The tax questions you need to ask before starting a business
Whether you're driving an Uber part time or launching a startup, it affects how you pay tax. Accounting expert Mark Chapman has the lowdown on what to look out for when dealing with the ATO.
Each time an Aussie starts a side hustle or moves into the gig economy, that's a new small business. There are already over 2 million existing small businesses and, with that number growing daily, it is no wonder the Australian Taxation Office (ATO) has been targeting them in recent years.
So, what do you need to consider for tax purposes? Let's take a look at two of the key questions you should address when you're starting out.
What small business structure is right?
This is the first question you'll need to consider before you can even start earning money as a registered small business. As each business structure serves a different purpose, here is a look at your main options:
Sole Trader
When you run a business as a sole trader, you simply record the business's income and expenses in your personal tax return. This is ideal if you're thinking of jumping into the sharing economy as an Uber driver or Airtasker worker.
From a tax point of view, the main advantage is that if it takes time to get your business going, any tax losses can usually be applied at the individual level against all your other forms of assessable income, including salary and wages and income from other business activities.
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 45% for those earning more than $180,000). 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.
Discretionary 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 trust will be able to distribute its income in the most tax effective way permitted by the trust deed, typically to the beneficiaries with the lowest marginal tax rates.
Each beneficiary records their share of the income of the trust in their personal tax return and pays the tax themselves. The trust usually only pays tax if it doesn't distribute all the profits that arise in the business.
There are also asset protection advantages in holding assets through a discretionary trust. Because 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.
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 the company lodges its own tax return and pays tax on its profits at the company tax rate – currently 27.5% (provided the company's aggregate turnover is less than $50m).
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 people choose a company structure is that it provides limited liability to the shareholders. There are also asset protection benefits because creditors of the company cannot access the assets of the shareholders.
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.
The procedure for applying for a business TFN is different to applying for an individual one. You can get one via the Australian Business Register (ABR) website.
Australian Business Number
An ABN is essential for any Australian business (including sole traders). This number is used in numerous 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. You can apply for one through the Australian Securities and Investments Commission (ASIC) website.
Pay As You Go Withholding (PAYG)
You'll need to register for PAYG withholding if you intend to employ people who will be paid wages or salary. You can register through the ABR website (see above).
Goods and Services Tax
Your business will need to register for GST once your annual turnover is $75,000 or more.
You can register for GST online via the ABR website (see above). You can also register for GST via the Business Portal on the ATO website.
Starting a new small business has an impact on your tax requirements because it means you will earn and potentially spend money in different ways to someone who is simply an employee. This is the case whether you're earning supplementary income or launching a large-scale venture with other people. So make sure you consider these factors before you get started – and seek professional advice if you have any questions or need help.
Mark Chapman is a regular commentator on tax matters for a variety of Australian broadcast and print media outlets. In addition to his columns in Money Magazine and My Business magazine, he has written for a variety of national publications such as The Australian Financial Review, The Daily Telegraph, The Age and Business Spectator. Previously, Mark was a tax adviser for over 20 years, specialising in individual and small business tax, in both the UK and Australia. As well as operating his own private practice, Mark spent seven years as a senior director with the ATO. Mark is a Chartered Accountant, CPA and Chartered Tax Adviser and holds a Masters of Tax Law from the University of New South Wales.
Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder has taken into account your personal circumstances. You should seek professional advice before making any further decisions based on this information.