What Is the Difference Between a Sole Trader and a Company?

Discussing business structures in Australia presents a set of crossroads, each demanding a decision that shapes the journey ahead. Why is it so important to look at the details before you get started? The business structure you choose needs to align with your vision, goals, and the level of adventure you’re ready to embark on. 

Whether you’re a solo visionary poised to carve your path as a Sole Trader, or an ambitious pioneer aiming to establish a Company, understanding the variations between the two can transform your business voyage from daunting to empowering.

As a business coach dedicated to nurturing the potential within every business, I’ve witnessed firsthand the transformative power of making informed, strategic decisions. The choice between operating as a Sole Trader and forming a Company is more than just a legal formality; it’s about finding the rhythm that resonates with your business’s heart and your business spirit.

In this exploration, we’ll dive into the essence of what sets a Sole Trader apart from a Company. Our journey will be guided by fresh perspectives and actionable insights, ensuring that you, the trailblazing business owner, are equipped with the knowledge to pave your path with confidence and foresight.

This is more than just a choice; it’s the foundation upon which your dreams will either soar or be steadied, shaped by the understanding that comes from a place of trust and genuine support.

Defining Sole Trader and Company

Defining the differences between a sole trader and a company is essential for anyone looking to start or restructure their business. 

A sole trader is the simplest form of business ownership in Australia and is owned and operated by one person, without any legal distinction between the owner and the business. In contrast

A company is a separate legal entity, which means it has its own legal rights distinct from its owners.

Setting up as a sole trader is generally straightforward, with fewer administrative and regulatory requirements than a company. This ease of management and full control can be attractive, but it comes with the limitation of personal liability. As a sole trader’s business is not legally separate from the individual, personal assets are potentially at risk if the business incurs debt or is sued. On the other hand, a company’s shareholders have the benefit of limited liability, which means their personal assets are generally protected in the case of business debts or legal action.

From a taxation perspective, a sole trader pays tax on their income at individual tax rates, which can vary depending on the income bracket. However, a company is taxed at the corporate tax rate and may have access to different deductions and concessions. Each structure has distinct implications for tax, management, and liability; hence, the choice between being a sole trader or forming a company impacts the day-to-day operations and potential growth of the business. Understanding the structure of a sole trader and a company is essential as they both come with unique legal and taxation obligations in Australia.

What Is a Sole Trader?

The sole trader trades under his or her name or a business name and uses an Australian Business Number (ABN). There is no legal distinction between you and your business; you are a single entity. As a sole trader, you are the exclusive owner, responsible for all aspects of the business. Here, the distinction between the business and the person is a fine line, with the business’s debts, obligations, and achievements mirroring your own. This direct connection is a powerful motivator, a reminder that every success is intimately yours, as are the challenges and responsibilities. 

• Personal assets are at risk if the business fails
• Personal income is considered the same as business income

While there are many benefits, low costs and ease of access, you will need to hold full liability for all business debts and obligations.

What Is a Company?

At its core, a Company in Australia is a legal entity separate from its owners and managers. This separation is not just a legal formality; it provides an independence that allows the business to operate, enter into contracts, incur debts, and own assets in its own name. The Australian Securities and Investments Commission (ASIC) is the sentinel at the gates, overseeing the registration and compliance of companies, ensuring that each step forward is in harmony with national standards and regulations.

The ownership of a company is divided into shares, which are owned by shareholders. The shareholders’ liability for company debts is usually limited to their share capital investment.

• Personal assets are generally protected
• Directors’ and shareholders’ personal income is separate from business income

Limited liability offers protection to personal assets, as shareholders are typically only responsible for debts incurred by the business to the extent of their share contributions. The beauty of a Company lies in its capacity to shield its shareholders with limited liability, offering a cloak of protection against personal financial exposure. 

Registration and Setup

Setting up as a sole trader or incorporating a company involves different registration processes and start-up costs. Both require obtaining an Australian Business Number (ABN), but a company must also acquire an Australian Company Number (ACN).

Registering as a Sole Trader

To register as a sole trader in Australia, an individual must apply for an ABN, which serves as a public identifier for the business. It’s a straightforward process that can typically be completed online through the Australian Business Register (ABR) website. No fees are involved in obtaining an ABN, however, if the individual wishes to trade under a name other than their own, they must register a business name with the Australian Securities and Investments Commission (ASIC) for a small fee.

