If you’re a small business, you probably started your journey as a sole trader … or you may still be one. However, at some stage your business will grow to a point where it’s important (and highly recommended) that you become a company for tax and liability purposes. In this blog, we’ll explain the difference between a sole trader vs company, and when to make the switch to a company?
Sole trader vs company: What’s the difference?
Deciding on the structure of your business and choosing the right one for your needs can be overwhelming, so understanding the differences and benefits will help make it easier for you.
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What is a sole trader?
This is the most common business structure. It is also the simplest and easiest to set up. In essence, a sole trader is an individual running a business. With this structure, you control and manage your business. However, as the sole trader, the Australian Taxation Office (ATO) states that you are “legally responsible for all aspects of the business, and debts and losses can’t be shared with other individuals. You can employ workers in your business, but you can’t employ yourself. As a sole trader, you are responsible for paying your worker’s super and your own super.”
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What is a company?
Meanwhile, when you set up a company, you’re creating a separate legal entity, which does involve higher set-up costs, but that can itself be liable for debt and other financial responsibilities. A company structure is more complex than a sole trader and has various tax, reporting and legal obligations to comply with. For example, a company must have at least one director who is a resident of the country and the company must be registered with ASIC. A company is run by its director/s and owned by its shareholders. However, while a company provides some asset protection, its director/s can still be held legally liable for their actions and, in some cases, the debts of the company, according to the ATO. Source: Australian Taxation Office
Main differences: Sole trader vs company
| Sole Trader | Company |
| Easy to set up, most businesses start here. | More complicated to set up with more paperwork. |
| The business owner is in full control of the business. | As a company, if you are the only director, you have control of the business. However, there can be multiple directors in a company. |
| Free to get an ABN, costs associated with registering your business. | Costs involved to set up. |
| There are minimal ongoing costs with a sole trader. | There are more ongoing costs for a company. |
| As a sole trader you are personally liable for financial or tax debts. | As a company, the company is liable for business debts. However, as a director, you are personally liable for pay as you go (PAYG) withholding and superannuation debts. Directors can be personally liable in some circumstances. |
| Money made as a sole trader is treated as personal income. | The money you make belongs to the company, and you can not take “personal drawings” from the company whenever you need it. |
| You can take money from the business whenever you need it. | The company can pay a director/s a salary or wage. You can also receive money via shares, dividends or loans. Income can be split between owners (directors). |
| You can employ and pay employees, however, the “personal drawings” you take are not considered wages from a tax point of view. | You can employ and pay employees and yourself for tax purposes. |
There is more information on the differences between a sole trader vs company here.
Your tax obligations as a sole trader vs company
Sole traders and companies are taxed differently, with a range of bookkeeping and reporting obligations, including income (type of tax return), what you are required to report (and what you are not), and tax rate. For example, companies pay tax at the corporate rate (27.5 per cent for certain SMEs), while sole traders pay tax based on their personal income. Accountants Australia reports there are also clear distinctions in regards to a sole trader vs company, including:
- Bookkeeping and reporting
- Ongoing operational costs
- Who is liable for business debts
- How business income is assessed
- Employment regulations
- Control of the business
Key benefits of each business structure
There are several reasons why a sole trader would change their trading structure to a company. The tax benefits are the main reason. Most small businesses start out as a sole trader because it’s easy to set up and has low costs. With this business structure, you are in full control of your business. However, you are personally liable for tax debts and other financial responsibilities as the business owner. If your business is growing and your income is increasing year on year, you may consider changing from a sole trader to a company. A company structure protects your personal assets, keeping your business assets separate from your personal and family assets. As a company your taxes, responsibilities, asset protection and operational costs will change, so it’s best to seek professional advice from a small business bookkeeper.
Ready to switch from a sole trader to a company?
It’s important that you think about all of your options when considering a sole trader vs company. If you’re ready to set up a company now, or you think you might in the future, please get in touch with us at Accounts All Sorted and we will put you in touch with one of the trusted accountants we partner with. Click here to contact us They will help you make the switch to a company so you’re set up correctly for your future business growth, bookkeeping needs and taxation obligations.
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