Entrepreneurs face many challenges and tough decisions when opening a business, and an important one is choosing whether to operate as a sole trader or a registered company. The simplest business structure is a sole trader, which is easy to set up but comes with personal liability.
Most small businesses in Australia opt to register as proprietary limited companies, known as Pty Ltd. Many Australian businesses choose the Pty Ltd structure for its credibility, professionalism, and growth potential.
Amongst the different business structures, Pty Ltd companies are the most common type in Australia due to their many advantages – but there are disadvantages to consider before making the important decision. Choosing the right business structure is crucial for your business’s needs and future plans.
We’ve broken these down to help you determine whether this business structure is a good idea for your company’s circumstances.
How Does a Pty Ltd Company Structure Work?
A proprietary company is privately owned rather than publicly, so it has fewer owners and shareholders. A private company must have at least one director, and it can’t have more than 50 shareholders.
Private companies offer limited liability and limited liability protection, meaning shareholders are only liable for the company’s debts up to the amount they’ve invested in shares. This structure shields personal assets from the company’s debts and obligations.
A company is a separate legal entity in its own right, giving it a distinct legal status. Other entities are able to sue a company, and the company can sue other entities. A Pty Ltd company is a private limited company and a proprietary company, and its separate legal existence means it is recognized as a distinct body under Australian law.
A Pty Ltd company can own assets, sign contracts, and incur debts in its own name, independent of its owners.
A Pty Ltd company must have at least one shareholder and can have multiple shareholders, up to a maximum of 50 non-employee shareholders.
Private companies can’t be listed on the Australian Stock Exchange (ASX) unlike public companies, so they are more limited when it comes to raising capital if needed. However, raising capital is possible by issuing shares to existing or new shareholders, but selling shares to the public is not allowed.
When setting up a Pty Ltd company, it is important to choose a unique company name and business name that comply with ASIC naming rules, and register them with ASIC.
You also need to obtain an Australian Company Number (ACN) and an Australian Business Number (ABN) when setting up a Pty Ltd company.
It is a requirement to open a separate company bank account to keep company funds distinct from personal funds.
Pty Ltd companies must maintain proper financial records, company records, and meet compliance obligations, including lodging annual income tax returns and complying with the Corporations Act.
The company’s constitution and other essential documents must be prepared and lodged with ASIC.
The Pty Ltd structure allows for flexible ownership and supports growth plans.
The company, as a separate legal entity, is responsible for its own legal responsibility and company’s debts, and shareholders are not personally liable beyond their investment.
Advantages of Operating as a Company
Business owners should consider the key advantages and key benefits of operating as a Pty Ltd company when choosing their business structure. These include:
Having a Pty Ltd structure enhances credibility with customers and suppliers, as it signals a more professional and stable business. Additionally, having ‘Pty Ltd’ after a business name signals maturity and stability to banks, suppliers, and corporate clients.
Limited Liability
Attracting Stakeholders
Avoiding Conflict
Perpetual Succession
Tax Efficiency
1. Limited Liability
A Pty Ltd company offers limited liability protection, meaning it is liable for its own debts as a separate legal entity.
Successful claims made against the company must be paid for using the cash reserves and assets owned by the company. This protects the shareholders’ and directors’ personal assets from the company’s debts. Shareholders of a Pty Ltd company are only liable for company debts up to the amount they’ve invested in shares.
However, personal guarantees can make directors or owners personally liable for certain company debts, despite the limited liability protection.
On the other hand, sole traders are at risk of their personal assets being nominated to satisfy any claims or debts.
2. Attracting Stakeholders
Investors, suppliers and customers generally prefer to do business with registered Pty Ltd companies over sole traders.
Pty Ltd companies can attract investors more easily because they can raise capital by issuing shares to existing shareholders, making them more attractive to investors who value the ability to invest and maintain privacy and control.
Company structures offer:
- security thanks to limited liability;
- flexibility to investors who want to sell shares or purchase others, and
- transparency.
Customers often feel more confident with registered companies because they’re more regulated. Similarly, a Pty Ltd company stands a better chance of winning tenders and contracts.
3. Avoiding Conflict
Upon registering a company, a shareholders’ agreement is usually created. This document governs shareholder relationships and offers protection against any disputes, such as if a shareholder leaves the company.
Additionally, the company’s constitution is an essential document for governance and compliance, and must be prepared and lodged with ASIC along with other key documents such as annual accounts.
