The difference between a sole trader and a company starts from the decision-making process. The Corporations Act sets out how a company is to make decisions. Most of a company’s decisions are to be made by the company’s directors. But other decisions are to be decided by the company’s shareholders. There are no such restrictions for sole traders. The sole trader alone makes all decisions about the business.
In terms of the liability of the business, the company has the advantage of limiting liability. Shareholders of a Pty Ltd company, the liability of the company’s shareholders is limited to the amount of unpaid capital on the shares they own. If the shareholders owe nothing on their shares, then shareholders’ liability is zero. If the shareholders have paid the amount owing on their shares, and the company defaults on a debt, then a creditor of the company cannot recover the debt from the individual shareholders.
If a company defaults on a debt, then a creditor of the company cannot recover the debt from the directors, unless the directors allowed the company to continue trading after it became insolvent. On the other hand, the liability of sole traders is not limited. If a sole trader cannot satisfy a debt, then the creditors can sue the sole trader personally to recover the debt. If the creditor is successful, then the creditor may be able to access the sole trader’s assets to satisfy the debt, including the family home. Accordingly, the risk of personal bankruptcy is much higher for a sole trader.
The business needs loans for expansion. A loan to a company can be secured only by the company’s assets while directors are asked to provide directors’ guarantees. Generally, loans to sole traders will be secured by the sole trader’s personal assets, often the family home.
When it is time for expansion, a company can encourage investment in the company by offering shares in the company to third parties.
Sole traders wishing to grow their business with additional capital need to rely on lenders or join with other entities or sole traders and trade as a partnership.
Capital raising & start-up costs
When a shareholder invests in a company, they cannot claim the investment as a deduction against their assessable income. Sole traders can claim a deduction against their assessable income for expenses incurred in setting up a business — for example, purchases of plant and equipment.
A company pays tax at the corporate rate, which is currently 27.5% for base rate entities or 30% for corporate tax entities.
A company also needs to have financial accounts prepared and submit a tax return. Sole traders pay taxes depending on their personal marginal rate. This is because income derived through a business operated by a sole trader is assessable income in the hands of the sole trader.
Generally, in any given year a company can decide to retain profits rather than distribute them to shareholders. (The retained profits are taxed as income of the company.) The company can then use the retained profits to grow the business. Sole traders cannot retain profits.
In the hands of the sole trader, profits are income that is taxed at the sole trader’s personal marginal rate.
A company that runs more than one business can offset losses from one business against sources of income in other businesses.
Similarly, a company in the same consolidated tax group as other companies can offset losses and other sources of income when submitting the group’s return. Sole traders can deduct losses from one source against assessable income from another source. For example, if the sole trader sustains a loss in respect of a rental property, that loss can be offset against the income derived from the sole trader’s business.
Carried forward losses
A company can carry forward tax losses into future years, subject to special ownership and business continuity rules. Sole traders can carry forward tax losses into future years.
Consumers transacting with a company are protected under Commonwealth legislation, primarily, the Trade Practices Act. Consumers transacting with sole traders are protected under state-based legislation, for example, the Fair Trading Act in Victoria.
Registration and fees
There are a number of costs associated with a company, including an ASIC registration fee of $538 and an ASIC annual review fee of $290 per year. If the company is to engage in certain types of activities, then the company must pay license fees (eg a liquor license) and those license fees are often more expensive for a company than for a sole trader.
There are no registration or annual fees for sole traders. Business licensing fees are often lower for sole traders than for companies.
Creditors and Insolvency
The rights of creditors of a company that becomes insolvent are set out in the Corporations Act.
For more information, creditors should contact the Australian Securities and Investment Commission (ASIC).
The rights of creditors of sole traders who become insolvent are contained in the Bankruptcy Act 1996 (Cwth) (and associated legislation).
For more information, creditors should contact the Insolvency and Trustee Service Australia (ITSA).
Regulated by specific legislation
Companies are regulated by Commonwealth legislation, the Corporations Act. Most companies are also governed by a Constitution, or the Replaceable Rules contained in the Corporations Act.
There are complex requirements for companies (and their officeholders) under the Corporations Act. Companies, officeholders and members should be aware of those requirements. For more information on the requirements in setting up a company, please contact us.
There is no equivalent legislation regulating sole traders.
A company enjoys “perpetual succession” — that is, a company is a distinct legal entity and so can survive the death of all of its members and directors (with share ownership being dealt with under the deceased person’s will).
A business operated by a sole trader does not enjoy “perpetual succession” (explained to the left). Instead, the assets of the business are dealt with under the sole trader’s estate plan etc.
Please feel free to reach out to Rands Financial Services on 0434391331 or send us an email at https://www.randsfinancialservices.com.au/contact-us for more information.