Businesses come in many different structures here in Australia, from sole traders to companies, partnerships, and trusts. If you’re a small business, you might be wondering whether you qualify as a small company or a sole trader and where certain limitations apply. It’s important to distinguish your business as one or the other as both contain different legal, tax, record keeping, set-up costs, and financial reporting obligations to the ATO, as do all the business structures. So, what’s the difference between the two and what are your obligations?
To help you understand the key differences between sole traders and small companies, Shoebox breaks it down for you.
The Basic Definitions
Starting your own business can be an exciting and challenging time. Understanding all of the complex financial obligations can be stressful, although it’s an important step towards not making costly mistakes down the track. The first decision you must make as a start-up is, what will you register as? A sole trader or a company? Here’s how the two are defined according to different authorities.
Definition of a Sole Trader
“A sole trader is an individual running a business. It is the simplest and cheapest business structure. If you operate your business as a sole trader, you are the only owner and you control and manage the business.” – ATO.
As per the name suggests, if you are the only individual (solely) responsible for your business, then you are a sole trader. Sole traders are not always individuals who are running a business in a traditional sense. Sometimes individuals start up their own business (and register an ABN) to receive payment for contract or freelance work. While a sole trader is an easy enough business structure to keep tabs on, as a sole trader you are fully responsible for all liabilities and debts incurred. This means the individual is solely at risk. Further, while you’re in charge of solely running a business, this doesn’t mean you’re necessarily doing everything by yourself – you can hire employees to help you. If you’re hiring employees, there may be more financial obligations to account for like tax, superannuation, and fringe benefits tax. Make sure you have a good understanding of what is involved in hiring employees by checking the ATO’s guidelines.
Now let’s look at a small company. Firstly, there is no specific category of ‘small company’ to register your business as – you’d simply register it as a ‘company’ when you apply for or update your ABN. The ‘small’ part is defined by different authorities for different purposes. Yes, it can be a little confusing but in Australia, what’s small for fair work purposes is not technically small for legal purposes, or for that matter, tax purpose. Let’s divulge.
Definition of a Company
“A company business structure is a separate legal entity, unlike a sole trader or a partnership structure. This means the company has the same rights as a natural person and can incur debt, sue and be sued.” – Business.gov.au
Further, as a member of a company, you are not liable for its debts. You are, however, liable for ensuring any amount unpaid for shares is covered, if called on to do so. Also, if the company has been found to breach any financial obligations, the directors of the company may be found liable. While setting up a business as a sole trader is relatively quick and easy, setting up and maintaining a company can be a lot more complex and involves more running costs. So, where does the ‘small’ in ‘small company’ come in?
A Small Business, According to ASIC: The Australian Securities and Investment Commission (ASIC) is an independent Australian Government body administered by legislation that is responsible for the regulation of corporations, markets, financial services and consumer creditors. They facilitate Australian companies and corporations to ensure they are legally compliant. They’re also a great resource for understanding all the legal parameters surrounding company sizes, structures, and obligations, and they also provide many specific business registrations.
According to ASIC, from financial years commencing on or after 1 July 2019, a ‘small proprietary company’ is defined as ‘small’ for a financial year if it satisfies at least two of the below criteria:
- Annual revenue of less than $50 million
- Less than 100 employees at the end of the financial year, and/or
- Consolidated gross assets of less than $25 million at the end of the financial year
For financial years commencing before 30 June 2019, a company is defined as small if it satisfies at least two of the following:
- Annual revenue of less than $25 million
- Less than 50 employees at the end of the financial year, and/or
- Consolidated gross assets of less than $12.5 million at the end of the financial year
A Small Business, According to ATO: From the 1 July 2016, a small business entity is defined as a sole trader, partnership, company or trust that:
- Operates a business for all or part of the income year, and
- Has an aggregated turnover less than $10 million (the turnover threshold)
Therefore, to the ATO, a company and sole trader can both be defined as a ‘small business’. This is for tax purposes and so that small businesses can apply for certain concessions that can partially alleviate some costs of running a business.
