What is the difference between a sole trader and a company?

Looking to start a business but don't know what entity structure to implement? 

There are in fact 4 different types of entity structures you may choose to trade under (not including non profit organisations or clubs).

They are:

• Sole Trader
• Partnership
• Company
• Trust

Sole trader

A sole trader is a business run by an individual under their own name. The business and the individual are the same legal entity and subsequently the owner is personally liable for all the debts and liabilities of the business. There is no legal separation between yourself and your business. 

The good news is the costs to set up and mantain a sole trader business are very low. You will have full control over how the business is run and get to retain all the profits.

A sole trader will pay tax in their own individual tax return therefore being eligible for the tax free treshold. That means you pay no tax on income earned under $18,200 but then pay tax at the Individual Tax Rates which can go as high as 45% plus the medicare levy for income earned over 190k (2024-25).

Partnership

A partnership is a business run by two or more individuals. A partnership is not a legal entity and therefore the partners are jointly responsible for all debts and liabilities incurred by the business.

While no longer having full control over how the business is run, partners are able to pool resources and experience and in some cases there may be a tax advantage. 

There is no legal requirement to have a written partnership agreement but is is highly recomended. It should contain what each partner is bringing to the endeavor and how profits should be split. It would also be wise to include what happens if one partner wishes to exit the partnership.

The costs to set up and maintain a partnership are still relatively low but you can expect to pay more than if the business was a simple sole trader entity. Each partner will pay taxes on their share of the profits in their own tax return same as above.

Company

A company is a separate legal entity. Ownership of the company is determined by the issuance of shares. There are many different types of companies but the most common type is a company limited by shares. This limits the liability to shareholders by the unpaid amount on any issued shares. 

The cost to set up and mantain a company can be high. The company will have to lodge it's own tax return and will pay tax from the first dollar in profit it earns. The current tax rate for companies is 30%.  Companies are taxed at a flat tax rate resulting in a lower tax liability on higher levels of income.

It is easy to transfer shares and therefore ownership in the business. 

Trust

A trust is a legal relationship between a trustee and it's beneficiares which is set up by a trust deed. While not a separate legal entity a trust is considered a taxation entity and must lodge a tax return. A trustee can be an individual or a company and holds the trust property for the benefit of the beneficiaries.

There are many types of trusts including unit, discretionary or hybrid trusts all which have their own advantages/disadvantages and rules.  The most popular type of trust is a discretionary (or family) trust for a business run by family members.  All profits in a family trust must be distributed to it's beneficiaries at the end of each financial year (otherwise it will be tax at the highest marginal rate). Beneficiaries then report their own distribution in their own tax return which can reduce the overall tax for the family.

The costs of setting up and managing a trust can be high and complex, requiring professional legal and tax advice.