
Sole trader vs company factors to consider
In addition to these advantages, there are other implications to be aware of before making the change.
- Depending on ownership, tax may be payable
‘Small Business Rollover Relief’ allows sole traders to move to company structures without incurring a tax liability. However, this is providing the ownership of the business does not change. If it does, the company may need to ‘buy’ the business from the sole trader and will potentially incur capital gains tax.
- Setup and ongoing costs are higher for a company
Set up and ongoing operating costs for a company include registrations for the company and the business name and opening separate business bank accounts. There are also extra compliance costs to consider, such as preparation of separate company financials and tax returns, wages/payroll for BAS lodgements, and annual ASIC fees.
- Implementing the change takes time
Moving to a company structure means making lots of changes so ensure you allow a decent transition time. For example, you’ll need to set up your new company bank accounts and credit cards and notify clients to update their payment systems; set up new ABN, TFN, GST and PAYG registrations; reissue or update contracts; and transfer the ownership of professional memberships to the new entity.
- New responsibilities as director of a company
Directors of companies also have additional legal obligations because companies are under the rules of the Corporations Act 2001. Directors’ responsibilities include avoiding conflicts of interest, preventing the company from trading when insolvent and reporting to a liquidator if the company gets wound up. You are also required to keep accurate financial records, pay fees to ASIC and notify ASIC of key changes.
- Getting money out of the company
As a sole trader, you can withdraw any extra cash as personal drawings with no tax consequence. Your business profit (sales less expenses) is simply your taxable income reported for tax purposes. Under a company structure, generally you would become an employee of the business, start drawing a wage or directors fee, and pay superannuation and insurances. Any personal drawings taken from your company bank accounts over and above your reported wage would typically be classified as dividends paid to yourself (or loans to yourself) and this has tax implications.
As you can see, making the move from a sole trader to a company can be complex and need specific advice and planning with your accountant. We would be happy to assist. Please contact your Accru advisor to find out more about whether changing to a company structure would be beneficial for your business.