Starting a business and wondering which type of business structure is best suited for you?
The vast majority would start off as a Sole Trader due to the simplicity in starting and the nil costs involved with set-ups.
Some may choose to go as a Sole Trader as they feel there may not be any profits in the first year. You can always change the structure later once the business grows, right?
Not many are aware about the future tax benefits of being able to utilise the losses (or are aware that you can carry forward tax losses) to offset against future profits. When you change structures, losses cannot be carried forward to the new entity.
There are also rules around utilising Sole Trader losses to offset against your other income (for e.g employment income).
The cost savings you thought you gained by starting out in a simple way, might actually be costing you potentially in thousands of dollars in extra lost tax savings.
Let’s look at some very simple examples just to give you some basic ideas.
Example 1
Total losses of $20,000 over the first two years, followed by $50,000 profit in year 3.
| Â | $ |
| Year 1 | ($10,000) |
| Year 2 | ($10,000) |
| Year 3 | $50,000 |
Â
By year 3, Peter decides he wants to move to a company structure.
If he switches before the completion of his 3rd year, those $20,000 tax losses are wasted. If he decides to complete his 3rd year, he could utilise the losses which will help him reduce his tax significantly.
Example 2
| Â | $ |
| Year 1 | ($10,000) |
| Year 2 | ($10,000) |
| Year 3 | $80,000 |
Company tax: $15,000
Individual/Sole Trader tax: $9,967
While the company tax is higher based purely on just the profits, with tax planning, Peter could potentially reduce it more than the individual/Sole Trader tax. For e.g by paying himself a wage from his company, say $40,000 (taxed at $4,142) and retain the rest under the Company, $20,000 (taxed at $5,000), total savings comes to just under $1,000.
Depending on your industry and nature of your business, there are certain restrictions on whether you can retain profits in Company, income splitting etc.
Apart from tax matters, as a business owner you need to think about risk factors, such as public liability, litigations, market perception and host of other things. Each structure brings about its own dynamics. You could even have multiple structural layers depending on the business industry and your appetite for tax savings, risk minimization and asset protection.
Again, depending on his circumstances, if Peter operated under a Trust for e.g, he could split the profits to other beneficiaries. There are restrictions here as well.
Structures depends on your personal circumstances too. So don’t rush and assume!
If you are serious about venturing into business, then you need to be serious into investing in tax advice. Find out the different scenarios and how they could potentially affect you and your ability to save money. It is too late to change anything once you have started out.
*note tax rates are based on 2021 financial year for individuals and 25% for company tax rate from 2022 financial year onwards
