5 Compelling Reasons to Operate Your Business from a Company Structure

By Defy Gunadi February 25, 2024 | Tags: Business Structure, Small Business

Business Structure: 5 Powerful Reasons operating Business

Are you considering starting your own venture, already managing your business as a sole trader, or an entrepreneur assessing whether your existing business structure aligns with your goals? If so, this article is tailored for you.

For new business owners, approaching entrepreneurship with a clear understanding and realistic expectations is crucial. The notion of financial freedom, often associated with the idea that building a business can lead to wealth, is frequently hyped in the marketplace. However, many enter the small business world believing that simply setting up a business will automatically bring significant success and autonomy within a few years. The reality, though, is far more complex.

Achieving stability and growth in the initial years demands that a business owner take on multiple roles—operator, financial controller, marketing manager, and administrator—all at once. Success hinges not just on a great idea, but also on the ability to execute it effectively across all business aspects. So, knowledge is the key.

Previously, we discussed the benefits of operating a business through a Trust. Now, we will shift our focus to the advantages of incorporating your business as a Company, outlining why this structure could be the ideal fit for your entrepreneurial endeavours.

What is a Company?

A Company structure is one of the commonly used business structures in the small business and business community. A company is essentially a legal entity established by an individual or a group of individuals aiming to conduct business activities, which can span from commercial ventures to industrial operations. The structure of a company can varies to optimise tax benefits and minimise financial liabilities, all of which is governed by the legal framework of the jurisdiction in which it operates.

A company is a type of business structure that is a separate legal entity from its owners. The owners of the company are known as shareholders. Every company must have at least one shareholder. Its legal status gives a company the same rights as a natural person, which means that a company can incur debt, sue and be sued. Companies are managed by company officers who are called directors and company secretaries.

Small business owners often use a type of company structure called a proprietary limited company (which has the words ‘Pty Ltd’ after the name). This structure is characterised by its limited liability, a key feature that protects the personal assets of the shareholders. In contrast to public companies, proprietary limited companies typically do not issue shares to the general public as a means of raising capital for their operations.

Why Should You Use a Company to Run Your Business?

If you do a quick search online, you’ll find countless reasons to start a company. But in this article, we’re going to zero in on the essential bits of wisdom that accountants and lawyers often share during their professional consultations.

One day Establishment

Do you need a business structure set up within a day? Your accountant can simply submit the necessary form to ASIC and secure a corporate number (ACN) within a day. Many of us don’t prepare a business structure or seek business structure advice in advance. Sometimes, opportunities come knocking at your door, and you need an immediate business structure to close the deal. All you need to do is complete a form and submit it to ASIC to obtain a corporate number. Once you have the corporate number, you can apply for an ABN and TFN. It is advisable to engage your accountant or lawyer to establish the company to avoid mistakes.

Recently, we encountered a client who tried to establish a company on her own and mistakenly issued an unpaid share class for herself. She believed that since she didn’t have a company bank account, she couldn’t pay for the shares, hence the shares would remain unpaid. It took her many phone calls and countless hours to rectify this with ASIC. While this may be an isolated incident, I’m sure you wouldn’t want to be part of such statistics, so it’s better to engage an accountant and lawyer to ensure it’s done correctly and avoid any mistakes.

if the company incurs debts or is sued, the personal assets of the members or owners are typically protected

Limited Liability

One of the greatest advantages of operating your business through a company is that the liability of members or owners is limited because the company is a separate legal entity. Generally, members will not be personally liable for the debts of the company in their capacity as a member.

When a company is established as its own legal entity, it means that it is separate from the individuals who own or operate it. This separation is crucial because it limits the financial liability of the company’s members or owners. In essence, if the company incurs debts or is sued, the personal assets of the members or owners are typically protected. They are not personally liable for the company’s debts solely because of their ownership or membership.

For example, consider a scenario where a company, “Tech Innovations Pty Ltd,” faces financial difficulties and owes substantial debts to its creditors. Because Tech Innovations Pty Ltd is a legal entity in its own right, the owners (shareholders) of the company are not automatically responsible for repaying these debts from their personal finances. If the company were to declare bankruptcy, the personal assets of the shareholders, such as their homes, cars, and personal savings, would generally not be at risk to satisfy the company’s debts. This limited liability encourages entrepreneurship by reducing the risk involved in starting and running a business, as the personal financial risk to owners is minimised.

25% Tax Rate for Small Business

Almost every business owner seeks tax minimization from their business structure, and operating as a company offers this advantage. The general tax rate for companies is 30%; however, small business entities recognized as base rate entities are subject to a 25% tax on company profits.

To qualify for this rate, a company needs to ensure its total yearly income does not exceed a specified threshold, recently raised to $50 million, and that no more than 80% of its income comes from passive sources such as dividends, rent, royalties, interest, or capital gains, diverging from the previous requirement to be actively conducting a business.

The determination of a company’s eligibility for this reduced tax rate is made on an annual basis, focusing exclusively on the financial activities of that particular year. The scope of passive income includes earnings from various sources including corporate distributions, royalties, rent, and interest, with some exceptions, as well as profits from securities and net capital gains.