Fair Work Australia also contains its own definition of a small business, for employment purposes. Fair Work considers businesses with 15 or fewer employees to be small businesses.
Further, for data collection purposes, the Australian Bureau of Statistics (ABS) defines small businesses as having 20 employees or fewer.
Now, let’s look at some of the financial obligations.
As a sole trader, there are fewer costs and set-up obligations. Firstly, you must obtain an Australian Business Number (ABN) which is free and you may want to (depending on the purpose of your ABN) register your business name which is $36 annually or $85 for three years. It is optional for you to set up an additional or separate business bank account. For some, it is easier to stay on top of incoming and outgoing expenses specifically pertaining to your business with a separate account. If you do open an additional account, always check for bank fees that it may incur.
Companies are more expensive and complex when it comes to their set-up costs. There are a few similarities to the set up of a sole trader, however. Again, your ABN is free, and registering a business name still costs $36 for a year and $85 for 3. You still have the option for opening your own individual business bank account; however, companies must have their own account. Also, while registering a business name is relatively cheap, choosing to reserve a company name can cost up from $50, and registering the company is $495 for a proprietary limited (Pty Ltd) company.
Record Keeping and Tax Payments
Sole traders generally have less paperwork due to the simplicity of the business structure. However, it’s a good idea to establish a spreadsheet (or similar system) of keeping track of your income and how much tax you should pay. Your tax won’t be automatically deducted, so it’s up to you to keep track. To pay your tax, you have the option of making a prepayment based on a calculation or waiting to see how much you owe after filing your return with your agent. Further, after your first return, you automatically enter the pay as you go (PAYG) system. When it comes to tax time, your business income and expenses are filed with your individual tax return using a separate business and professional items schedule – you don’t need to lodge a separate tax return for your business. Finally, as a sole trader, your financial and tax records need to be held for five years. So, make sure you’ve got them in a safe place – like with a professional advisor or online.
A company needs to lodge its own tax return and keep tax records for five years and financial records for seven. Financial records should explain the business’ financial position and performance and the reporting must provide a true and fair view of statements and allow for these to be audited. In addition, companies must send ASIC their annual review on the anniversary of their registration each year, and in turn, ASIC will send a review statement and fee.
How Much Tax Should You Be Paying?
Thankfully, this is pretty simple. Sole traders are taxed for their business income by the same tax bracket of their individual income. Companies, on the other hand, are taxed at the company flat rate of 30%.
If at this stage you’re already feeling a bit overwhelmed, it’s worthwhile to consider speaking to a bookkeeper or accountant. Shoebox Books has advisors all around Australia looking to provide advice and help you sort out your business’ financial obligations and paperwork. Use our search feature to find your nearest bookkeeper.
Who Makes the Decisions?
In a sole trader business structure, the individual has all the power to make decisions. Companies, however, are more complex. Typically, decisions are made by a majority vote on behalf of a company by the directors. If your company contains shareholders, they may also have a say in some decisions and votes.
Sole traders are personally liable for financial or tax debts in a sole trader business structure. As there is no differentiation between personal and business assets, this means that items like your family home can be used to settle business debts. The risk for sole traders obviously is much higher as responsibility is completely personal.
On the other end of the spectrum, the liability for all business debts falls on the company (if it operates as a company rather than sole trader structure) as it is its own entity. As mentioned, directors can be personally liable for financial breaches (often the director must agree or be a guarantor for this to happen).
The Advantages and Disadvantages?
To Tie Things Up
Running a small business is a lot of responsibility, but it is also very rewarding work. While there are a lot of financial obligations to keep tabs on, you don’t have to do it alone. The team at Shoebox Book are waiting to help you navigate the world of sole trader tax, company tax, and general small business finance. Get in touch with us today on 1300 65 35 83 or enquire online.