Sole trader or company: what are the tax differences?

You may be starting out in business and trying to decide whether to become a sole trader or to set up a company.

Alternatively, you may already be an established sole trader and considering switching to become a company. Tax considerations are of course a vital component in deciding which of the two business structures is most suitable for you.

Start with the returns

The first practical difference is in relation to your tax return. As a sole trader, you simply add your business income and expenses to a separate Business and professional items schedule in your individual tax return that you lodge each year.

In the case of a company, there’s a separate annual tax return, and tax to pay on the company’s income. It’s important to note that companies are subject to annual reviews by the Australian Securities and Investments Commission (ASIC), so financial records must clearly show transactions and the company’s financial position, and allow clear statements to be created and audited if necessary.

A number of strict legal and other obligations need to be met. Tax returns for a company must clearly list the income, deductions and the liable income tax of the company. Also, directors and any employees of a company must lodge their own individual tax returns.

Tax rates

There is no tax-free threshold for companies – tax is simply paid on the whole amount taxable income. However, for sole traders, whose tax is assessed as part of the individual’s personal income, $18,200 is the tax-free threshold.

For all companies that are not eligible for the lower company tax rate, the full company tax rate of 30% will apply.

To be eligible for the lower company tax rate of 25% (from the 2021–2022 income year), the company needs to meet strict requirements to be a base rate entity.

One of the tests is that your company’s aggregated turnover for the relevant income year must be less than the aggregated threshold for that year – which since 1 July 2018 has been $50 million a year.

Other taxes

Both sole traders and companies can: register for goods and services tax (GST) if your GST turnover is $75,000 or more, or you’d like to claim fuel tax credits;

and regardless of your turnover, you must register for GST if you provide taxi, limousine or ride-sourcing services; and employ people, and if the business’s gross wages exceed the threshold set by your state or territory, then you will have to pay payroll tax.

Both types of business also need to pay capital gains tax (CGT) if a capital gain has been made, but a sole trader may be able to reduce this gain by what are known as the discount and indexation methods.

The latter may also be used by some companies. If your employees in either business structure receive a fringe benefit then you may also need to pay fringe benefits tax (FBT). Weighing up the pros and cons In the process of making the final decision on which business structure is most suitable to you, many factors beyond tax issues need to be considered.

You may prefer to have full control over your business and not want to worry about ongoing costs and reporting requirements – in this case you may choose to be a sole trader. If it’s a question of protection against potential personal liability, then a company structure may be more suitable.

Navigating these and other important issues will require expert guidance and advice to ensure you make the most effective decision for your business.