Why change from a Sole Trader to a Company?

Why changing from a Sole Trader to a Company structure can be right for you

Why changing from a Sole Trader to a Company structure can be right for you

So you have taken your skills and talent, and turned them into a living! No longer ‘working for others’, you are embarking on (or have already set up) running your own business.

Congratulations on having come this far!

Whether you have already been ‘in business’ for some time or are just starting out, choosing the right structure for your business is important, and it is a consideration that is important not only from the start but also as your business grows and develops.

While it is common for people to start out – and often keep going – as a sole trader, there are reasons to look at your set-up and ask – can I do this in a better way? And why would I make the change?

Why change from a Sole Trader to a Company?

The key reasons for looking at changing from a sole trader to a company are these: 1. Taxation benefits
2. Legal liability/risk reduction benefits
3. Funding growth / expanding your business
4. Bringing in business partners / working with others
5. Expanding into new commercial opportunities

Let’s look at these reasons separately.

1. Taxation Benefits

This is the key issue for most people looking at changing from a sole trader to a company structure. And for a good reason, as the potential benefits can be significant.

The first thing that needs to be considered here is that, for a sole trader business, the owner is taxed on ALL of the profit for the year in their own name, even if the money has been ‘kept in the business’ and not taken as salary or drawings. This compares to a company set-up, where the company is taxed on the business profits (less salaries or fees paid to the owners), and the owners are only taxed on the income they have taken from the company as salary/fees.

This can provide for some substantial tax benefits if it is managed properly as well.

There is also scope that the business can also pay family members for work done within the company – or to receive a share of the profits by way of dividends, which can reduce the overall tax payable on the business’s profits.

Case Study:
Mick & Christie MacFleet came in to look at their business and tax situation.

Mick is a musician, performing regularly and involved in a number of areas, including film compositions, recording his original material, and teaching music to students.

Christie is a health consultant with a growing consultancy.

In the 2021 year, their earnings were as follows:
Mick – local earnings – $160,000
Royalties and performance income – $150,000
Tax credits from overseas earnings – $6,200
Christie – contract earnings – $95,000
PAYG paid by Mick – $53,000
PAYG paid by Christie – $8,800

Total tax payable – $138,469 (not including offsets and tax paid)

Their net tax position as individuals led to additional tax payments of $48,157.00 required on what they had already paid through the tax year.

If their professional activity had been undertaken through a corporate structure, depending on their lifestyle and income needs, the following would have been possible:

Company income – $405,000
Less salaries paid to Mick & Christie – $80,000 each
Net company profit -$245,000
Tax payable by company – $61,250
Tax payable by each director – $18,067 each – $36,134
Total tax payable – $97,384

A total of $41,085 in tax is saved in this situation. While funds have been retained in the company in this process, there is scope to utilise this to both grow the business operations and also acquire related assets such as Motor Vehicles, business equipment etc., in a tax-effective manner, as well as ‘non-business’ investments to build up income in other areas.

Essentially, as a sole trader, every dollar earned above $45,000 p.a. (On 2022 income tax scales) will be taxed at a higher rate in a personal tax return than within a company structure. And it is difficult to ‘split’ the income from a sole trader business to your partner or family members.

Superannuation and other long-term investment arrangements can also be funded through this process, leading to greater tax savings.

There is also significant scope to make additional tax-effective deductions via a company that are not possible within a sole trader set-up. Items like Tax-free Travel Allowances, equipment purchases, vehicle and related purchases with a personal benefit element, study and self-education, and ‘incidental’ personal expenses can be claimed in various circumstances that can provide a substantially greater benefit within a company structure.

2. Legal liability/risk reduction benefits

As a sole trader, the risks inherent with your profession, your skill base, and your responsibilities to your clients lie with the individual. i.e. with you. There is no limit to the liability that can be put onto the person resulting from their business activities. So, if things go bad and you have to liquidate assets to cover losses, your personal assets may be liquidated. That means the things you’ve worked hard for — the family home and car, for instance — are potentially vulnerable in a dire situation.

