Tax Considerations for Setting Up a New Business

If you're starting a small business, here's what you need to do for tax

So, you're setting up a new business and you need to know the tax implications.

The first question you'll need to consider is what structure to use. Do you form a company, or maybe a trust or do you simply set yourself up as a sole trader?

It helps to know the difference between each business structure, so we have outlined your options below.

Sole Trader

First, let's consider the simplest of the various business structures, starting a business as a sole trader or as part of a partnership (which is treated for tax purposes as basically a collection of individuals).

The main advantage of this structure is it's simplicity, there's less red tape to negotiate to start your business and the associated legal and professional costs are minimal.

As a sole trader, you simply record the business's income and expenses in your own personal tax return. Aside from it's simplicity the structure also adds benefit as if it takes time to get your business going, any tax losses incurred in the early years of trading can usually (subject to some anti-avoidance rules) be applied at the individual level, against all your other forms of assessable income. This may include income such as salary and wages, and income from other business activities.

Alternatively, if there is no other source of current year income, the losses can be carried forward and applied against income generated in future years.

Therefore, for those with relatively simple tax affairs, the easy access to loss relief can make operating as a sole trader very attractive. In addition, the availability of the 50% Capital Gains Tax discount  when you ultimately sell can also make this a desirable way to invest.

On the downside, once you start trading at a profit, you'll pay income tax at your applicable marginal tax rate (which could be up to 47% for those earning more than $180,000 - this threshold will increase to $190,000 in the 2025 year). The potential to split income between family members, which is often available where a trust is used as the business vehicle, does not exist.

In addition, setting up as a sole trader does not provide you with any form of asset protection from creditors or protection in the event of family break-ups. That kind of protection can be offered in discretionary trusts, which we consider next.

Trust

A trust is a business structure where a trustee (an individual or company) carries out the business on behalf of the members (or beneficiaries) of the trust.

Family businesses are often set up as a trust so that each family member can be made a beneficiary without having any involvement in how the business is run.

The major advantage of using a discretionary trust to run your business is that you are able to decide who benefits from the income of the trust. So, when you start trading profitably, the trustee will be able to distribute income in the most tax effective way permitted by the trust deed, typically to the beneficiaries with the lowest marginal tax rates.

In addition, any capital gains the trust incurs can be streamed to those beneficiaries who, for example, have capital losses. The trust can also stream gains to those entities which are able to use the 50% discount (typically individuals) rather than those who can't (companies, for instance).

There are also asset protection advantages in holding assets through a discretionary trust. As the beneficiaries of the trust are not the legal owners of the business, creditors cannot easily access the assets of the business if a particular beneficiary encounters financial problems. This contrasts with other ownership structures such as companies (or owning the asset as an individual) where creditors have easy access to business assets.

The downside of investing through a trust is that tax losses will be trapped in the trust as the trust cannot distribute losses to beneficiaries. This will usually mean – subject to some complex anti-avoidance rules – that losses can only be rolled up and used against future income within the trust.

Company

The other possible scenario is to set up your business through a company.

A company is a separate legal entity to the people who run it. That means that the company lodges its own tax return and pays tax on its profits at the company tax rate – currently 25% for companies with annual revenue less than $50M, where 80% or less of the assessable income of the company is passive income (such as dividends, royalties and rent, interest, a net capital gain) and 30% otherwise. The company can then distribute profits to shareholders in the form of franked dividends. These dividends are taxable to the shareholders less a credit for the tax already paid by the company.

The most common reason why people choose a corporate structure is that it provides limited liability to the shareholders. In other words the extent to which shareholders are liable for the debts of the company is limited to the amount they've invested as share capital. There are also asset protection benefits because creditors of the company cannot access the assets of the shareholders.

Unfortunately, companies cannot access the 50% capital gains tax discount. Setting up and maintaining a company is also more expensive than the alternatives, with greater compliance obligations imposed by regulators like ASIC.

A Hybrid?

It is common for people to opt for a mixed structure, often running their trade through a company, which is then owned by a discretionary trust. This provides both the asset protection and lower tax rate advantages of a company, combined with the ability to stream income (in the form of dividends) to beneficiaries of the trust.

And what if you want to change?

Many businesses evolve. Commonly, businesses start out as sole traderships and then, as they become bigger and more successful, they look to incorporate or to roll the business into a trust.

It has always been possible for a sole trader to transfer their business to a company without being hit by capital gains tax on the transfer of the assets. From 1 July 2015, that relief has now been broadened so that most changes of business structure are exempt from capital gains tax.

What registrations do I need?

Tax File Number

If you're operating as a sole trader, you will simply use your own TFN.

If you're creating another entity, such as a trust, partnership or company, that entity will need its own TFN. You can get one via the Australian Business Register (ABR) website.

Australian Business Number

An ABN is essential for any Australian business since it is used in numerous other business interactions, with customers, suppliers and other government agencies. You'll need an ABN for instance before you can register for GST.   You can get an ABN through the ABR website (see above).

Australian Company Number

You'll only need this if you are planning to run your business through a company. If so, you'll need to get this before you apply for an ABN. You can apply for one through the Australian Securities and Investments Commission website.

Director Identification Number

If you plan to become a director of a company, you must apply for a director ID (DIN)  before you’re appointed. If you are already a director, you should already have a DIN.  You will only ever need one director ID. You don’t have to apply for another one if you become a director of other companies or corporations. 

To apply for a DIN, you need a myGovID with at least a Standard identity strength. Use your myGovID to log onto ABRS online to apply for your director ID online.

Goods and Services Tax

Your business will need to register for GST once your annual turnover is $75,000 or more.  

Taxi drivers and ride-sharing drivers (such as Uber drivers) need to register for and charge GST no matter what their turnover is.

What are the tax breaks for new businesses?

For small businesses just starting out, their is additional tax relief which may help to reduce the tax burden in those difficult early days.

The relief applies to all businesses with an aggregated turnover of less than $50m a year (which will be most businesses in start-up phase) and allows an immediate deduction for many professional costs incurred in starting a business venture, such as costs for accounting and legal advice, as well as a range of government charges and taxes.

The relief can also be claimed by individuals who intend to set up a small business through another entity such as a company or trust. In other words, the entity which claims the deduction for start-up costs (the individual) need not be the same one which ultimately runs the business (the company or trust).

What can be claimed?

A new business can immediately deduct costs incurred in getting advice from a lawyer or accountant on how to structure the business. This includes advice on whether to set up the business as a company, trust or partnership, how the business should be financed, costs of market research, and so on. It also covers costs incurred in actually setting up the legal structure of the business.

Eligible costs would also include professional advice on the viability of the proposed business (including due diligence where an existing business is bought) and the development of a business plan. Also covered would be the costs associated with raising debt and equity capital for the operation of the proposed business.

Note that you can claim the deduction even if the business doesn't go ahead. For example, you might prepare a business plan, which ultimately demonstrates that the business will not be profitable, and hence choose not to proceed.

It's also now possible to claim an immediate deduction for a range of payments to government agencies relating to the regulatory costs incurred in setting up the new business. This includes costs such as the fee for creating a company as well as costs associated with transferring assets to that entity, such as stamp duty.

H&R Block can help you set up your business

If you're looking to set up your business, talk to H&R Block for advice on how best to do it. Contact our Tax & Business Services team today by email or call 13 40 42 to talk about your business needs.