Businesses structured for profit

07 Sep 2016 - 14:37 | Version 6 |

Contributed by SulifaTonga, KirstyGrainger and DavidQin and current to 1 May 2016

A person who wants to start their own business has available to them a number of different business structures, ranging from sole trader and partnership to incorporation as a company, cooperative, joint venture, association or trust. Circumstances usually dictate the kind of business structure adopted, but it is a good idea to explore all options before 'taking the plunge'. For advice on setting up a small business consult the Territory Business Centre (TBC) which also produces free publications on establishing a new business, a solicitor or accountant.

A range of factors influence the choice of business structure, such as:
  • the purpose of the business
  • the tax consequences
  • the anticipated duration of the business
  • the cost of forming and maintaining the structure
  • legal liability that may attach to those involved
  • availability of finance
  • whether members' interests need to be transferable
  • whether an established business is being purchased or a new one started
  • the division of control amongst those involved and who is to profit
  • whether the business needs to be independent of the owner's capacity to sue and be sued, hold property and enter into contracts
  • whether there needs to be the capacity to change the structure and the way profits are distributed
  • whether children are to be involved in the business or entitled to any profits.
The three main types of business structure used by small business are sole trader or proprietor, partnership, and company. Each of these structures is broadly outlined below.

Sole trader

Sole trader is the most common form of business structure used by the small business person. It is easily established and simply administered, only requiring the registration and renewal of a business name. The owner has full control over the business and receives all of its profits. Any losses can be offset against other income. The only impediment to the sale of the business is market demand, although the approval of financiers and insurers may be required, for example, if the sole trader brings a new investor/partner into the business.

A disadvantage of this form of enterprise is that it does not allow for perpetual succession; that is, it does not endure when the owner dies. The owner is personally liable for all debts and is open to claims on personal assets by creditors. A certain amount of protection may be afforded by public liability and professional indemnity insurance and both are highly recommended (see Insurance).

There are no special laws governing this type of business structure. The sole trader needs to familiarise themselves with a range of business and legal regulations, including tax law, planning requirements, occupational health and safety requirements, workers' compensation, public liability and other forms of insurance, compulsory superannuation and local council by-laws (see Employment and Superannuation).

Business names

On 28 May 2012, the Australian Securities and Investments Commission (ASIC) implemented a new scheme for the registration of business names. This scheme is nationally administered by the ASIC and is governed by the Business Names Registration Act 2011 (Cth) (BNRA). By replacing what was previously state and territory maintained registers, the BNRA created a central national Business Names Register that incorporates an online registration process for both Australian Business Numbers (ABNs) and business names(including trademark searching).

It is an offence for an entity to carry on a business under a name while that name is not registered [BNRA s.18], unless:
  • the entity is an individual and the name is the individual's name;
  • the entity is a corporation and the name is the corporation's name;
  • the entity is a partnership and the name consists of all of the partners' names; or
  • the name is registered to the entity on a notified State/Territory register.
A business name can be operated by up to 20 people. Obviously, once there is more than one person associated with carrying on a business under the one business name, the business structure will cease to be that of a sole trader or proprietor. If more than 20 people are involved in the same enterprise, the group must incorporate according to the Corporations Act 2001 (Cth) (CA) [s.115].

How to register a name

The registration of a business name is now an online process. For a fee, you can complete the registration of your business via the following website: http://asic.gov.au/for-business/registering-a-business-name/.

You will be asked to provide certain information when you complete the online registration process, including:
  • the Australian Business Number (ABN) of the proposed business holder;
  • the proposed name (the form allows for four alternatives);
  • the preferred registration period (this may range from one year to three years);
  • the address in Australia for service of documents and principal place of business in Australia.
For a sole trader (as opposed to a partnership or corporation) you will need to provide:
  • the date of birth of the business name holder;
  • the place of birth of the business name holder; and
  • the residential address of the business name holder.

The registration of a business name needs to be renewed after the registration period has expired. The person who has registered the name will be notified of the requirement to renew 28 days before the expiry date.

Renewing registration

If you wish to continue to carry on a business under the business name, you must renew your registration before it expires. The renewal process can be completed through ASIC Connect as an online process. Similar to the initial registration process, you will need to elect whether to renew your business name registration for a further one to three years.

