For many, starting a business is a dream and a step towards financial independence. With making the leap into starting your own enterprise, the decisions made within the business’s inception can have drastic implications down the track including asset protection, capital gains tax (CGT), income tax, estate and succession planning.
Here are 5 things you need to consider for your startup.
1. What structure is right for you?
The first question you’ll need to consider is what structure to use. Do you form a company, do you operate through a trust or do you simply set yourself up as a sole trader? What’s the difference?
Sole Trader
The main advantages of operating a business as a sole trader is its simplicity in nature along with its minimal associated professional costs. As a sole trader, all your business income and expenses are recorded in your personal tax return – which can be a double-edged sword. If it takes time to get your business going, the tax losses can usually be applied against any other income you may have such as a salary (subject to the non-commercial loss rules). However, if your business begins to generate serious profits, you can be penalised with higher marginal tax rates, potentially paying up to 47 cents on each dollar of earnings.
In addition, trading as a sole trader does not provide you with any form of asset protection which is attainable in the other structures mentioned below.
Trust
A trust is a structure where a trustee (an individual or company) carries on a business on behalf of its beneficiaries. Trusts are a common structure for family businesses where family members can benefit from business profits without necessarily being involved in how its run.
The major advantage of using a trust to run your business is that you have the discretion to decide who benefits from the profits of the trust. Generally, profits are distributed in the most tax effective way, typically to the beneficiaries with the lowest marginal tax rates – potentially savings thousands in tax compared with a Sole Trader structure. Each beneficiary records their share of the profit in their personal tax return and pays the tax themselves.
In addition, any capital gains or franking credits can be streamed to those beneficiaries who would ultimately benefit from it; for example, beneficiaries who could have capital losses. Trusts are also eligible for the 50% capital gains discount.
There are also asset protection advantages in holding assets within a trust. The downside of investing through a trust is that tax losses will be trapped in the trust as the trust cannot distribute losses to beneficiaries. However, these losses can generally be offset against future profits.
Company
A company is a separate legal entity that is run by directors on behalf of its shareholders. A company pays its own tax on profits at 27.5%, provided the company’s aggregate turnover is less than $10m. The company can then distribute profits to shareholders in the form of franked dividends. These dividends are taxable to the shareholders less a credit for the tax already paid by the company (franking credit).
Companies are a commonly used structure as they provide limited liability to its shareholders. In other words, the extent to which shareholders are liable for the debts of the company is limited to the amount they’ve invested as share capital – acting as a form of asset protection as creditors of the company cannot access the assets of the shareholders.
However, similar to a trust structure, losses cannot be streamed to shareholders. They are locked in the company and offset against future profits. However, if there is ever a change of ownership of the company or the nature of business changes, the losses may be foregone.
In addition, companies cannot access the 50% CGT discount, meaning all capital gains will be taxed at the corporate tax rate of 27.5%. Setting up and maintaining a company is also more expensive than the alternatives, with greater compliance obligations imposed by ASIC.
2. Do you need to be registered for GST?
Many business owners automatically register for GST, unaware that in some circumstances it may be optional. It’s only mandatory to register for GST if you expect your annual turnover to be $75,000 or more. However, if your turnover will be less than this, registering for GST is optional, and you should consider the cash flow and administrative implications of your decision.
If you’re forecasting a turnover below the $75,000 threshold, not registering for GST means you’re selling prices will effectively be 10% cheaper than those of your GST-registered competitors. Or you could charge the same price as your competitors and enjoy a healthier profit margin. However, you won’t be able to claim back the GST on your expenses or on any goods you purchase for sale. Generally, a business with high service-based sales and minimal expenses may benefit from not being registered for GST.
3. Are you employing?
If you intend to have employees, you need to consider the conditions of employment that you will offer your employees. There are certain minimum standards in Australia that apply to all employees, such as minimum wage. To ensure you are operating lawfully, you must familiarise yourself with your industry requirements as stipulated by the Fair Work and Occupational Health and Safety Acts.
In addition to the Fair Work obligations, you must ensure you have appropriate workcover insurances should your rateable remuneration exceed $7,500 for the financial year. The ATO also prescribe that you must be PAYG registered, withholding the correct amount from each employee’s wage whilst also being SuperStream compliant.
4. Systems
Business owners start businesses because of passion for what they do – not to spend time managing paperwork and compliance. It is crucial to invest in the right systems to automate functions of your business to provide you with real time, accurate and timely information when you need it most. After all, your time is better spent developing your business.
5. Exit strategy
Great businesses are formed with an exit strategy in mind. It’s not enough to build a business worth a fortune – you have to make sure you have an exit strategy, a way to get the money back out. Whether that’s through a sale or succession planning, the decisions made upon incorporation of your business can have crucial implications on your exit.
Experts in start-ups…
Starting your own business can be an exciting but daunting time. To make sure you get off on the right foot, it’s imperative to plan properly and find out what’s involved.
If you’re thinking of starting your own business, speak to us today to get your chips in order to ensure you’re taking the right steps towards your financial independence.
