Company VS Sole Trader: What is best for your businessUnderstanding the differences between the two, the set-up process and when is the right time. July 12, 2019
Running a business is far from simple. We don’t want to scare you, but there’s a lot to plan and consider, especially when you’re starting from scratch. And, as someone who’s just is just at the beginning of this journey, choosing a company vs sole trader structure is one of the first things that come to mind. Which one of the two options is the most suitable for you?
Well, there are a lot of things to consider. How is tax calculated? What are the setup costs? How does liability differ? Whew! There’s definitely a lot to go through.
Table of contents
- What are the main differences between a sole trader and a company?
- Set-up steps and costs for a sole trader and a company
- Ongoing Costs
- Why you might want to change your business from Sole Trader to Limited Company
- Useful Resources
What are the main differences between a sole trader and a company?
Explaining the difference between a sole trader and a company, as much as we’d want to, can’t be thoroughly explained in a couple of sentences. We’ll definitely try though!
As a sole trader, you and your business are the same entity. You share the same Tax file number (TFN) and the same Australian business number (ABN). This makes you personally liable. If the business gets sued, you get sued.
A company is a separate legal entity. It has it’s own TFN and ABN. You’re an employee of your company. This means that if the company suffers a loss, or it gets sued, only the company’s assets can be accessed and your personal assets are safe.
For most tradies, the sole trader structure is their first, and best option. That’s why you see businesses like Mike’s Fantastic Carpet Cleaning. While, as for companies names would be more like Fantastic Cleaners Pty Ltd. (btw, if you’re looking to start a cleaning business in Australia, we have a pretty in-depth guide on that).
What is a sole trader
The sole trader structure is usually chosen because it’s easy to set up and it’s easy to understand.
Let’s say you’re the business owner. As a sole trader, this makes you the one who’s making decisions. You’re in charge of where you want your business to go. how it will be positioned in the market, etc. You’re the captain of the ship so to say. The biggest drawback of the sole trader structure is that you’re personally liable.
To explain it, again, let’s take you as an example. You’re running a business registered as a sole trader and things may not be going as planned. You need to take out a loan. Generally, to secure the loan you’ll have to use personal assets (your car, your home, etc.).
If you can’t pay back your loan the creditor can sue you, and if they do so successfully they can take away your personal assets to satisfy the debt. This is why the risk of personal bankruptcy for sole traders is a lot higher than for company owners.
A sole trader cannot retain profits. Instead of profits, it’s seen as an income, which is taxed appropriately to your personal marginal rate. More on that below.
What is a Proprietary Limited Company
Running a company is a bit different. Decision making is done by the company’s directors and some of it is even done by the shareholders.
The limited liability of the company structure is its main advantage. Let’s say you’re a shareholder. You’ve purchased and paid AU$100 for 100 shares in the company. If the company defaults on a debt the creditor can’t take anything from you. They can only access the company’s assets and not yours.
When a company is trying to secure a loan, only the company’s assets can be used and in some instances, directors may be required to give a directors’ guarantees.
A company pays tax at the standard corporate rate. If the company decides to retain profits it pays an income tax. The profits can also be distributed among shareholders.
Set-up steps and costs for a sole trader and a company
Great! Now you have a basic understanding of what a sole trader is and how it’s different from a company. As you might have noticed, the initial set up is the first thing that sets them apart.
Setting up as a Sole Trader
Setting up a sole trader is a pretty simple and straightforward process. Everything you’ll need is an Australian Business Number, a business name registration and a standalone bank account (you can use your own if you’re okay with it).
The cost of setting up a business as a sole trader is as follow:
- Obtain an Australian Business Number (ABN) is free;
- Register a business name is AU$36 for one year and AU$84 for three years;
- Register a separate bank account will have varying costs which will depend on numerous factors (like the bank of choice, for example).
Draw the line and you have around AU$150 – AU$200 price point for starting a business and registering as a sole trader in Australia.
Tax returns are quite simple, as sole traders are taxed as individuals. You report your business income in your individual tax return.
Setting up a Company
Running a company is a bit more complicated. Okay, it’s a lot more complicated. For start, you have a board of directors and shareholders who’ll be responsible for making decisions.
Registering a business as a company is a lot more complicated as well. You’ll still need an ABN and a company name, business name and company registration. To break up costs for you, here’s how registering a company might look like:
- Obtain a free Australian Business Number (ABN).
- Reserve your company name. Though it’s not required, reserving your company name can give you peace of mind. Depending on the type of application the cost will vary. Company name reservation starts from AU$50.
- Register your company. It will cost you AU$490 to register a proprietary limited company.
- Business name registration. It is another AU$36 to AU$84 and it varies if you’re registering for one or three years.
- Set up a separate bank account. It’s mandatory for companies to have separate bank accounts. Bank fees vary depending on the bank of choice that you have.
Unfortunately, there may come a moment where you’d want to de-register a company. That’s why it’s always good to know how to do it and what steps you have to take in order to be eligible to apply for deregistering.
In order to apply for deregistering a company, the entity will have to meet certain criteria. Your company shouldn’t have any outstanding debts, you should apply for deregistration at least two weeks before the annual review date and all parties should agree upon deregistering.
These are some of the many criteria that the company should meet. For the full list of criteria that you’ll have to meet in order to deregister a company, check out this page by ASIC.
In order to maintain your business, there are some ongoing costs that you’ll have to cover. Of course, the more complex the structure of your business is more expensive it will be to maintain it.
Ongoing costs for Sole Traders
As a sole trader, the only recurring cost that you’ll have is your business name registration. Thirty-six dollars per year or AU$84 for three years. Whatever you choose, it’s still fairly inexpensive.
You also must keep tax records for five years minimum.
Ongoing costs for Companies
You’ll have to cover a business name registration fee. Again, it’s AU$36 for one year and AU$84 for three years.
On top of that, an annual review fee is mandatory and it will set you back around AU$263 for a proprietary company.
Why you might want to change your business from Sole Trader to Limited Company
While the sole trader structure is super easy to maintain, switching to a company structure can help you with paying less tax, provide a layer of protection between you and the customer and help your business reach its full potential.
As a sole trader, you may have to pay tax rates up to 49%! Working so hard for your money, this just isn’t cool…
But there’s a catch. Simply by switching to a company structure won’t help you with cutting the per cent of tax you’re paying. In fact, if you’re the only one who’s doing all or the majority of the work you’re better off sticking with the sole trader structure.
But, if you’re employing workers, and they’re doing the same thing as you, considering a company structure might be good for your business.
Other benefits are travel allowances. A company can pay tax-free travel allowances to employees. Sole traders can’t.
There are some tax benefits when it comes to selling your business, as well. As a sole trader, you’ll be liable for the resulting tax completely. The company structure offers some flexibility on that matter.
Scaling your business is another good reason to switch to a company structure. You’ll be able to take investors, provide a layer of protection between your assets and your business, and provide security for your employees.
Also, if you’re already having a pretty successful business, but you’re still operating as a sole trader, you’re exposing yourself to a level of risk. Adopting a company structure is a great way to change that.
By the way… If you’re running a cleaning, handyman or pest control business on your own we can help you out. Check out our franchise opportunities to learn more!
Making the transition
Changing your business’ structure is a big step. You can even say it’s like writing a new chapter in your entrepreneurial venture.
That’s why we’d always suggest that you make this step by taking your time and doing your research. Consult with lawyers and accountants. Is this the right time for you?
If you’ve never done this before it’s best to consult with someone who’s done it. Maybe a company isn’t the best structure for your type of business. Maybe it’s another type.
Consultations are for that – to find the most suitable type of legal structure for your business.