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Whether you are starting a new business or purchasing an existing one, one of the most important decisions you make will be how to structure your business. While there are several different business structures available, most owners will choose between structuring their business as a company or sole trader. It is essential to make a more informed decision about how to structure your business. This article provides an overview of these two business structures and their advantages and disadvantages. 

Sole Traders

A sole trader is someone who simply conducts business in their own name and not through any separate legal entity. For this reason, sole traders are by far the simplest business structure available and the cheapest to set up. Sole traders are particularly common amongst people:

  • starting a business for the first time; 
  • turning a hobby into a business; or 
  • working as a contractor for another business.

A key disadvantage of working as a sole trader is that you are personally liable for the business’ debts and liabilities. When engaging with third parties (such as lenders, suppliers, customers or employees), you do so in your own name. Therefore, if any sort of dispute or liability arises from these relationships, it is you personally who is liable.

While it is possible to mitigate this risk by taking out business insurance, the fact remains that you are personally liable for the business.

Paying Tax as a Sole Trader

From a taxation perspective, as a sole trader, your business income is simply included in your personal income. You pay tax on this income at your regular income tax rate. You use your personal IRD number for all taxation matters with Inland Revenue (IR) relating to the business. If you are employing people, you must also register as an employer with IR.

While it is not legally required, you should also get a NZBN – a New Zealand Business Number. A NZBN is a unique 13-digit number that identifies your business. Getting a NZBN is free and makes your dealings with government bodies and other businesses easier.

If your business is making over $60,000 in annual revenue, you will also need to register for GST with IR. Once you register for GST, you must start charging 15% GST on the goods and services you sell and complete regular GST returns to IR. If your business is earning less than $60,000, you can still choose to register for GST. The advantage of registering for GST is that you can claim GST refunds on GST you pay for business expenses. As a sole trader, your GST number will be the same as your IRD number.

Companies

A company is a separate legal entity that is distinct from the people who own or manage it. Companies are managed by directors, who make decisions and sign contracts on behalf of the company. A company is made up of shares (or ‘share capital’). The people who own these shares are known as shareholders (who may or may not be directors as well). Shareholders are entitled to a share of the company profits in the form of dividends. 

The nature of share capital means that companies are a good business structure for taking on board business partners and attracting investment.

For example, Emily is the sole director and shareholder of Atlantis Aquariums Pty Ltd. There are 100 shares in total. Frank proposes to go into business with Emily as an equal partner in exchange for a $100,000 investment. Emily issues 100 new shares in the company to Frank at $1,000 per share. This makes her and Frank equal shareholders in the company with 100 shares each. 

Another key advantage of companies is that they have limited liability. This means that if the company goes into debt or another party sues the company, the shareholders and directors of the company are not personally liable. This is a significant advantage for larger businesses or businesses involved in riskier industries such as construction.

There are important exceptions to limited liability for company directors. Directors are generally liable where they have breached their director’s duties, committed acts of fraud or been involved in criminal activity.

Paying Tax as a Company

Because a company is its own legal entity, it has its own IRD number and pays tax on its own company income. This means that the company must file its own tax returns, which can make your business somewhat more challenging to manage than as a sole trader. However, the company tax rate is 28%, which is lower than the highest income tax rate for individuals (33% for income over $70,000). As such, there are tax advantages to operating your business through a company.

As with sole traders, if your company will be employing staff, you will also need to register it as an employer with IRD. You will also need to register your company for GST if it will be making over $60,000 in annual revenue.

Key Takeaways

This article has only provided a brief summary of the key features of sole traders and companies. There are several other factors to consider in deciding on a business structure, as well as numerous other possible structures. If you require assistance with selecting an appropriate business structure, contact LegalVision’s New Zealand business lawyers on 0800 005 570 or fill out the form on this page.

FAQs

Should I start my business as a sole trader or a company?

Whether a sole trader or company structure is best for you will depend on your circumstances and business plans. If you want a business that is easy to set up and run, a sole trader structure will be ideal. However, sole traders risk their personal assets because they are personally liable for their losses. In contrast, a company is more complex to establish and operate. Nonetheless, it allows you to limit your liability for losses and access a flat tax rate.

Do sole traders need to pay GST?

If your sole trader business is making over $60,000 in annual revenue, you will need to register for GST with IR. Once you register for GST, you must start charging 15% GST on the goods and services you sell and complete regular GST returns to IR.

Is it better to pay tax as a sole trader or as a company?

The company tax rate is 28%, which is lower than the highest income tax rate for individuals (33% for income over $70,000). As such, there are tax advantages to operating your business through a company. However, this will depend on how much you are earning as a sole trader.

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