So, a private company’s shareholders’ rights and responsibilities are regulated regarding how shares are divided, dividends are paid and how conflicts are resolved.
4. Perpetual Succession
Because a company operates as a separate legal entity on its own, it exists indefinitely.
If the company becomes wound up, the owner can sell it when they retire or resign. If a shareholder or director passes away, the business can continue to trade, and the person can be replaced – so long as a shareholders agreement is in place.
A sole trading business will cease to exist if the sole owner of the business passes away, or the business could be given to the next of kin as per the owner’s will.
5. Tax Efficiency
Sole traders are treated like individuals and are taxed at the normal marginal rates, with a maximum of 45%.
A Pty Ltd company pays income tax at a flat corporate tax rate. Most small Pty Ltd companies that qualify as base rate entities pay a flat 25% corporate tax rate on profits, which can be more tax efficient for reinvestment compared to personal income tax rates. Larger companies are charged 30%.
A private company is able to offset tax losses against the profits made by any other company in their group, that is if the company is a holding and owns multiple businesses. They could also bring tax losses forward into more profitable years.
Disadvantages of Operating as a Company
Here are the disadvantages of operating as a proprietary limited company to consider:
Pty Ltd companies generally have higher set up costs and ongoing costs compared to operating as a sole trader, due to registration fees and ongoing compliance requirements. Ongoing compliance with ASIC regulations and tax obligations is necessary to avoid penalties and maintain good standing.
Pty Ltd companies also face more administrative burdens, including maintaining proper financial records and complying with statutory obligations.
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Directors Duties
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Expenses
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Tax
1. Directors Duties
Directors of a Pty Ltd company have specific duties and responsibilities under the Corporations Act. Some of these include:
- stopping the company from trading while insolvent,
- acting and making decisions in the best interests of the company, and
- reporting the company’s affairs to the liquidator.
Directors must also ensure that the company is in keeping with all the legal obligations set out in the Corporations Act by:
- maintaining the latest financial records;
- letting the Australian Securities and Investments Commission (ASIC) know of any company changes, and
- paying ASIC fees.
Directors who breach their duties under the Corporations Act can be exposed to personal liability.
Directors who breach their duties can be:
- liable for paying particular company debts personally,
- exempt from managing another company,
- fined,
- or even put in prison in some cases.
2. Expenses
Opening and maintaining a proprietary limited company can be expensive. Here are some expenses to keep in mind:
- it costs around $560 to register a company with ASIC, plus an annual review fee,
- if you hire an accountant or lawyer to set it up, they will charge you professional service fees,
- you must pay an annual review fee to ASIC, which is currently around $310, and
- there are ongoing accounting costs incurred to maintain a correct set of company accounts, including compliance with annual review fee requirements.
3. Tax
Pty Ltd companies have specific tax obligations, including the requirement to lodge an annual company tax return. They must register for company tax and, if their turnover exceeds certain thresholds, also register for GST. They don’t have the initial tax-free threshold and are taxed at the flat company tax rate from the first dollar that they earn.
As part of their tax compliance, Pty Ltd companies must obtain a tax file number (TFN).
Individuals and sole traders are eligible for a 50% capital gains tax discount, while companies aren’t.
And, a loss made by a company can’t be used to offset any other personal income, but individuals that earn more than $250,000 can offset their business losses against other sources of income.
Key Takeaways
If you are a sole trader considering registering your company as a distinct legal entity, you should first consider the advantages and disadvantages of the Pty Ltd structure. The Pty Ltd structure is popular among Australian businesses because it offers liability protection, enhances credibility, and is often the most suitable structure for supporting business growth. Choosing the most suitable structure is crucial for long-term success and should be based on your business goals and circumstances.
The Pty Ltd structure can also benefit business finances by supporting efficient management of funds and facilitating international trade while maintaining regulatory compliance.
Private companies:
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have limited liabilities,
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are more attractive to stakeholders,
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are protected and regulated during conflict,
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have perpetual succession, and
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They are tax-efficient with a flat rate of 26%.
Small proprietary companies, in particular, enjoy flexibility and regulatory benefits compared to larger proprietary or public companies.
But, if the directors don’t do their duties adequately, they can face severe consequences. Registering and maintaining the company’s legalities can be expensive, and the company will be liable for paying tax from the very beginning.
Huge financial decisions shouldn’t be taken lightly or made alone, so contact us today to discuss your options with one of our professional and highly qualified business advisors at KNS Accountants.
Disclaimer
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.