ASIC has published a regulatory guide for registering and renewing business names. Further details can be found in the following guide http://asic.gov.au/for-business/registering-a-business-name/.

Effect of registration

Significantly, registration of a business name does not, in itself, provide any legal protection. This is because the mere registration of a business name does not constitute the creation of a separate legal identity. It doesn't give a person any ownership rights over the name, only a right to trade under it. The registration of a business name also does not, in itself, provide any direct tax advantages.

It should be remembered that the requirement to register a business name is primarily for consumers, as it enables businesses to be publicly identified and prevents deception and confusion by disallowing the registration of similar names (i.e. ASIC will not allow other entities to register a business name that is identical to yours).

Using a business name

If an entity is carrying on a business under a business name, that entity is required to display the name prominently at every place at which the entity carries on business that is open to the public (unless such display is contrary to the law). The entity must also include such information in their written correspondence such as a business letter, account, invoice, receipt or cheque,

It is an offence if the above requirements are not met [BNRA s.19 & s.20], unless:
  • the entity is an individual and the name is the individual's name;
  • the entity is a corporation and the name is the corporation's name;
  • the entity is a partnership and the name consists of all of the partners' names; or
  • the name is registered to the entity on a notified State/Territory register;

Change of particulars

After your business name is registered, you must ensure that your details in the Business Names Register are kept up-to-date. If any information provided to the ASIC is no longer correct due to a change of circumstances, you must lodge a notice of the change within 28 days of you becoming aware of it. Similarly to renewing your business name registration, changes of information provided to ASIC could also be completed through ASIC Connect as an online process.

Australian Business Number (ABN)

An Australian Business Number (ABN) is an 11 digit number that identifies a business for tax purposes. ABNs are issued by the Australian Business Registrar. Any business in Australia, including sole traders, can apply for an ABN.

In order to register a business name, you need to obtain an Australian Business Number (or be in the process of applying for an ABN). However not everyone is entitled to apply for an ABN. To be eligible for an ABN, you must:
  • be able to demonstrate that your business structure is in place; and
  • fulfil one of the following criteria:
    1. You are carrying on an enterprise in Australia; or
    2. You have undertaken sufficient activities to commence an enterprise; or
    3. Be a company in accordance with the Corporations Act (Cth) 2001.

Working from home

Where a business is to be located is an important consideration for anyone starting up. Working from home may be a viable option for a sole trader. A home office can mean significantly lower business running costs, particularly with rent and utilities (electricity, water and gas). In some professions a licence, permit or approval is needed to work from home. One should also check with the relevant government department to ensure that any legislative requirements are complied with. For more information about setting up a home office visit The Australian Business Licence Information Service's website at https://ablis.business.gov.au/pages/home.aspx or contact the TBC.

Tax issues

The Australian Taxation Office (ATO) publishes a range of publications about tax issues for businesses, including Complete tax guide for small business, a comprehensive guide to tax and small business. This publication can be obtained by telephoning the ATO's Business Tax Info Line: 13 2866 or by visiting a local ATO.

A person earns no direct tax benefits when they establish themselves as a sole trader. They are still taxed at individual income tax rates, using their personal Tax File Number, and assessed on the net profit. However, any expenses associated with the running of the business are tax deductible.

Winding up

One of the benefits of being a sole trader is the ability to make decisions about the business, including on whether to sell, transfer or close up shop. As a sole trader has unlimited personal liability, winding up doesn't mean that they can walk away from commitments or debts: contracts must be carried through to completion and debts paid. Creditors can continue to pursue a sole trader for outstanding debts even after the trader's business has been wound up.

Finally, if a business ceases to operate under a business name, you may cancel your business name through ASIC Connect as an online process.

Partnership

Partnership is a general term given to an enterprise in which two or more people carry on a business in common with a view to profit. Partnerships are regulated by the terms of the agreements drawn up to form them, and by partnership legislation. In the NT the relevant legislation is the Partnership Act 1997 (PA).

Generally a partnership can have no more than 20 members however exceptions are made for certain professions who may have more. Some professions do not allow partnerships to be created with people who are not working in the same profession (check with the relevant professional body).

