There are several different ways that a business can be owned, and each has its own benefits and disadvantages.
It is important to ensure that whichever structure is chosen, the business name must be registered and must comply with relevant licensing requirements. See Registration and Licensing for more information.
Other aspects to consider are considered in more detail in the following headings:
An individual person can own and operate a business. There is no special procedure to set up as a sole trader, other than the requirement to register a business name under the Business Names Registration Act 2011(Cth) if the name of the business is not exactly the same as the individual's name.
ASIC is responsible for the registration of business names under the Act, and useful information about what is required to register is available on ASIC website on the Business Names page.
A person running a business as a sole trader becomes personally responsible for any debts and obligations arising from the business, which is the main disadvantage of this structure. However, it is very easy to set up, and the ongoing administrative requirements are minimal compared to other methods of holding.
All of the income from the business and expenses are, for tax purposes, assessed in the name of that owner. If the turnover of the business exceeds $75 000, it must be registered for the GST. Check www.ato.gov.au for further information.
A partnership is formed when between two and twenty people agree in writing or verbally to jointly carrying on a business in common with a view to a profit. Each partner is liable for the actions of the other partners. The Partnership Act 1891(SA) sets out the circumstances where the law assumes that people are in 'partnership'. Even if there is no intention to form a partnership, a number of people co-operating in a venture may be legally regarded as partners.
The Partnership Act 1891(SA) also specifies various rights and duties of partners. These include:
- each partner has an equal say in controlling the business unless they otherwise agree
- each partner can enter into a contract or create a liability which is binding on other partners as though they had created the contract or liability. Another person who deals with one partner can presume that all the partners will be equally and totally liable for anything that is promised.
- if a partner dies the partnership is dissolved, unless otherwise agreed
- all partners will share profits and losses equally, unless otherwise agreed
- one partner cannot be expelled by the other partners unless otherwise agreed
- a partner is only responsible for partnership debts and liabilities that arise after the person becomes a partner
- a partner who properly retires from a partnership remains liable for debts and liabilities incurred by the partnership before the retirement. A partner who does not formally retire will continue to be responsible for debts incurred after the retirement, see resignation of a partner
- if a partner is unable to pay her or his debts, or becomes insolvent, the partnership is terminated.
Some of the above assumptions can be altered by written, verbal or implied agreement between the partners. It is therefore advisable to have a written partnership agreement prepared by a lawyer. An agreement should state who the partners are and what share they each own of the partnership's capital as well as how much income each partner can draw and how much of the debts each will pay. The agreement may also specify that a particular partner is a 'silent partner' who contributes capital and shares in the income but does not otherwise assist in operating the business, although having the same responsibilities as the other partners.
Carrying on of business does not usually extend to hobbies conducted jointly by friends or joint family arrangements, such as the ownership of a car.
A partnership may be used to distribute the income of the business to the members of a family to minimise income tax. However, the Australian Taxation Office can require partners to prove they exercise real and effective control over the assets and profits of the partnership. The presence of a partnership agreement prepared by a lawyer and signed at the commencement of the partnership may assist as evidence of a genuine partnership.
A joint venture is not the same as a partnership. A joint venture is usually established for the purpose of a single purpose or project or a defined period of time, and is not considered to be a single separate entity which means that liability falls on each individual (although this may be varied by agreement). Joint venturers share in the product of the venture, whereas a partner will share in the profit, and joint venturers can (subject to agreement) sell their interest in the venture freely. Joint ventures are entirely governed by the common law (there is no specific legislation), and given the subtle differences which could give rise to a partnership, legal advice should be sought before business is commenced to avoid disputes about control and liability.
A trust is formed when a person (trustee) holds property as the legal owner for the benefit of someone else beneficiary. The trustee controls the property and is its legal owner. However, the trustee is obliged to use the trust property to benefit the beneficiary. A beneficiary can demand that the trustee explain her or his or actions and show that the trustee has been acting in the best interests of the beneficiary.
A formal declaration of trust should be prepared by a lawyer saying that the capital of a business is owned by a trustee. Any person or company may be a trustee and is usually the controlling interest of the business. The declaration of trust will also explain that the trustee will use the income of the business to benefit the beneficiaries of the trust. The beneficiaries of a trust must be able to be identified.
A trust allows the trustee to distribute the income of a business in any way to minimise the income tax liability of beneficiaries. The trust must submit a tax return every year. The trust must pay a high rate of tax on any income that is not distributed before the end of a financial year. The trust does not pay income tax on income it distributes to beneficiaries who must lodge their own tax returns.
A company may be formed under the Corporations Act 2001(Cth) to run a business. The major advantage of forming a company is that on incorporation it becomes a separate, independent legal entity, distinct from its members, directors, employees and agents. Therefore a company is capable of suing and being sued in its own name, and it can hold property and earn income in its own name.
A company must have at least one member (shareholder). The company's members own the company's capital. Members may receive a dividend on their shares but are not responsible for the company's debts. A dividend is a form of income paid to a member from the net trading profit (if any) of a company. If the company is wound up and the debts have been paid, the members are entitled to any capital that is left in proportion to their share holdings. Members can call general meetings on a specific issue and a majority vote will usually bind the company.
In addition to having at least one member, the common form of family company called a proprietary limited company (or Pty Ltd) must also have at least one director (who can be the same person as the member). Directors owe certain duties to the company, and the law in this area is quite complex. It i very important to properly understand the duties of a director before agreeing to become one as breaches of the duties can attract both civil and criminal penalties. For further information, see company directors.
Large public companies (usually listed on the Australian Stock Exchange or ASX) are required to have at least three directors and at least two of them must ordinarily reside in Australia [s 201A].
A company must have a Constitution (formerly known as the Memorandum and Articles of Association) that sets out the rules by which the company must be run. Unless a company makes its own Constitution, the Corporations Act 2001 (Cth) contains sections setting out the rules that the company must obey. These are known as Replaceable Rules. It is possible to adopt rules that control or abolish members' voting powers or that give certain members preferential rights to take shares issued by the company. Shareholders may also sign a shareholders agreement which may give additional protection for minority shareholders, as well as setting out rights for the transfer of shares and other matters affecting the relationship.
Companies pay company income tax on profits currently at a flat rate of 30%. Members pay personal income tax on any dividends received. If the dividends are franked by the company, the member does not pay tax on the dividend as the company has paid the tax already.
How is a company incorporated?
A company is incorporated by lodging the required documents and fee with the Australian Securities and Investments Commission ("ASIC").
Detailed information about the steps required to incorporate a company are set out on the ASIC website (click here). Certain preliminary matters need to be attended to prior to incorporation, and it is prudent to obtain advice from either a lawyer or an accountant to ensure that the correct process is followed.
The advantage of conducting business via a company is that the liability of members (or shareholders), unlike in a partnership, is limited to the amount, if any, which remains unpaid on the shares of the company which they own although in the case of a proprietary or family company, most credit providers (including suppliers) require personal guarantees from the directors before they give credit or lend money to the company. The other main advantage is the tax benefits as the company tax rate is considerably less than the personal income tax rate for people in the higher tax brackets.
It is a criminal offence for any person to contravene a provision of the Corporations Act 2001 (Cth) [s 1311].
The content of the Law Handbook is made available as a public service for information purposes only and should not be relied upon as a substitute for legal advice. See Disclaimer for details. For free and confidential legal advice in South Australia call 1300 366 424.