With a company, the risk lies initially with the business. The owners’ personal liability’ for the business and its activities are limited to the amount that has been invested into the company by the owners. The company can enter into contracts, borrow money and buy and sell its own assets. So, the business’s debts, for example, will be met by the company, not you personally.

It is expected (of course) that the company has taken out suitable insurance policies to protect itself, its employees and its customers/clients in the proper running of the business.

This also protects the owner regarding staff employment and the responsibilities in this area. And it provides the business owner with a level of insurance and protection regarding work-related injuries they incur themselves that they would not otherwise have as a sole trader.

3. Funding growth and expanding your business

If you have big growth plans for your small business, then operating as a sole trader won’t cut it in the long run. You won’t easily – if at all, be able to take on investors as they’ll want the security and flexibility of the company structure. 

You may also find that some customers won’t engage with you or add you to their preferred supplier lists if you’re not operating as a company. This is typical of larger organisations that are worried about getting into trouble for not paying employee entitlements, such as superannuation, which can happen if you are a sole trader, but typically isn’t an issue if you operate the business via a company. i.e. it is harder for some businesses to differentiate between an “employee” and an “independent contractor” when engaging a sole trader. The ATO and authorities like Workcover take a very close look at these arrangements, making it harder for businesses to engage with sole traders.

It can also help to say to potential clients that you are a company and that it isn’t “just you” –  a company implies a certain scale and level of seriousness that a sole-trader-operated business can’t match.

When dealing with Government business support and business activities, it is often the case that the Government Agency or their grant requirements specify a corporate structure rather than a sole trader operation for their contracts. (This was frequently the case with the support provided during the pandemic in 2020 and 2021 – many grants available for companies were not possible for a sole trader in the same industry.

The banks also look at a corporate structure more favourably than a sole trader enterprise – even with the need for personal guarantees etc. – as they see this as a position of confidence in your activities and something that can be established to be ‘beyond’ the scope of ‘just one person’. Sole traders appear ‘transitory’, whereas a company appears to have continuity.

4. Bringing in business partners

Being a sole trader can be a lonely affair, and while it may have its benefits in terms of having the final decision on everything, there may come a time when you want to (or need to) bring in a business partner, or group of people, to assist with running the business.

Changing to a company structure makes this future arrangement easier, without having issues later in terms of ‘selling a portion of the business’, who has responsibility for what elements of the business, etc.

For a musician, collaborations can be an issue when it comes to both contracts and taxation matters. E.g. If you are performing in a quartet for some performances, as a duo in others, and then have a contract to compose work for a TV series, potentially, each of these separate activities would be seen as being three different ‘businesses, with the need to prepare three separate tax returns (for the 4 person partnership, the 2 person partnership and your sole trader earnings).

If you have a company structure, it would be possible to ‘hire’ each of the ‘partners’ in these various activities, paying them via a wage or invoiced-based arrangement – making it easier for them to process their tax matters!

In various industries, where there is a need to collaborate on projects, the ‘partnership Vs employee Vs Joint Venture’ issue can often come up. With a corporate structure, it becomes easier to work out the engagement arrangements, taking on support staff as needed for short-term contracts, or entering into service contracts.

5. Expanding into new commercial opportunities

Operating as a company can project the image of a larger, more sustainable commercial enterprise instead of a lonely sole trader doing all the work themselves.

Under a company structure, businesses can more easily take on investors. Investors can easily see what percentage of the business they’re investing in and where their investment is going. As a sole trader, the investment goes directly to the owner without any clear structure.

It is also possible within the company structure to expand your ‘personal’ business activities to a range of services, enabling your partner or family members to operate within the business. While there can be some inherent risk with this, if there are potential issues with any of the business activities, It does lend itself to enabling you to more efficiently split incomes within the family environment and reduce tax payable overall.

