Are you thinking about your current business structure and wondering if it’s still the right fit for your growing business?
In our 3 part Business Structuring series, we analyse the risks and benefits of a selection of common business structures. In part 1 we examined operating as a sole trader, now let’s explore the business structure ‘Company’.
Operating through a company structure
A company is a separate legal entity that is owned by the company’s shareholders. Its directors are responsible for oversight of the company’s affairs, must act in the best interest of the shareholders and must comply with Australia law. Its important for company shareholders and directors to remember that the company is the owner of the company’s assets. They can’t be treated as if they are owned by the directors and shareholders.
Shareholders receive their entitlement to company profit by way of dividends. If the company has paid company tax in the past and has adequate franking credits available, the dividends paid to shareholders can be franked. When the individual shareholder reports the dividend income in their personal tax return, they will receive a tax offset for the franking credit. This stops company profits being double taxed.
A big advantage of operating through a company structure is the asset protection that it offers in many circumstances. The only capital that the shareholder puts at risk is the value of the shares they own in the company, along with any loans the shareholders have made to the company. The company is responsible for paying its debts (like to creditors, the Australian Taxation Office, its employees), so the shareholder’s personal assets are shielded from company debts. However, if a director fails to perform their duties and breaches the law, the consequences can be severe. These consequences can include the director becoming responsible for the company’s debts, being fined, or even being charged with a criminal offence.
Another attractive attribute of operating through a company is the tax rate. If the company’s aggregated turnover is less than $50 million, and the company earns more than 20% of its income from business operations, company profits are usually taxed at 25%. This is a major advantage for businesses that require a large amount of working capital or carry a high level of debtors.
A key consideration for many business owners when selecting the right structure is succession planning. Is there a plan for children to take over the ownership and control of the business in the future? Could there be a need to offer a key employee an ownership interest in the business? Shares in a company can be bought and sold, or new shares can be issued, making the transfer of ownership a reasonably straight forward process in most circumstance.
There are many other considerations that may sway business owners to choose a company structure over other options. These can include:
- Some government grants only available to companies
- Research and Development Tax Incentive only available to companies
- Building industry entities may find it easier to satisfy the requirements of their state and territory licensing bodies when operating through a company
- Easier to restructure and to diversify operations
Company example – advertising agency
Following on from the sole trader example, Rachel has decided to shift her business offerings and strategy. Rather than contracting with agencies for an hourly rate, she will market her services to the industry at large and offer fixed price services. Rachel has also decided to expand and to take on employees to assist with principal work, and to also hire support staff. Her business will generate profits from the business operations and structure rather than solely from her personal labour. Due to the expansion, her business is expected to carry a much higher level of debtors. She will also be required to rent office space to accommodate the new staff, and to provide a place to meet with clients.
How well does the company structure suit this business?
If Rachel selects a company structure and intends to be the director, she needs to be willing to take on additional responsibilities and administration work. The establishment costs are higher, and after the company is established, she will need to set up a company bank account and ensure the company has obtained appropriate insurance, legal and accounting advice.
As Rachel’s expanded business is expected to have a high level of debtors and will require significant working capital, paying a tax rate of 25% on company profits is very attractive and will free up cash flow. Should one of the debtors fail to pay (and providing Rachel has not breached any of her director’s duties) and Rachel’s company cannot pay its debts, Rachel’s personal assets are shielded from the company’s creditors. Should Rachel wish to bring in a key employee as a business partner in the future, the company structure can facilitate this.
After considering the additional costs and responsibilities, Rachel assesses that the benefits outweigh the costs in her circumstance and opts for the company structure. The business ticks along for a few years and more staff are hired. The rented office space no longer accommodates the growing number of staff, and Rachel starts looking for a commercial office space to purchase for her business operations.
Stay tuned for part 3 where we explore the business structure ‘Discretionary Trust’.
At Crest Accountants, we have a range of business structuring services all benefiting from our extensive experience in working with and advising about the processes, systems, and plans, essential to the overall structure and success of a business. We take the time to get to know our clients so that you feel confident we have your best interest at heart.
Contact us and book an appointment to discuss your business accounting needs today.
Disclaimer: The information contained in this news post is general in nature and is intended to provide a general summary only and should not be relied on as a substitute for professional advice.