A lot of clients ask us when they should change running their business through a Sole Trader structure to a Company structure. There are many reasons to change structures however, to save tax or pay less tax is the biggest reason for most.
There are many factors to consider when thinking about changing from a Sole Trader into a Company Structure.
Tax Benefits of Changing to a Company Structure
Where you operate in a company structure and qualify as a Base Rate Entity (aka SBE) with an income turnover of less than $25 million, the current company tax rate applicable in 2018/2019 is 27.5%. This rate is also set to reduce to 25% by 2021/2022. This tax rate is very attractive where the top marginal tax rate for an individual in 2018/2019 is 47% including the Medicare Levy.
Given that Individuals running a business as a Sole Trader are able to access the Tax Free Threshold essentially allowing them to pay no tax on the first $18,200 that they earn. Over and above that, Individuals then are able to apply a sliding tax scale according to how much they earn, there is a “magic number” where the tables are turned and it becomes more tax effective to pay tax at the company tax rate from the first dollar of taxable income. That “magic number” in 2018/2019 is $108,750 of taxable income. For simplicity, the magic number calculation has not taken into account any Small Business Tax Offset the Sole Trader may be entitled to as this can be subject to personal circumstances. Once a Sole Trader is earning more than $108,750 in taxable income, it becomes worthwhile from a tax minimisation point of view to change into a Company structure.
Where you operate a business that falls under the Personal Services Income (PSI) regime, the tax benefits of a company structure may not apply.
Other Reasons to Consider When to Change to a Company Structure vs Sole Trader
The following reasons should be considered when deciding to change from a Sole Trader to Company structure:
- Asset Protection. As a Sole Trader you are personally liable for all aspects of the business. This means in the event the business goes bad your personal assets are at risk. As a company shareholder, you are able to limit your personal liability.
- Your Business Ownership Changes. In the event a new business partner or additional capital is needed, a company structure will allow for these changes.
- Requirement for Business Contracts. Some businesses require a company structure to enter into business contracts and arrangements.
- There are more setup and ongoing costs for a Company including annual ASIC Fees and higher accounting fees with additional tax return and financial statements reporting requirements
- Withdrawing money out for personal use is a little more complex as profits in the company belong to the company in the first instance. Income for personal use needs to be withdrawn from a company and declared as wages or dividends. When declared as wages, superannuation and workers compensation become mandatory and therefore add to the costs of running inside a company structure.
- Implementation and transition to a company takes time and effort. A company needs to be registered with ASIC and ATO registrations for ABN, TFN, GST and PAYG withholding need to be completed. A separate company bank account must be opened and maintained. Customers and suppliers must also be advised of the changes.
- Additional responsibilities as a Company Director. Company directors have legal obligations and must perform certain duties such as reporting changes to the company to ASIC as outlined in the Corporations Act 2001.
The decision of if and when to change from a Sole Trader to Company Structure is a complex one and advice should be from an Accountant with the relevant expertise. Why not contact us today to see whether this is the decision for you?