When you’re starting your small business, deciding whether to use a sole trader or company structure is the first legal decision you’ll likely make. Most small businesses are sole traders, as it’s quicker to set up, but is that how your business should remain? While there are tax differences, that’s mostly an accounting issue. What are the differences from a legal perspective? In this article, we go over legal considerations for your small business’ structure in Australia.
What is the difference between a sole trader and a company?
A sole trader structure means that your business is not a separate legal entity to you. Your business’s contracts are your contracts, its debts are your debts, and its assets and liabilities are yours as well.
A company is considered a separate legal person. Under the Corporations Act 2001 (Cth), it has the legal capacity and powers of an individual, so it owns the assets, signs the contracts and owes the debts in its own name. You take part as a director (running it) and a shareholder (owning it). Money that the company earns belongs to the company, even when you own every share. This is why in practice, a business with a company structure needs its own bank account and why you (as the director) cannot take from that bank account the way a sole trader can.
Who’s liable if something goes wrong?
Sole trader
As a sole trader, you are liable for anything that goes wrong. A supplier dispute, an unpaid loan or an uninsured claim is linked to you directly. This is important because assets in your personal name (including your share of the family home) forms part of the pool to pay your business’ debts.
Company
In a company limited by shares (the ordinary Pty Ltd structure), a shareholder generally cannot be made to contribute more than the amount left unpaid on their shares if the company is wound up. In most small companies the shares are fully paid, so that means there’s no further liability. There are some exceptions to this:
- Personal guarantees: banks, landlords and some suppliers routinely ask a director to guarantee the company’s obligations. This means that you personally take on liability for that debt if the company can’t fulfil its obligations.
- Insolvent trading: a director must not let the company take on a debt when the company is already insolvent, or would become insolvent by taking it on, and there are reasonable grounds to suspect that. Action is usually brought by a liquidator, and compensation orders against a director are potentially unlimited. Defences and safe harbour provisions exist, but they don’t help if a director was negligent or careless about the accounting.
- Unpaid tax and super: a director can be made personally liable through a director penalty notice from the Tax Office. This applies when the company doesn’t meet its PAYG withholding and superannuation guarantee obligations, and if a director resigns during or after the period that the company didn’t meet its obligations, they can still be liable.
The effect of business structure on workers’ compensation
Workers’ compensation covers workers. If you’re a sole trader, you are the business rather than a worker in it, so it does not cover your own injuries. But regardless of whether you’re a sole trader or company, you need cover for your staff, if you have any. The schemes differ State by State, including on whether a sole director can cover themselves, so check yours and talk to your insurance broker about coverage.
What extra legal duties come with a company?
Once you have a company, someone has to be its director, and that office carries duties under the Corporations Act. Directors must act with due care and diligence, act in good faith in the company’s best interests and for a proper purpose, and must not misuse their position or company information. Where dishonesty or recklessness is involved, some breaches can be criminal. Read more about directors’ duties in our article on directors’ duties.
Before you appoint yourself director of your company, you must have a director identification number. Failing to have one when required is a strict liability offence, so it does not matter that you did not mean to break it. You could be subject to significant fines, with some directors having been fine $10,000, for failing to have one.
ASIC also says that from 1 July 2027, new laws will require companies to give their directors’ IDs to ASIC through normal reporting, including the annual review.
There are other reporting obligations for companies as well, including:
- Annual financial and sustainability reports;
- Financial and sustainability records kept for at least seven years;
- Changes notified within 28 days; and
There is a fee to register a company and another at each annual review, and ASIC publishes the current amounts. If you set up a company with other people, this is also the point to decide whether you need a company constitution rather than the default replaceable rules.
What about tax?
The two structures are taxed differently, and which one leaves you better off depends on your numbers. You can ask your accountant to assess the tax implications of each business structure on your actual figures. However, choosing on tax alone means that you ignore legal risks and don’t consider where you business is heading, which usually leads to restructuring later anyway. Therefore, it’s best to consult both a lawyer and a consultant about which business structure you want for your business.
Which structure suits partners, investors or a sale?
If you plan to bring in a partner, raise money or eventually sell the business, a company is built for it. Unlike with sole trader businesses, company shares can be issued, split and transferred, and buyers expect to buy into an entity rather than into you personally. Our business structure service works through the options, including whether a trust should hold the shares.
Sole trader vs company: when should you switch?
There’s no requirements or triggers for switching, but these are the signs we see most often:
- You are taking on employees. More people means more exposure to liability, which will fall on you personally as a sole trader.
- Your contracts are getting bigger. Larger customers often expect to contract with a company rather than an individual. The complexity and value of larger contracts makes limited liability worth the paperwork.
- The work carries risks. You want the company to be liable if something goes wrong. This is especially so when you provide products or advice that people rely on, or if you use physical work for your business.
- A partner, investor or sale is on the horizon: restructure before the deal to avoid unnecessary complications.
You should also consider that timing of the switch can affect tax consequences. Generally, you can reduce this risk by switching earlier rather than later, but you should obtain professional financial and accounting advice as early as possible.
What has to move across when you switch?
Registering the company is easy, but transitioning can be tricky. Your sole trader ABN cannot be transferred, it has to be cancelled. This also cancels any GST registration attached to it, so check the timing of your cancellation with your accountant first.
Licences and permits, supplier and customer contracts, leases, insurance policies, domain names, intellectual property, and any registered trade marks all have to be transferred from your name to the company’s name.
Doing this early is generally cheaper than untangling it later.
What next?
If you are starting out, or the business has outgrown the structure you started with, book a free consultation. Tell us what you do and where you want your business to go, and our business lawyers will recommend a structure with a fixed fee quote, covering the company set up and the transfers that go with it.
