Best Trades Business Structure – Pty Ltd Or Sole Trader?
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.
I’m going to use Australian terminology here because that’s where I live. Proprietary limited (pty ltd), 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 a sole trader.
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.
Sole trader VS Proprietary limited
First, let me explain the difference between the two so you understand where I’m coming from.
- If you’re a sole trader that doesn’t mean there’s only you. What that means is that you’re trading, your business structure, is a sole trader and your business is YOU.
You can still have employees and it doesn’t mean you just work on your own. You can have 20 people if you want but as far as the law is concerned, you and the business are the same legal entity even though you keep accounts for the business and you make profits. 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 under the ABN. This is a really important thing to understand.
When your accountant does your tax return, or whether you do it yourself, 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 sorts out the mess for you.
Importantly, it’s you that owns all the assets and it’s you that owes any money owed.
Recommended Reading: Where To Borrow Money For Your Trades Business?
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.
So you can be forced to sell your house or your other assets to repay the debt and even if you’re going bankrupt, it won’t help you.
- If 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 17th century for some businesses and before that even for guilds and monastic communities in the 15th century.
And they were set up so that investors could risk a certain amount in a venture rather than 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.
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, they sue the business, not you, personally.
That’s the important difference. It’s the business that borrows 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 chase you for unpaid GST and Pay-As-You-Go tax.
(It’s a bit similar in the UK, I think.)
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 it.
So you’ve got some protection from your business’s debts but it’s not complete. 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.
What about tax?
(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 more clear.
It’s probably still the right advice if 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 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 book a chat with me.
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