What's the best business structure
for a trades business - is it sole trader or is it proprietary limited?
It's a choice. You have a choice. I'm going to explain the differences
between the two. I'm going to help you choose because you should. You should choose and you shouldn't
just sort of go along with the flow.
And it's more about risk than it is about tax.
Now I'm going to use Australian terminology here because that's where I live.
Proprietary limited- pty ltd, that one.
In the UK that's called a private limited company or just limited, same in New Zealand.
I think in America, it's LLC.
It's a company rather than sold trader.
Now I hear about accountants advising people they're big enough to move to limited now
and they're talking about the tax paid on profits
rather than the risk usually when they say that.
I'm going to come back to that in a moment.
First let me explain the difference between the two so you understand where I'm coming from.
So if you're a sole trader
that doesn't mean there's only you.
What that means is that your trading your business structure is a sole trader and your business is you.
You can still have employees and all that
doesn't mean you just work on your own. You can still have employees, you can have 20 people if you want
but as far as the law is concerned you, and the business are the same illegal entity
even though you keep accounts for the business and you make profits and you think of it as a thing in its own.
It's not, it's you
trading as your business name.
When you've registered your business name, it's registered to you. It's just the name
that you trade and they all trade you trading ads. This is a really important thing to understand.
When your accountant does your tax return or you do it yourself if that's what happens,
there's only one tax return because there's only one legal entity which is you trading as.
There are your business accounts and there's the profit and then there's your personal deductions as well
and if you have an investment property or anything that's all going to be on there as well but it's one tax return.
The accountant adds up all the income including from your investment property
and the drawings from the business and all the expenses and it kind of sorts out the mess for you.
Importantly, (this is important) it's you that owns all the assets and it's you that owes any money owed.
And here's where the risk comes in.
If you own a house or other assets and your business goes sh*t
and you owe someone money, it's you they sue and your house is on the line.
That's important.
So you can be forced to sell your house or your other assets to repay the debt
and even if you going bankrupt won't help you.
If however, you're a limited company or a proprietary limited company,
it's a bit different. It's called a limited company for a reason. Your liability as the investor is limited
to what you invest in the company. The most you could lose is what you put in
in the first place with certain rules and exceptions.
Limited liability came about back in the day in the 17th century or around
for some businesses anyway and before that even for guilds
and monastic communities like in the 15th century.
And they were set up
so that investors could risk a certain amount in a venture rather than kind of everything they had before that
these people would risk something on a venture and then they'd get sued and then lose fortunes
so all these rich people who had fortunes wanted to protect themselves and stimulate
economic investment.
So in this instance back to tradies, the business is a separate legal entity or it's a legal person.
Your liability is limited to what you paid for your shares or what you invested in the business in the first place
so if the business fails and it's got debts and it's unable to repay a debt,
the person who the business owes money to or the business that the business owes money to or whoever,
they sue the business, not you personally.
That's the important difference. It's the business that buy the money so the creditor gets to sue the business.
And you're not the business. You're a separate person, you're a director,
you do have some responsibilities but you're not the business.
So your house isn't directly on the line. They don't come to you for your house necessarily.
Now as always, it's a bit more complicated than that so keep listening.
The directors of a company remain liable for certain debts and in Australia, the superannuation guarantee,
for example, is payable by the directors even if the business goes under
and the ATO can but don't always chase you from paid GST and pay as you go tax.
It's a bit similar in the UK I think.
So you're not completely scuff-free. You can't fail a business and go, "Oh, sorry and liquidate and fold
the business and be completely free from all your debts but you'll be free from most of them.
Most of your trade creditors for example
won't be able to come after you and say, "Sell your house, you owe me $100k."
If you've signed the director's guarantee though on a loan or a lease,
you might remain liable for you do remain liable for it.
So you've got some protection for your business's debts or from your businesses debt but it's not complete.
So that's the risk position and if you've got assets, you might want to be a limited company
to protect them, to make it harder for people to come and chase you.
Now there's a cost, of course, to set up and maintain a business. It's a few hundred to register a company
and you'd have to spend a bit of money every year a couple hundred a year
and it's a couple of thousand if your accountant sets it up for you.
There's an annual registration fee I just mentioned and the company being a legal person
has to do a tax return. So you've got to do two: one is for yourself and one for your business.
You've got to pay your accountant to do that. Now companies and sole traders aren't your only options
but they're all either unlimited liability or limited.
Partnerships are unlimited, trusts are limited, that kind of thing.
So you should talk to your accountant. This is their area.
This is something that you should be talking to them about your risk and your assets
and they should be setting it up for you.
If you have assets, it's probably worth protecting them from you failing your business.
I know you don't think you're going to. No one ever does, do they? and it can happen and if you have a house,
I would protect it back to the tax before I finish.
Company tax is less than the highest rate of personal tax. In Australia, it's 30%
and the highest rate of personal tax is 45% at the moment
so it's 37% if you make
more than $90k and it's 45% if you make more than $180,000.
So if your earnings are more than the $90,000 a year, your accountant might suggest that you'll save tax
by moving to a company structure and that way, you can pay yourself a salary of $90,000
and then the rest of your profit you'll pay 30% tax on instead of 37%,
that's only really true if you leave it in the business. If you put it all out,
then you're going to pay the 37% because then it becomes your personal income
but if you leave it in the business and reinvest it into the business, you'll only pay the 30%
so your accountant's right. I hope I've made that a bit clearer.
It's probably still the right advice. You're big enough
but I would be considering moving to a company structure if you own your own house
perhaps sooner. It might feel expensive. It is expensive but your house isn't on the line.
I hope that helps.
I hope that puts a business spin on it rather than just a tax spin on it or a business perspective.
And of course, I'm a business coach for traders and builders. I know some other stuff too.
So if you want to talk to me about some other stuff in your business, if you want to consider
business coaching which is what I sell,
book yourself a 10-minute chat with me,
we'll have 10-minute chat if we like each other enough, we'll invest a full hour and that's the path into coaching.
Another thing you can do is come to my next Tools Down workshop. We run three or four or five a year,
I'll teach you the framework you can use to grow your business.
So there you go. See you later.