If you’re a sole trader with a successful business, you’re likely to consider at some stage whether it would be worth transitioning to become a Pty Ltd company. But before you do, it’s important you consider a number of factors, which could make or break your transition experience.
1. Your tax situation
If you’re earning say $250K or more after your deductible expenses, you and your business are considered to be one and the same thing and hence you’ll pay the top marginal tax rate (45% + medicare levy) on every cent over $180K. And whilst you can keep some extra cash locked away in a bank account for a rainy day, you can’t ‘retain’ profits for next year. Ie: you’ll still pay the full tax in the year it was earned.
As a company though, you’ll pay only company tax on your profits, which is currently 27.5% for small businesses up to a turnover of $10 million (who are still paying 30%). The rate has somewhat constantly been in the news of late and there’s talk of reducing it more. But that legislation could be years away – so let’s just go with what we have now.
You might be thinking, great a drop from 45% to 27.5% is awesome – but it’s the ATO and they ALWAYS get paid. There’s no tax-free threshold for companies (like there are for people). And if you require a regular salary, you’ll still pay the regular tax rate on whatever you pay yourself.
Oh and whilst you can loan the company money (and have it pay you interest – which you then pay tax on), it can’t ‘loan’ you money – you and it are now separate entities. Any funds you take from the company will be deemed as salary (unless you’ve documented a dividend payment). Just something that a lot of small business owners get caught out on (and then have to find the funds to pay tax on).
Even on dividend payments, you’ll still pay tax. It’s just that the company will have paid it’s tax already, hence you’ll just have to make up the difference between what’s already been paid and your marginal tax rate. But if you’re earning hundreds of thousands (or millions) of dollars in your business, it can be a significant chunk of change back in your pocket.
2. Room to grow and protection whilst you’re at it
Tax aside, one of the main reasons for the conversion are the possibilities available for company owners including the opportunity to grow. By its very definition, when operating as a sole trader it’s just you (you and your business are one).
However as a company, you have more flexibility. Whilst you can hire staff as a sole trader, you’re unlikely to want to grow too big as you. The more staff you take on, the greater the leverage you can achieve. If you follow the rough rule of 1/3 of revenue to fixed costs, 1/3 to direct costs and 1/3 profits – the more leverage you can create, the greater the profits.
But the more staff you have, the greater the liability too. If you have staff and they (or you) make significant mistakes by accident or not, and a client sues you, they can go after all your personal assets – your home included. We’ve seen this happen and it’s not pretty. As a completely separate entity, a company has its own assets and hence if someone chooses to sue the company, they can only reach those assets. Hence a lot of business owners think about creating a company for personal asset protection reasons.
Of course if you as a director are found guilty of criminal activity, breaching ASIC legislation or not paying your employees entitlements like salary and super appropriately, you can be held personal liable (so creating a company isn’t a get out of jail free option).
3. Greater credibility
And finally, adding a ‘Pty Ltd’ to the end of your business’ name does have a nicer, more secure ring to it and others will notice this as well (although make sure you register your business name with ASIC). Being a Pty Ltd could open doors and make larger organisations or government departments more open do doing business with you.
So if you’re planning on taking your business to its next level, looking at ways to consolidate your tax position or you’re interested in protecting your personal assets, it might be time to think about transitioning to a Pty Ltd.
And that’s where we can help. If you’d like to investigate if transitioning your business is right for you, we’d be delighted to discuss it with you. You can give us a call on 02 6023 1700 or drop us a note via the form below.
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If you've got financial or business questions, or you just want to run something by us, we'd be delighted to really talk to you – in person, over the phone - call us on 02 6023 1700 - or you can use the form below and we'll get back to you.
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