Incorporating a Company

When incorporating a company, the process is more complex. The entity needs to:

1. Register a company name: Settling on a unique name that abides by the ASIC guidelines is the first step.
2. Obtain an ACN: Before an ABN can be issued for a company, it must first secure an ACN through ASIC.
3. Register for an ABN: After receiving an ACN, the company can then apply for an ABN.

Set-up costs for a company are higher due to the ASIC registration fee for the ACN and business name, along with potential fees for professional advice. Additional ongoing costs include annual review fees and obligations to maintain specific company details with ASIC.

Ownership and Control

Understanding how the ownership and control work under each structure is going to help decide which way you need to go. For those who cherish independence and simplicity, becoming a Sole Trader may align with your vision, while establishing a Company could be the route for those looking to expand, share ownership, and mitigate personal risk, despite the increased regulatory and operational complexities.

The distinction between ownership and control influences legal and tax implications as well as your business journey’s strategic, financial, and emotional pathways. Weigh these aspects carefully, considering the long-term vision, risk tolerance, and the level of control you wish to maintain as your business grows.

Control in a Sole Trader Business

A sole trader business is owned and controlled by a single individual who makes all the key business decisions. As there is no separation between the owner and the business, the sole trader is personally responsible for all aspects of the business, including debts and losses. This direct control allows for quick decision-making and a straightforward business structure.

Ownership and Directors in a Company

The day-to-day control of a company’s operations is typically in the hands of appointed directors who are accountable to the shareholders and must operate in the company’s best interest. Shareholders have ownership but exercise control indirectly through their voting rights on key issues, typically in proportion to their shareholding.

Taxation and Liabilities

Tax obligations differ significantly between these entities. A sole trader is taxed at personal income tax rates, which are progressive and may increase with higher income levels. Companies enjoy a fixed company tax rate, potentially offering tax benefits at certain income thresholds.

• Sole Trader:
  
  • Taxed on their income at personal rates
  • No GST registration is required unless turnover exceeds AUD $75,000
  • Superannuation contributions are voluntary
• Company:
  
  • Taxed at the corporate rate of 25% for small to medium businesses (as of 2021-2022)
  • Must register for GST if turnover exceeds AUD $75,000
  • Required to pay superannuation for employees

Both entities must maintain accurate financial records. Insurance may also be necessary to mitigate risks, with companies often required by law to take out certain types of insurance while sole traders must assess their own need for coverage.

Operational Considerations

The operational considerations for Sole Traders and Companies in Australia are different and carry implications that might affect your business success. To ensure the smooth functioning of your business, compliance with legal requirements, and efficient management of resources you need to consider them carefully. In this section, we’ll highlight the differences in managing business operations and adhering to compliance and reporting requirements.

Sole Trader Operational Considerations

• Simplicity in Setup and Management: Setting up as a Sole Trader is straightforward, requiring minimal paperwork, often just an ABN and registration of your business name if different from your personal name. The ease of managing your business without the need for complex structures or processes is a significant advantage.
• Personal Liability: As a Sole Trader, there’s no distinction between personal and business assets. This means you’re personally liable for all aspects of the business, including debts and losses.
• Taxation: Taxation is simpler, as business income is treated as your personal income, and you pay tax at individual income rates. You’re also responsible for your own superannuation and may need to register for GST if your turnover exceeds the threshold.
• Decision Making: All decisions are made by you, allowing for quick changes and direct control over the business direction. However, this also means bearing the full weight of those decisions and their outcomes.

Sole Trader Compliance and Reporting

A sole trader is required to maintain records for tax purposes and might need to register for Goods and Services Tax (GST) with the Australian Taxation Office (ATO) if the turnover is over a certain threshold. They’re also responsible for lodging an individual tax return that includes their business income.

