In Australia, businesses can be organized in a wide variety of ways, from sole proprietorships to corporations, partnerships, and trusts. If you’re at the helm of a small business, you may be unsure about whether to classify yourself as a sole trader or a small company and where specific restrictions apply. Both structures have different legal, tax, record-keeping, setup fees, and financial reporting obligations to the Australian Taxation Office (ATO). It’s crucial to understand the distinction between the two and your responsibilities. Here, Shoebox explains the main differences between sole traders and small companies.
ESSENTIAL DEFINITIONS
Launching your own business enterprise can be both exciting and challenging. While the various financial responsibilities can be overwhelming, understanding them is important to avoid costly mistakes in the future. The first choice a startup must make is how to register the business: as a sole trader or a company. Here’s how these two structures are defined by various authorities.
WHAT IS A SOLE TRADER?
As the name indicates, a sole trader is an individual who operates a business. While not all sole traders operate businesses in the traditional sense, some people establish their own companies (and obtain an Australian Business Number – ABN) to receive payment for contract or freelance work. While a sole proprietorship is a relatively simple business structure to manage, it also means that you are solely responsible for all liabilities and debts incurred. This implies that you bear all the risks associated with the business. As such, it is advisable that you put sole trader insurance in place. However, being solely responsible for running a company doesn’t mean you have to manage everything yourself; you can hire staff to assist you. If you plan to employ staff, there may be additional financial requirements to consider, such as taxes, superannuation, and fringe benefits taxes. It’s essential to review the ATO’s guidelines to ensure you fully understand the employment process requirements.
Now, let’s explore small companies. When you apply for or update your ABN, you simply register your business as a “company”; there is no specific category for “small company” registration. Different authorities have different definitions of what constitutes the “small” component. In Australia, what is considered small for fair work considerations may not be the same as what is considered small for legal or tax purposes. Let’s delve into it.
AN ANALYSIS OF COMPANIES
Unlike sole proprietorships or partnerships, a company is a distinct legal entity. This means that the company can owe money, file lawsuits, and be sued just like an individual. As a member, you are not personally liable for the company’s debts. However, you are responsible for ensuring any outstanding balances related to your shares are paid if requested. Additionally, if it is found that the company has violated any financial responsibilities, the directors of the company may be held accountable. While establishing a company as a sole trader is generally quick and simple, establishing and maintaining a company can be more complex and costly. So, where does the “small” in “small company” come into play?
According to ASIC (Australian Securities and Investment Commission), a legally sanctioned independent agency of the Australian Government responsible for overseeing the regulation of businesses, markets, financial services, and consumer creditors, a “small proprietary company” is considered “small” for a financial year starting on or after 1 July 2019 if it ticks the boxes on at least two of the following requirements:
- Revenue of less than $50 million per year
- Less than 100 employees or total gross assets of less than $25 million at the end of the financial year.
For financial years beginning before June 30, 2019, a company is treated as small if it meets at least two of the following conditions:
- Annual income of under $25 million
- Less than 50 employees at the end of the financial year or consolidated gross assets under $12.5 million at that time.
The definition of a small business entity by the ATO includes sole proprietorships, partnerships, companies, or trusts that have an aggregated turnover of less than $10 million and operate a business for all or part of the income year starting from July 1, 2016. Therefore, both companies and sole proprietors can be considered “small businesses,” according to the ATO. Being classified as a small business entity allows small businesses to apply for specific concessions that can help offset some operating costs and provide tax benefits.
Understanding the distinction between a sole trader and a company is crucial for complying with legal and tax obligations. While a sole trader has simpler setup and management processes, they also bear full liability for the business’s debts. On the other hand, a company is an independent legal entity that offers limited liability protection to its members but involves more complex administrative requirements.
It’s advisable to seek professional advice or consult with relevant authorities such as the ATO and ASIC to ensure you make informed decisions and meet all legal and financial obligations based on your specific business structure.