For example – Innovations Pty Ltd is a company that specializes in developing cutting-edge tech gadgets. Its founder, Ava Smith, is looking to diversify the product line to include smart home devices. To finance this expansion, she allocates the required capital into a term deposit while finalizing deals with new manufacturers.

During the 2022–23 income year, Innovations Pty Ltd.’s total revenue stays below the $50 million threshold. Its total income amounts to $120,000, broken down as follows:

$115,000 in trading income from its tech gadget sales

$5,000 in interest income from the term deposit.

The interest income qualifies as base rate entity passive income. Since this passive income constitutes only 4.2% of its total income, Innovations Pty Ltd meets the criteria for a base rate entity in the 2022–23 income year. Therefore, the reduced company tax rate of 25% is applicable to its profits.

Source – ATO

Optimising Personal Tax Management

In contrast to a Discretionary Trust, a company is not obligated to distribute profits or issue dividends annually. If you’re drawing a salary from the business and don’t need extra funds for personal expenses or investments, you can retain the profits within the company after settling the 25% tax obligation. However, if you issue a profit distribution or dividend, you will incur a personal tax liability on this profit.

Let’s use the example of Innovations Pty Ltd to better understand this concept. Ava Smith is the sole shareholder of Innovations Pty Ltd and has a $200,000 annual salary from her company. In the 2024 financial year, if she were to issue herself an additional $100,000 as a dividend from the company’s profits, this dividend would come with a 25% tax credit, reflecting the tax already paid by the company at the corporate rate.

Given Ava’s total income, her personal tax obligation would be in the higher brackets, with a marginal rate of 47% including the Medicare levy. The $100,000 dividend, with its 25% tax credit amounting to $25,000, would not fully cover her personal tax liability on this income due to her higher rate. Therefore, Ava would need to pay the difference between the 47% personal tax rate and the 25% tax credit from the dividend.

However, Ava has the flexibility as a company shareholder to choose not to distribute such large dividends. Instead, she could retain the profits within the company, issuing dividends at a later time when it may be more advantageous for her personal tax situation.

Flexible Ownership Structure to Raise Capital

At some point in their journey, every small business owner encounter growth challenges. These obstacles may stem from limited resources, the departure of key employees, or funding constraints. When faced with such hurdles, one viable solution that often emerges is to raise capital to fuel business growth. However, raising capital doesn’t necessarily mean navigating the complex paths of creating public companies. Instead, it might involve engaging one or two key stakeholders—be it employees or investors—to contribute to the business’s growth and, in turn, share in its successes.

Incorporating a company provides a strategic framework that not only simplifies the management of ownership and equity distribution but also significantly boosts the business’s capacity to acquire the crucial capital it needs. The adoption of a company structure introduces a flexible share allocation system, enabling the assignment of varying ownership percentages and influence on essential stakeholders and investors. This flexibility is key to customising the business structure to suit its unique needs and growth strategies.

Moreover, the opportunity to allocate ownership stakes through shares is a powerful tool for attracting and retaining top talent. Offering equity as part of compensation packages not only aids in recruitment efforts but also ensures the retention of key employees by aligning their personal interests with the long-term prosperity of the company. This alignment fosters a shared commitment to the company’s success, creating a motivated and invested workforce dedicated to achieving collective goals.

Navigating the complexities of business structures can be daunting, especially when the success of your business journey hinges on making informed decisions. While this article has illuminated the significant advantages of incorporating your business as a company, it’s crucial to remember that each business is unique. The ideal structure for your venture depends on various factors, including your long-term goals, financial strategies, and the level of liability protection you seek.

Choosing the right business structure is a pivotal step that can shape the trajectory of your business growth, tax obligations, and legal liabilities. It’s a decision that merits careful consideration and expert advice tailored to your specific circumstances.

If you’re pondering the future of your business structure or standing at the crossroads of entrepreneurship, seeking professional guidance can enlighten the path ahead. Investax specialises in guiding entrepreneurs and small business owners through the maze of business structuring options. Our team of seasoned experts is dedicated to understanding your vision and crafting a business structure that aligns with your aspirations and maximizes your benefits.

Don’t leave your business’s future to chance. Contact Investax today to explore how the right business structure can set the foundation for your success. Let us help you build a robust framework that supports your growth, protects your assets, and optimizes your tax position.

Pro Tips

Long Term Business Plan: When selecting a business structure, think long-term. Consider not just your current needs but also your future business goals and potential expansion.
Smart Business Structure: Consider using a Discretionary Trust as a Shareholder instead of having individual shareholders for greater tax advantage and asset protection.
Bucket Company: If you are distributing profit from a trust to the company same base rate entity rule applies for the reduced tax rate.
Personal Guarantee Pitfalls: Be careful about the personal guarantee for lease or loans. members and directors may still be liable for a company’s debts in certain circumstances, such as when they have provided personal guarantees to borrow money.
Use Professionals: When considering the establishment of a business, it’s wise to conduct your own research and seek advice from an experienced tax accountant or lawyer. This ensures that you’re well-informed about the legal and financial implications of your business structure. If you’re in need of professional guidance and don’t have an experienced tax accountant specialising in business structure, feel free to reach out to Investax. We’re here to discuss your business plan and help you choose the most suitable structure for your needs.