If the partnership intends to trade under a business name other than the names of all partners, the name must be registered with the ASIC. The business name is registered in the name of the partners and not the partnership (see How to register a name).

Advantages

Partnerships are useful business structures in that they enable the responsibility for the running of the business to be shared between all members. Also, a partnership in itself is not taxable; the tax liability is split between the members, which can be a significant benefit if there are large differences in the amount of income partners earn. As partnerships, by definition, involve more than one member, they have a greater access to capital and involve the pooling of resources, knowledge and skills. They can also be relatively easier and less expensive to set up than other structures.

Disadvantages

As with sole traders, a partnership is not recognised as a legal entity separate from its members. This means that the rights and liabilities of a partnership are the rights and liabilities of the partners and are enforceable by and against them jointly as well as individually. So a member of a partnership is personally liable for the debts and contracts of the partnership and any civil wrongs it commits, such as negligence and trespass. With the exception of limited liability partnerships, the personal liability of partners is unlimited. A partner may even be held criminally liable for the acts of other partners, unless it can be shown that the partner was acting on their own and not on behalf of the partnership.

A common difficulty that arises in partnership associations is that decision making can become deadlocked. As a partnership necessarily involves the coming together of several personalities, the potential for conflict is high.

Partnership agreements

Partnerships are formed by agreement between the partners. Agreements are usually written, but can be verbal or evidenced by the way partners behave. A partnership agreement (partnership deed) should include the following information:
  • the name of the partnership
  • the duration of the partnership (for fixed term partnerships) and why it was created
  • financial details, including how profits and losses are distributed
  • details about how the partnership is to be administered, such as duties of the partners and criteria for expulsion
  • a dispute resolution clause
  • provisions for dissolving the partnership.
Partnership agreements are not required to be registered.

Generally, any major changes to a partnership agreement require the unanimous decision of all members. This includes the admission of a new partner into an existing partnership. Furthermore, a partner can't be expelled from the partnership unless there are provisions for expulsion in the agreement. If there aren't any suitable provisions, the only way to remove a partner is to wait until they retire or to dissolve the partnership altogether. For these reasons, partners should be chosen carefully and the time should be taken to form a proper agreement. It is a good idea to have a solicitor assist with the preparation of an agreement.

If a partnership does not have a written agreement, the PA will determine many of the rights and obligations of the partners in relation to each other.

Ending the partnership

While partnerships are easily established, they can be quite difficult to get out of. Dissolution can be a contentious issue, particularly where a partnership is formed by friends or associates, without proper planning and formal agreements. In the event of a falling out, originally good intentions can wear thin and, where there has been no agreement as to the distribution of assets, dissolution can be both costly and messy.

There are two ways a partnership can be ended:
  • by voluntary dissolution
  • by a court order.

By dissolution

Subject to the terms of an agreement, a partnership can be dissolved or terminated in the following circumstances [PA ss 36-38]:
  • retirement: where the partnership is not for a fixed period, such as two years, a partnership can be dissolved when one partner notifies the others of their intention to retire
  • expiration or notice: when the single venture or fixed period (except where the partners continue to do business) of operation expires or when a partner gives notice of their intention to end the partnership
  • death or bankruptcy of a partner: if a partner dies, is declared bankrupt or mortgages their share of the partnership property, for example, as security for a loan
  • illegal partnership: if the business of the partnership becomes unlawful, for example, where a partnership involved solely in the logging of timber cuts down a forest that is declared a national park.

By court order

A partner can apply to have a partnership wound up by an order of the Supreme Court [PA s.39]. An application can be made if any one of the following six circumstances apply:
  • insanity: if a partner is permanently of unsound mind.
  • incapacity: if one of the partners is permanently incapable of performing their part in the partnership because, for example, of poor health.
  • prejudicial acts of a partner: if one partner's behaviour has a detrimental effect on the partnership's trade, such as where they have been convicted of a criminal act and that is likely to affect the goodwill of a business. The behaviour does not have to be connected with the partnership business and no loss need be proven.
  • impracticable for partnership to continue: if one partner is persistently or wilfully breaching the partnership agreement or behaving in a way that make it impossible for the partners to carry on business together.
  • loss-making partnership: where a partnership can't continue profitably and partners can't agree to end the partnership.
  • just and equitable: if the court decides that it is just and equitable to wind up the partnership. The court has a wide discretion to wind up partnerships, often exercising it when partners only agree to talk to each other through an intermediary. The court tries to determine the best option for all partners involved.

