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1. Sole Traders
1.1. ‘Sole trader’ refers to a natural person who carries on business with income wholly in the individual’s hands and taxed individually, using their personal Tax File Number.
1.2. The benefits of the sole trader structure are that it is the simplest way to operate a business and the start up costs are relatively low. Such costs may include registering a business name, Australian Business Number and taking out an insurance policy.
1.3. However, one significant downside to being a sole trader is you personally have unlimited liability, potentially putting personal assets like the family home at risk to the creditors. This may be overcome by placing such assets in a close relative’s name or a family trust, though to an extent this defeats the purpose of having such a simple business structure.
2. Partnerships
2.1. Partnerships are made up of two or more people who operate a business together and income and losses are distributed between themselves.
2.2. Generally, a partnership will have a partnership agreement, however this is not essential. All that is required is that the partners intend to act as partners and carry on a business in common. Such intention can be established by joint registration of a business name and joint bank account amongst other acts. A partnership agreement gives partners greater flexibility to vary the rights of partners, particularly where only one actually works in the business.
2.3. The biggest issue with a partnership is that it is not a separate legal entity. This means that each partner is exposed to the full liabilities of the partnership, not just their portion of the partnership, so a creditor is able to access the assets of each individual, much like with a sole trader.
2.4. A partnership is required to lodge a tax return but does not pay tax. The individual partners include their proportion of profit or loss in their individual tax returns. To calculate a partner’s assessable income, you calculate the partnership’s net income (excluding any advances paid to the partner during the year) and then divide that according to each partner’s share in the partnership.
3. Companies
3.1. A company is a separate legal entity from its owners, the shareholders.
3.2. The tax rate is generally a flat rate of 30% unless it is a base rate entity, in which case it is 26%. This provides a significant advantage over individual tax rates which are up to 45%.
3.3. Shareholders (being the person entered on the register of members) are then taxed on the dividends they receive, which may be franked (ie the company paid tax so the credit is passed on).
3.4. A company must not pay a dividend unless its assets exceeds its liabilities and that excess is sufficient for the payment, it is fair and reasonable and does not materially prejudice the company’s ability to pay creditors.
4. Trusts
4.1. A trust arises where a settlor transfers property (the settled sum) to a trustee to manage on behalf of a group of beneficiaries. Everything is held in the trustee’s name.
4.2. The trustee is bound by general law fiduciary duties, the provisions of the relevant trust deed, if any, and the relevant Trustee Act.
4.3. There are a number of trust structures available.
Discretionary Trusts
4.4. In a discretionary trust, the trustee has complete discretion on how to distribute income to the beneficiaries. Until the trustee exercises their discretion, the only interest the beneficiaries have is in the due administration of the trust by the trustee.
4.5. This structure is best where the taxpayer wants flexibility in distributing income and capital such as in a family business and estate planning.
4.6. Unfortunately, the trust itself does not offer limited liability, though the trustee is indemnified out of the trust fund. It is for this reason that appointing a corporate trustee is always recommended.
4.7. There may also be difficulties arising in raising finance and substantial CGT and stamp duty consequences in introducing new beneficiaries into a trust.
Fixed and Unit Trusts
4.8. A fixed trust is one in which the trustee has no discretion as to the beneficiaries, but may have discretion as to the timing and amount of distribution. Fixed trusts are used where the aim is to provide for identified beneficiaries in a predetermined manner, such as family members.
4.9. A unit trust is a type of fixed trust in which the beneficiaries hold units in the trust. A unit trust will usually be used where unrelated persons are carrying on a business.
4.10. In a unit trust, each unit holder purchases units which usually have a fixed income, capital and voting rights attached. Unlike shares in a company, units in a unit trust confer proprietary interest in all property of the trust.
4.11. A unit trust is preferable to a discretionary trust as an investor’s equity is easily identifiable and transferred income is distributed gross of tax, making it easier for unit holders to meet their obligations and attract finance.