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There comes a time in the life of any business where a decision needs to be made whether continuing as a sole trader or as a partnership should give way to incorporation – that is, forming a company to continue the business.
Whilst operating as a sole trader or partnership brings with it freedom and flexibility, those business structures can also expose the owners to substantial personal risk. The losses of the business will be individual owner’s losses, potentially putting things such as the family home and car at risk.
Through incorporation, owners can separate the risks inherent in running a business from their personal assets. This is because companies are recognised as having a separate legal ‘personality’. A company can do such things as form contracts, buy, sell and lease property, and sue and be sued in its own right separately to the person or persons who founded the company or hold shares.
There are two main forms of companies in Australia:
- private companies; and
- public companies which are further categorised as:
- companies “limited by guarantee” (often used by charities or enterprises operating for a public benefit); and
- public companies listed on the Australian Stock Exchange.
The most common option for small to medium enterprises (SMEs) is to form a private, limited liability company. The term “proprietary” and the letters “Pty Ltd” following the company’s name are there to let people know that they are dealing with a private company.
A company is made up of members (the shareholders) who have been issued and paid for shares in the company. Shares are often issued for nominal value, hence the term “twodollar company”. Shareholders’ legal responsibility for any debts incurred by, or liabilities of, the company is limited only to the amount they paid for the shares. That is the basis for the term “limited” (or “Ltd”) in the company’s name.
A company structure not only separates shareholders’ personal risk from business risk, but also allows the business to take advantage of the corporate tax rate – (companies with less than $50 million a year in revenue are taxed at a rate of 27.5%, while those turning over $50 million or more pay 30%) – and to raise money for growing the business by issuing or transferring shares.
However, forming a company also brings with it significant legal compliance, regulatory and tax considerations. Australian companies are governed by the Corporations Act 2001. As is commonly the case, any decision to restructure a business comes with certain costs – there are capital gains tax and stamp duty implications for transferring assets from one business to another which are outlined below.
Other benefits and obligations of incorporation
Once a company is formed, it takes on a life of its own and, legally, stands on its own two feet. Goods and property are purchased and owned in the company’s name. Likewise, intangible assets such as intellectual property – logos or patents, for instance – can be owned by the company itself.
When assets change hands, taxes or fees relating to the change in ownership are borne by the individuals who make up a partnership or other unincorporated business. However, that is not the case when a company is “sold” because the assets owned by the company remain the property of the company even if the shares in the company have been transferred to a new owner.
Consider, as an example, the ownership of a courier or transport business. For a sole trader or partnership, any change in ownership which brings in a new partner (or sees one retire) will require a new ABN, transfer of vehicle registrations and assignments of leases and finance contracts. State stamp duty and Capital Gains Tax will also likely apply. On the other hand, a company operating a similar business can change the shareholdings of members or even hand effective control to a new shareholder without anyone in the “outside world” being aware of any change and for whom, as far as they are concerned, business with the courier company continues as usual.
Incorporation provides continuity of the business operation. If a senior executive or shareholder leaves the business, the company continues to trade uninterrupted because its equity (its shares) can be transferred easily to a new member. This ensures certainty for investors, creditors and customers.
The business or the company is managed and “directed” by the directors. These are often, but not necessarily, elected from the shareholders. The directors are the driving mind of the company and with that comes a burden of responsibility.
A common misconception is that the director who holds the most shares in the company gets the majority vote at, and can control the board table. That is not the case and voting on a resolution of directors is one vote for each director. A majority shareholder can potentially control the company by controlling who is appointed as a director.
However, once a director is appointed, it is important that they understand that they have a common law and statutory fiduciary duties which, if breached, can expose them to personal liability or prosecution.
The key duties of company directors and other office-holders are, in summary:
- to always act in good faith in the best interests of the company;
- to act for a proper purpose; and
- to exercise reasonable care, skill and diligence in carrying out their role.
- making sure the company can pay its debts on time and that it does not trade while insolvent;
- avoiding conflicts between personal and company interests; and
- refraining from taking advantage of their position or information they have gained in the role for personal advantage.
Breaching these duties can result in directors being personally liable and subject to damages as well as other penalties.
What are the downsides of forming a company?
The costs of setting up a company are greater than starting a business as a sole trader or partnership.
Incorporation involves registering for an Australian Company Number (ACN) through the Australian Securities and Investment Commission (ASIC), registering a business name, opening a separate company bank account, and possibly hiring an accountant or financial adviser to ensure compliance with tax and other statutory obligations. The company must also have a registered office and a principal place of business.
A company must lodge its own tax returns and keep financial records for a minimum of seven years under the Corporations Act 2001.
Key issues around taxation
Taxation is a complex area to consider in the process of incorporating and will be ongoing once incorporated. The services of a qualified adviser and/or solicitor should be sought to ensure compliance with the ATO requirements for corporate tax, GST, employees’ PAYG tax and superannuation.
Small businesses – those with less than $10 million aggregated turnover – may also be able to claim income tax, GST, pay-as-you-go (PAYG) and fringe benefits tax (FBT) tax concessions.
The process of restructuring a business into a company will often trigger a capital gains tax event. If certain conditions are satisfied, relief is available to rollover or disregard the capital gain or loss under the CGT rollover provisions in the Tax Acts.
Rollovers are available by election and allow, for example, eligible small businesses to defer any potential tax liability when transferring assets, trading stock, revenue assets and depreciating assets. The rules are complex and you should seek advice from your accountant and lawyers at an early stage.
Stamp duty is payable on the transfer of business assets and collected by the state in which the business operates. In Queensland, transfer duty concessions are available on the transfer or acquisition of primary production business property from a family member with the intention of running that business. These concessions are not available to companies and, whilst a decision to incorporate part of a business may make sense for asset protection or tax management, the stamp duty concession under part 10 of the Duties Act 2001 may well be lost. In a farming operation, that cost could be in the hundreds of thousands of dollars.
The importance of good advice
In any business decision, there is a lot to consider and even more so when restructuring into an incorporated entity. The advantages such as risk management, taxation and the flexibility to expand the operation must be weighed against the extra burdens of compliance, governance, start-up costs and other parts of the tax laws governing companies.
At South Geldard Lawyers we offer a highly personalised service that will provide practical advice and guidance on the implications of forming a company. If you have questions or concerns regarding incorporation, contact us at (07) 4936 9100 or through our website to arrange an initial, fixed fee appointment.
It is important to seek specific advice regarding your circumstances as this fact sheet provides general information only and does not constitute legal advice.
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