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.
Most small businesses in Australia opt to register as proprietary limited companies, known as Pty Ltd.
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.
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 have limited liability, so the shareholders are only somewhat responsible for liabilities such as company debts depending on the shares they own. If a business goes under, the shareholders only have liability in losing what they invested in their share of the business.
A company is a separate legal entity in its own right. Other entities are able to sue a company, and the company can sue other entities.
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.
Advantages of Operating as a Company
As a business owner, here are the advantages of operating as a company that could make this option an attractive one:
- Limited Liability
- Attracting Stakeholders
- Avoiding Conflict
- Perpetual Succession
- Tax Efficiency
1. Limited Liability
As its own legal entity, a Pty Ltd company is liable for its own debts.
Successfully 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.
The only way a company director may expose their personal assets if they breach their duties or provide a personal guarantee to a contract.
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.
They generally portray a larger and more serious level of business operation, which gives stakeholders higher confidence, and investors are more likely to invest in company structures.
Company structures offer:
- security thanks to limited liability;
- flexibility to investors who want to sell shares or purchase others, and
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.
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 rate of 26% regardless of profits, and 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:
- Directors Duties
1. Directors Duties
Sometimes, company directors fail to understand their responsibilities. 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 corporations law 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 can be:
- liable for paying particular company debts personally,
- exempt from managing another company,
- or even put in prison in some cases.
Opening and maintaining a proprietary limited company can be expensive. Here are some expenses to keep in mind:
- it costs $495 to register a company in government fees,
- if you hire an accountant or lawyer or to set it up, they will charge you professional service fees,
- you will be charged an annual reporting fee of $267 for ASIC, and
- there are ongoing accounting costs incurred to maintain a correct set of company accounts.
Companies are liable for lodging an annual company tax return. 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.
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.
If you are a sole trader considering registering your company as a distinct legal entity, you should first consider the advantages and disadvantages.
- have limited liabilities,
- are more attractive to stakeholders,
- are protected and regulated during conflict,
- have perpetual succession, and
- They are tax-efficient with a flat rate of 26%.
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.
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.