Sole Trader vs Company – What You Need to Know 

 

When starting a business in Australia, one of the first decisions you’ll face is choosing the right business structure. Two of the most common options are operating as a sole trader or setting up a company. Each has its own set of advantages and disadvantages, and the choice you make can significantly impact how you run your business, your tax obligations, and your personal liability. In this article we’ll break down the key differences between these two structures to help you make an informed decision on Sole Trader vs Company – what you need to know. 

What Is a Sole Trader?

 

A sole trader is the simplest and most straightforward business structure. As a sole trader, you are the sole owner and operator of your business, meaning you have full control over all decisions and all financial implications are with you personally. A sole trader has no legal status separate from the operator. This structure is popular among freelancers, small business owners, and individuals offering services on their own.  

Advantages of Being a Sole Trader:

• Ease of Setup: Setting up as a sole trader is quick and relatively inexpensive and you can usually do it all yourself. You don’t need to register a company, just apply for an Australian Business Number (ABN) and register for GST if your turnover exceeds $75,000. 

• Complete Control: As the sole owner, you have complete control over your business decisions, allowing you to manage your operations as you see fit. 

• Simple Taxation: The income you earn as a sole trader is considered your personal income, so you only need to lodge a personal tax return, simplifying the tax process.  

• Offset losses: trading losses can be offset against other income in the sole traders personal tax return 

• A Sole Trader: is the most cost-effective business structure to establish  

Disadvantages of Being a Sole Trader:

• Unlimited Liability: One of the biggest disadvantages of being a sole trader is that you are personally liable for all the business’s debts and obligations and for any risk. If your business runs into financial trouble, your personal assets, such as your home, could be at risk. A sole trader structure is often not a good idea if you have risk in the business or employees.  

• Limited Growth Potential: Raising capital or going into business with a partner can be challenging as a sole trader, and there is a limit to how much you can expand without taking on additional risk and the business structure doesn’t allow for partners to come in.   

• Tax Efficiency: As your income increases, operating as a sole trader may become less tax-efficient, as you are taxed at personal income tax rates, which depending on your income levels, could be higher than the corporate tax rate. 

• Limited Succession: It is difficult to succeed a business that is operated by a sole trader. A sole trader is possible the least beneficial for succession planning. 

• Funding Difficulty: Banks can struggle to lend to a sole trader business 

• Perception: As you grow and start having larger customers, operating as a sole trader doesn’t look professional or give the perception of scale  

What Is a Company?

 

A company is a separate legal entity from its owners, known as shareholders. A company acts much like a natural person. It can sue. It can be sued, and it pays tax.

A company structure is an effective and transparent structure where arm’s length parties can go into business together. Each party can own a fixed interest (via shares) in the company, with the relationship governed by the Corporations Act 2001 and the company constitution.

A company structure is generally well understood, however is more complex than a sole trader but offers distinct advantages, particularly for businesses looking to grow or protect personal assets of its owners. 

Advantages of Operating as a Company: 

• Limited Liability: One of the primary benefits of a company structure is limited liability. Shareholders’ personal assets are generally protected, as they are only liable for the amount they have invested in the company. 

• Tax Benefits: Companies are taxed at a flat corporate rate, which is currently much lower than the highest personal tax rates in Australia. This can result in significant tax savings as the business grows. 

• Access to Capital: Companies can raise capital more easily by issuing shares, which can be a key advantage if you plan to expand your business. 

• Unrelated Business Owners: a company allows for unrelated business owners to do business together. This is possible as shareholders have fixed entitlements to capital and income and all companies have the protection of The Corporations Act 2001 which regulates all matters to do with a company.  

• Franking Credits: When a company pays income tax to the ATO, this gives rise to a franking credit for the company, which is held until such a time as the company pays dividends. These dividends with a franking credit attached (a credit to the value of tax already paid by the company on profits) is passed onto shareholders as a tax credit to be claimed against their taxable income. This prevents double taxation on company profits.  

• Ability to do business: for contractors where the entity they contract with require them to operate through a company. Some Government agencies and other businesses may only deal with a company.  

• Going Public: where the entity may be listed in the future as a public company, establishing the business in a company at the start will make this easier.  

• Tax Concessions: the R&D tax concession can only be accessed via a company  

Disadvantages of Operating as a Company:

• More Complex Setup and Administration: Setting up a company involves more paperwork, including registration with the Australian Securities and Investments Commission (ASIC) and ongoing compliance requirements, such as filing annual financial statements. 

• Less Flexibility: Running a company involves more formalities and may require additional governance, such as appointing directors and holding regular meetings.  

• The money is not yours: Money or assets held within a company are not yours. To access such funds or assets, you need to usually pay a dividend.  

• Personal Services Income: If your income is generated from your personal efforts or skills and you operate in a company, you may still be required to remit this income in your personal tax return. 

• 50% CGT Discount: a Company cannot access the 50% CGT discount if it is selling an asset held for more than 12 months (like an individual or trust can). However, with company rates at 25% (base rate entity), there is not a lot of difference between top marginal tax rates and receiving the 50% CGT discount and not receiving it with a company base rate of 25%.  

• Losses: Losses are trapped in the company, unless the company consolidates within a corporate group 

• Directors Liability: Directors can be personally liable for some debts, such as superannuation, GST and PAYG W.  

Sole Trader vs Company: Which Is Right for You?

 

When deciding between a sole trader vs company, the right choice depends on your business goals, the level of risk you’re willing to take, and your long-term plans. You really need to also consider the longer term when choosing a business structure – not just the now and what is the cheapest.  

• Start Small: If you’re just starting out, have minimal financial risk, and want to keep things simple, operating as a sole trader might be the best option. It’s easy to set up, and you can always transition to a company structure later if your business grows (under circumstances, there are capital gains exemptions for a rollover from a sole trader to a company). 

• Planning for Growth: If you plan to grow your business, seek investment or operated with unrelated parties, or want to protect your personal assets, setting up a company may be more appropriate. While it requires more effort and ongoing compliance, the benefits can outweigh the drawbacks as your business expands. 

Understanding the differences between a sole trader vs company – what you need to know is essential for making the best decision for your business. Each structure has its pros and cons, and the choice you make will affect how your business operates, how you’re taxed, and how much risk you take on personally. 

If you’re unsure which structure is right for you, professional advice can make all the difference. At Rogerson Kenny Business Accountants, we specialise in helping Australian business owners choose the right structure for their needs. Contact us today to discuss your options and get tailored advice on setting up your business for success.