Business Structures - Which one should you choose?

by The FindLaw Team

How do you decide which is the most appropriate structure for your business? Each type of business structure has different advantages and disadvantages. Some of them are explained below.

Sole Traders

Running your business as a sole trader has several advantages.  The main advantage is simplicity. Sole traders are individuals who trade under their own name, or under a business name, without setting up a formal legal entity such as a company, partnership or trust. Operating your business as a sole trader avoids the costs and formalities involved in establishing and operating a separate legal entity. From a tax perspective, if you operate your business as a sole trader, your income is taxed at progressive individual tax rates. 

The most significant disadvantage of running your business as a sole trader is that your liability is unlimited.  In addition, operating as a sole trader can make it more difficult to split your income with other family members who may be involved in your business. From a tax perspective, if you operate your business as a sole trader, your tax liabilities are subject to the provisional tax payment regime. 

Running a business as a sole trader is best suited to a small business operated by one person,  where income-splitting is not a consideration.

Partnerships

Running your business as a partnership can have a number of advantages.  The main advantage is again simplicity. Partners are individuals who trade together under a business name, without setting up a company. Ideally, business partners should have a written partnership agreement. However, the costs and formalities of establishing and operating a partnership are usually less onerous than for a company. Partnership income can be split between the partners in fixed proportions.  From a tax perspective, if you operate your business as a partnership, each partner’s income is taxed at progressive individual tax rates. Some partnership losses may be deductible against other income.

The most significant disadvantage of running your business as a partnership is that your liability is unlimited. In addition, if you operate your business as a partnership,  you have to comply with partnership law.  Although operating your business as a partnership can facilitate income-splitting, income allocations may be inflexible. From a tax perspective, if you operate your business as a partnership, each partner’s tax liabilities are subject to the provisional tax payment regime.

Running your business as a partnership is best suited to co-professionals operating joint business practices  (eg medical/ engineering/ accounting/ legal practices), or family members operating a business together, where income-splitting can be achieved with minimal formalities.

Limited Liability Companies 

Running your business as a limited liability company can have several advantages.  The main advantage is that as a shareholder, your liability is limited.  Limited liability company structures are generally well understood by financial institutions, suppliers and customers.  Companies can now have a single shareholder, and a single director. If your company has more than one shareholder, company income can be split between the shareholders in proportion to their shareholdings.  From a tax perspective, if you operate your business as a company, the flat company tax rate applies.  There may be tax advantages to running your business as a company (eg the availability of imputation credits).

The most significant disadvantages of running your business as a limited liability company are the costs and formalities of establishing and operating a company.  If you operate your business as a company,  you have to comply with the legal and regulatory requirements that apply to companies. Operating companies in compliance with those requirements can be complex, costly and onerous.  Although operating your business as a company can limit your liability as a shareholder, in practice financial institutions lending to small companies usually require  personal guarantees. In addition, if you are a director of your company, you must comply with statutory directors’ duties. You are personally liable if you breach those duties. Although income-splitting can be achieved by way of shareholder dividends, that can be inflexible and cumbersome. From a tax perspective, the flat company tax rate may result in a higher tax liability than if progressive individual rates applied. In addition, some of the tax advantages of running a business as a company may not apply to your particular company.

Running a business as a company is best suited to businesses with sufficient resources to ensure that the company is operated and administered in compliance with all the legal and regulatory requirements that apply to companies.

Trusts

Running your business through a trust can have advantages.  The main advantage is that a trust structure is relatively flexible. It can provide for income-splitting and the distribution of capital gains to family members involved in your business. From a tax perspective, income retained by the trust is taxed at the flat trustee rate.

The most significant disadvantages of running your business through a trust are that trust structures are not well understood by financial institutions, and can make borrowing difficult. In addition, if you operate your business as a trust,  you must comply with trust law. Operating trusts in compliance with trust law can be onerous. From a tax perspective, the flat trustee tax rate on retained income may result in a higher tax liability than if progressive individual rates applied. Losses can be recouped only against future trust income.

Running a business through a trust is best suited to family or community businesses with sufficient resources to ensure that the trust is operated and administered in compliance with trust law.

If you need legal advice on which type of business structure best suits your needs use the Find A Lawyer directory to locate a firm in your area who can help.



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