Deciding to transition from a sole trader to a company structure marks a significant shift in how your business operates, encompassing everything from tax obligations and legal structures to asset protection and personal liability. It’s a step that many entrepreneurs take when their operations outgrow the simplicity of the sole trader model, necessitating a more complex arrangement to accommodate new hires, investments, or the ownership of assets. ANC reached out to us as accountants and tax professionals to provide guidance with this transition.
This guide is tailored to facilitate a smooth and informed change, mainly focusing on the need for asset protection, compliance with tax and reporting obligations, and safeguarding your personal assets. By understanding the benefits of changing from a sole trader to a limited company, you’re paving the way for not just compliance but also potential growth and stability in the challenging landscape of business.
Understanding Sole Trader and Company Structures
Sole traders and companies represent two fundamental business structures with distinct implications for legal identity, liability, and tax obligations. A sole trader operates as a single entity with the business owner, meaning there is no legal distinction between personal and business assets. This structure allows for straightforward decision-making and fewer formalities, but it also means that sole traders bear unlimited personal liability for any debts or losses the business incurs.
In contrast, a company is recognised as a separate legal entity from its owners (shareholders) and management (directors). This separation is crucial as it provides protection to the shareholders. Therefore, in the event of financial failure, the shareholders’ personal assets are typically protected. Companies are subject to more rigorous regulatory requirements, including the need to maintain detailed financial records, lodging annual returns with the ATO and Australian Securities and Investments Commission (ASIC), and adhering to similar tax filing practices regarding GST.
Shareholding Structure
There are two common ways to hold shares in a company: in an individual capacity or via a discretionary trust (also known as a family trust). We recommend that you hold shares in a discretionary trust to offer the maximum flexibility for tax purposes. The key features of discretionary trusts are:
Flexibility in the distribution of profits to trust beneficiaries (typically family) who are then taxed at their marginal tax rate (the tax free threshold for individuals is $18,200 and a tax rate of 19% applies on income between $18,200 and $45,000 which is lower than the company rate of tax, being 25%). Caution should be used in distributing income to minors. Only the first $416 is tax free. Income between $416 and $1,307 is taxed at 66% and income over $1,307 is taxed at 45%.
Profits generally do not accumulate in a trust as they need to be distributed each year, otherwise they attract tax at 45%. Trusts are not typically used to operate a business in, and we tend to use trust structures to stream dividends declared from your company to your family group. Companies can also be used to retain profits, if it earns $1,000 and is taxed at 25% then it has $750 available to reinvest back in the business.
Key Differences in Taxation and Reporting
- Tax Obligations: While sole traders are taxed at individual income rates and can access the tax-free threshold, companies are taxed at a flat corporate tax rate, which is currently 25% for entities with a turnover less than $50 million. This difference can significantly affect the overall tax burden depending on the business’s profits.
- Reporting Requirements: Companies face more stringent reporting obligations, which include submitting of annual financial reports to ASIC and ensuring all company details are kept up-to-date. Sole traders, while still required to keep financial records, do not need to file solvency statements with ASIC and have fewer compliance requirements.
- Operational Costs and Governance: Setting up a company involves higher initial costs and ongoing fees, such as the annual review fee, whereas sole traders benefit from lower setup and operational costs. Additionally, companies require a formal governance structure, including director’s signing off on accounts and tax returns, passing annual resolutions, and anything else which may arise which can add to the administrative burden.
Understanding these differences is crucial for any business owner considering transitioning from a sole trader to a company structure. It involves not only a change in how the business is perceived legally but also how it is managed and taxed, impacting everything from daily operations to long-term strategic planning. At National Accounts, we specialise in streamlining these processes so that you can get on with what you do best.
Pros of Converting to a Company Structure
Transitioning from a sole trader to a company structure offers numerous advantages, particularly in areas such as tax efficiency, asset protection, and business scalability. Here, we explore some of the key benefits that can influence a business owner’s decision to make this significant change.
Enhanced Tax Benefits
One of the most compelling reasons for a business to transition to a company structure is the potential for tax savings. Companies that qualify as a Base Rate Entity enjoy a reduced company tax rate of 25%.
Depending on your unique situation, income can be split with family members.
Depending on how your income is structure, super will not be payable, and these funds can be reinvested into further grow.
Companies offer the ability to structure and control your tax situation with greater control vs. a Sole Trader structurewhere all the profits are taxed against the individual.
Asset Protection and Limited Personal Liability
Unlike sole traders, where personal assets can be at risk if the business fails, a company structure legally separates personal assets from the business’s liabilities. This separation not only safeguards personal wealth but also significantly reduces personal liability, making it a safer option for business owners as they expand and take on more significant risks.
If vehicles are owned/registered in a company structure, demerit points from driving infringements can be avoided at the individual level if the corporate levy is paid.
Business Growth and Funding Opportunities
Companies are often viewed more favourably by investors and financial institutions, making it easier to secure funding for growth or expansion. The ability to issue shares and attract equity investment is essential for businesses looking to scale operations or explore new markets. Additionally, having a company structure can enhance credibility with potential clients and partners, who may prefer dealing with a more formally organised entity.