And, in the event of a change of activities, such as moving from one career to another, or one business type to another, the structure can continue to be used with little or no impact on its set-up. This allows you to ‘support’ your partner’s business activities while maintaining flexibility and control over the investments and cashflow.

Are there additional responsibilities for a company that I don’t have as a sole trader?

Yes, there are. A company is treated as ‘separate’ from the people operating it. One description I have heard is that a company is a ‘body without a soul – the individuals operating it provides the soul, but anyone can take that position.’

The company will need to lodge its own tax return, separate from the individuals that run it. It will have its own tax liabilities and its obligations that are separate from that of its owners.

As an employer – even just of its owners – it will require worker’s compensation insurance with state authorities.

It should also have adequate insurance to cover its obligations – public liability, professional indemnity, equipment coverage etc. This will depend on its activities and operations, but most contracts the company is involved in for its services will require a form of insurance that is not always available for a sole trader.

For some industries, the company will need to lodge additional reports and returns annually regarding the contractors it uses or its annual turnover and employment costs.

With the new Director ID provisions, you will also need to register your details with ASIC and the ATO to obtain a Director ID before you are appointed as a director. We can assist you with this process.

Ok, so how do I become a company?

With your sole trader business, you should currently have one or more of these items in place:

  1. An ABN; (and possibly registered for GST as well)
  2. A business name;
  3. A bank account for your business activities
  4. A method of keeping track of all of your income and expense items.

    To set up a company, we will need to replace a number of these items and create ‘new’ versions for the business.

To set your activities up as a company, you will need to do the following:

  1. Select a name for your ‘new business’. You can use a name that you have already registered and transfer this to a company name, or create a new name that has not already been used and is not abusive, illegal or protected under various laws (e.g., you won’t be able to call your business “Queen Elizabeth Enterprises Pty Ltd”);
  2. Who is going to be a part of your company? You need to nominate your company’s directors and shareholders (owners). This can be one person, or it can be several people. Generally, you would limit this to the people who will be actively involved in the business and the people who can provide a benefit by ‘being involved’ in the business. We can advise you on this aspect.
  3. Apply to ASIC to set up a company. A number of documents are needed to be prepared that establish the company’s details, including its ‘rules of operation’. This can be a complex area and usually requires legal or accounting advisory support to prepare the documents correctly.
  4.  Once the company is registered, contact the ATO to obtain a new ABN (Your existing ‘personal’ ABN is unique to you and cannot be transferred to the company), a Tax File Number, and registration for GST and PAYG (i.e. collection of tax from wages paid to staff to be remitted to the Tax office.
  5. Set up a new bank account for your company. Your ‘personal’ bank account (or the one you use for your sole trader business) can not be the bank account for the company. Contact your bank and show them the details of your company, and they will establish a new account for you.
  6. Change over your paperwork – invoices, letterheads, email signatures etc. to show your new company’s details. Current contracts for services/work you do may also need to be updated to bring the company into the arrangements.
  7. Register with relevant state authorities. For E.g. Workcover registration is required even if ‘you’ are the only employee of the company.
  8. Set up your accounting process. This may mean buying new software or an online subscription to track your expenses and income, prepare invoices, pay wages etc. Again, we can advise on the best way to do this for your needs

This sounds complicated – Help Me!

At Fiscal Artisans, we have assisted many people in undertaking this process and can make the process as simple and streamlined as possible for you.

We have a Company Starter Package that helps you with the set-up that provides the following:

  1. Registration of your company with ASIC;
  2. Registration of all details needed with the ATO
  3. Set up your new accounting system, including 6 months of the accounting software subscription.
  4. Set up a data collection system, capturing your receipts and payments for your tax records.
  5. Work with you and prepare and lodge your business’s first two Business Activity statements.
  6. Advice and assistance on your business operations, and ‘telephone & email advice’ for the first 6 months.

    The total value of the services and registration costs is $3,500 + GST

Total Cost – $2,000 + GST (The GST can be claimed back on the first Bas for the business)

To get this underway, Please complete the details that follow and email it to Info@fiscalartisans.com.au

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