Company Operational Considerations

• Complex Setup and Compliance: Forming a company involves more paperwork, including registration with ASIC, creating a constitution, and understanding the obligations under the Corporations Act. Ongoing compliance includes annual reviews, updates to ASIC, and maintaining proper records.
• Limited Liability: Shareholders in a company enjoy limited liability, meaning their personal assets are generally protected from business debts. This structure can offer peace of mind but requires careful governance to ensure compliance with legal duties.
• Taxation and Finances: Companies are taxed at the corporate tax rate on profits, which can differ from individual tax rates. Companies need to keep detailed financial records, report annually, and manage payroll, superannuation, and GST obligations if applicable.
• Management and Governance: Companies are managed by directors who make operational decisions, while shareholders have a say in major decisions affecting the company. This structure requires clear roles and responsibilities, potentially complicating decision-making processes.

Company Compliance and Reporting

Companies must comply with the Corporations Act 2001 and are regulated by the Australian Securities and Investments Commission (ASIC). They need to keep comprehensive financial records, lodge annual company tax returns, and ASIC returns, and they may be subject to regular audits. 

Compliance is generally more demanding for companies, which have to meet obligations for both ASIC and the ATO, including reporting any changes in company details and paying the corporate tax rate on profits. Record keeping thus becomes more rigorous as it must support thorough and regular reporting to these entities.

Common Operational Considerations for Both

• Record Keeping: Accurate and timely record keeping is crucial, not just for compliance, but for understanding your business’s financial health.
• Regulatory Compliance: Both structures must adhere to Australian laws and regulations, including taxation, employment, and industry-specific requirements.
• Financial Management: Effective financial management, including budgeting, forecasting, and monitoring cash flow, is vital for the sustainability of any business structure.

Choosing between a Sole Trader and a Company involves weighing these operational considerations against your business goals, resources, and risk tolerance. Each structure offers different advantages and challenges, and the right choice depends on your specific situation and aspirations.

Conclusion

The journey of starting and running a business is as diverse as the visionaries who embark upon it. Whether you’re drawn to the simplicity and direct control of being a Sole Trader or inclined towards the collaborative potential and structural robustness of a Company, the path you choose will lay the foundation for your business’s future.

The choice between a Sole Trader and a Company is not just about legal definitions or tax implications; it’s about aligning with your aspirations, lifestyle, and the impact you aim to create.  Each business structure offers unique advantages and challenges, and the right choice depends on your personal and professional goals.

As you prepare for the road ahead, know that you’re not alone. The support, guidance, and insights of experienced professionals can illuminate your path, helping you navigate the complexities of small business ownership with confidence and resilience. Let us know what trouble spots you’d like assistance with.

What Is the Difference Between a Sole Trader and a Company? – FAQs

1. When should I go from sole trader to company?

Transitioning from a sole trader to a company is often advisable when your business starts to grow in size, complexity, or risk. Consider making the switch if you anticipate expanding operations, hiring employees, or seeking external investment. Additionally, forming a company can offer legal protections and tax advantages that may be beneficial as your business evolves.

2. What are the disadvantages of a sole trader?

While being a sole trader offers simplicity and autonomy, it also comes with several disadvantages. Sole traders have unlimited personal liability, meaning they are personally responsible for business debts and liabilities. Additionally, sole traders may find it challenging to raise capital or obtain financing compared to companies. Moreover, the absence of separate legal entity status can limit growth opportunities and asset protection.

3. Can a sole trader be a company?

No, a sole trader and a company are distinct legal structures for businesses. A sole trader operates as an individual, while a company is a separate legal entity. While it is possible for a sole trader to transition into a company by registering as such, they cannot simultaneously operate as both a sole trader and a company.

4. Are you a business owner if you are a sole trader?

Yes, as a sole trader, you are considered the owner of your business. Sole traders have complete control over business decisions and operations, as they are personally responsible for the management and performance of the business. However, it’s important to note that being a sole trader does not provide the same legal protections or tax advantages as operating through a company structure.

5. What happens when you go from sole trader to company?

When transitioning from a sole trader to a company, several changes occur. Firstly, the business becomes a separate legal entity distinct from its owner(s), providing limited liability protection. Additionally, the company must adhere to legal and regulatory requirements applicable to corporate entities, such as filing annual reports and maintaining corporate governance. From a taxation perspective, the company becomes subject to corporate tax rates and may be eligible for different deductions and incentives. Overall, the transition offers opportunities for growth, scalability, and enhanced credibility in the marketplace.