These advantages illustrate why changing from a sole trader to a company can be a strategic move for businesses aiming to optimise their operations and position themselves for future growth.
Cons of Converting to a Company Structure
While transitioning from a sole trader to a company structure offers numerous benefits, it also comes with its set of challenges and drawbacks that need careful consideration. Here are some of the primary cons associated with this change:
Increased Financial and Administrative Burden
The setup and ongoing maintenance costs are significantly higher. This includes the initial ASIC registration fee, which is $576, and annual costs such as the ASIC renewal fee of $310. Additionally, companies are required to prepare and lodge more complex tax returns and Business Activity Statements, with costs typically starting from $2,000 annually. We have offered special pricing to all ANC Deliver drivers to assist with the transition.
Legal and Contractual Complexities
The transition also involves complex legal and contractual changes. Existing contracts, such as leases, supplier agreements, and employment contracts, may need to be renegotiated or amended to reflect the new legal entity. This process requires legal knowledge, time, and potentially more expenses. Moreover, the company formation involves submitting specific forms like the application for registration and acquiring a new ABN.
Potential Loss of Control and Personal Asset Protection
Converting to a company structure can dilute this control due to the involvement of other directors or shareholders. While the company structure provides limited liability protection, thereby safeguarding personal assets, in cases of fraud or non-compliance with legal duties, personal assets might still be at risk. Furthermore, the company’s profits are no longer solely entitled to the owner but must be shared with shareholders.
These considerations highlight the importance of thinking through the logical steps required before transitioning from a sole trader to a company as everyone’s situation is always a bit differnet.
Key Considerations Before Making the Transition
When planning the transition from a sole trader to a company, it’s crucial to consider several key factors to ensure a smooth and compliant changeover. Here are some of the primary considerations:
Consult Professional Advisors
- Engage with a Professional Advisor: Before making any changes, consult with an accountant or business advisor who specialises in business structures. They can provide personalised advice based on your business’s financial health and future goals.
- Legal and Tax Implications: Seek legal and tax advice to understand the implications of changing your business structure. This includes changes in tax obligations, asset protection, and personal liability.
- Director and Shareholder Responsibilities: If you plan to become a director or a shareholder in the new company, familiarise yourself with your legal obligations and responsibilities.
Operational and Structural Changes
- Choosing a Company Structure: Decide which structure will company best suits your needs, considering their respective advantages and disadvantages and if you would like a trust structure to be the shareholder.
- Company Registration: Register your company and choosing a suitable company name.
- Setup Processes: Establish new operational processes, including accounting systems, payroll, and insurance requirements. This might involve changes to existing workflows.
Financial Management and Compliance
- Asset and Liability Management: To avoid legal complications, transfer assets and liabilities to the new company structure.
- Maintaining Cash Flow: Ensure the transition does not disrupt your business’s cash flow. This may involve strategic planning of major expenses and managing receivables and payables.
- Compliance and Record Keeping: Update all business records and comply with new reporting and tax requirements. Regularly update company details and adhere to ASIC’s regulations to avoid penalties.
By carefully planning and consulting with the right professionals, you can navigate the complexities of changing your business structure from a sole trader to a company, positioning your business for future success and growth. At National Accounts we work with businesses all around teh country helping them to navigate all of the above consideration.
Conclusion
Transitioning from a sole trader to a company structure signifies a pivotal moment in the growth and evolution of any business. By weighing the key benefits, including tax advantages, asset protection, and enhanced business credibility, against the challenges of increased administrative duties and potential dilution of control, entrepreneurs can make an informed decision tailored to their business’s unique needs and aspirations.
As businesses evolve, the decision to shift from a sole trader to a company structure should be approached with careful planning and professional advice. This transition not only stands as a testament to a business’s growth potential but also reshapes its operational, legal, and financial landscape. For entrepreneurs, especially those like courier drivers currently operating under the simpler sole trader model, contemplating this move represents a threshold across which lies the opportunity for substantial growth, enhanced credibility, and improved asset protection. Making such a transition, therefore, is not just about meeting current needs but also about positioning the business for future success and sustainability.
FAQs
Can I switch my business from a sole trader to a company structure?
Yes, you can change your business structure from a sole trader to a company. However, it will also alter your reporting, tax, and legal responsibilities. It’s important to understand how these changes will impact your business operations and the steps involved in making this change.
What steps should I take to change from a sole trader to a limited company?
To convert from a sole trader to a limited company, follow these steps:
- Register a limited company.
- Inform ATO about your decision to cease operating as a sole trader.
- Transfer your sole trader business to the newly formed company.
- Open a business bank account under the company’s name.
- Notify all stakeholders about the change in your business structure.
How do I transfer assets from a sole trader to a company?
To transfer assets from a sole trader to a company, you need to:
- Establish the company structure.
- Prepare a business sale agreement.
- Transfer the business assets and liabilities of the sole trader to the company in exchange for ordinary shares in the company. This can be done with no capital gains tax considerations due to rollover exemptions for sole traders.
Is it possible to transfer a business name from a sole trader to a company?
Yes, you can transfer a business name from a sole trader to a company. To do this, you must provide the new proposed business name holder with a consent to transfer letter. The new holder will then need to submit this to ASIC for manual review.