Consequences of ending a partnership

When a partnership ends it doesn't necessarily mean that the business the partnership was operating has to be wound up also. The future of any business operated by the partnership has to be decided by the partners.

If one of the partners has retired or died, the remaining partners can choose to carry on the business. To do so they must buy the departing partner's share or pay any profits arising from it calculated on the date of the withdrawal. A valuation would be required. The business' clients and suppliers need to be notified of the change in the makeup of the partnership. When a partner retires or the business of the partnership is dissolved, any partner has a right to issue a public notice to that effect, a step to which the other partners must agree. Notices of this kind are usually placed in the Government Gazette or the local newspaper.

A partner who has died or retired is not liable for the debts of the partnership from the date they died or retired. Similarly, a partner who has become bankrupt is not liable for the debts of the partnership from the date of their bankruptcy.

If a business is to be dissolved along with the partnership, certain matters need to be dealt with, such as:
  • completing outstanding contracts
  • realising stock and assets (turning them into money)
  • finalising arrangements with employees.
These can all be dealt with by the former partners, who retain their authority to complete any business in progress at the date of dissolution. Alternatively, a court can appoint a receiver or manager or both to wind up the business.

The PA gives certain rights and responsibilities to partners, creditors and those dealing with a partnership in the process of being dissolved. For example, a person dealing with a partnership, is entitled to treat all previous partners as current partners of the business until notified otherwise [PA s.40(1)]. An advertisement notifying the change in the partnership's constitution in the NT Government Gazette and in a local newspaper is deemed to be sufficient notice to any person who has not dealt with the business previously [PA s.40(2)]. Long standing clients and creditors should be given a more direct form of notice, such as a letter.

If the assets of the firm are not enough to account for its debts, a creditor can look to the assets of individual partners. As members of a partnership are jointly liable, where a creditor recovers a debt from a partner that partner can, in turn, recover the amount from the other partners. The property of a partnership also includes goodwill. If the business of a partnership is to be carried on after the departure of one of its members, the value of the outgoing partner's share of goodwill will also have to be assessed and 'bought'.

If to enter the partnership a partner has paid a sum of money that is not a contribution of capital, but the partnership dissolved (other than by death) before the entry formalities were completed, the court can order the money returned, subject to any agreement between the partners, and provided that the partner was not responsible for the dissolution due to their own misconduct.

When a partnership is dissolved the assets of the business are sold to pay any debts; partners then have access to any remaining money. Subject to any contrary agreement between the partners, the PA outlines the order that debts are to be paid and excess money distributed when a partnership dissolves [s.48]. Any losses sustained by the partnership must be covered first by profits, then any remaining capital, and then contributions from the partners [PA s.48(a)]. The amount a partner contributes is proportionate to their entitlement to profit. The partners' contributions have to be applied in the following order:
  • to pay creditors
  • to pay partners the proportional amount (other than capital) they are due, such as outstanding income and relevant out-of-pocket expenses
  • to pay partners what they are owed with respect to capital contributions
  • to pay the amount remaining, if any, to the partners in proportion to the amount of profit they are entitled to (not in proportion to the amount of capital each partner contributed).

Companies

There are various types of company structures, including:
  • companies limited by shares or by guarantee or a combination of both (see Community organisations)
  • unlimited companies
  • no-liability companies (mining companies)
  • proprietary and public companies.
An accountant or a solicitor can advise on the most appropriate option given the circumstances.

The company structure most commonly used by business ventures is the proprietary company limited by shares and, for this reason, is the only type of company discussed here. For further advice contact the ASIC.

A proprietary company operates under the following rules:
  • the right to transfer shares is restricted
  • up to 50 people can own shares in a company
  • the company is not allowed to invite the public to deposit money with the company or buy shares in it
  • the company must have at least one director and one shareholder (appointment of a secretary is now optional) and if there are more directors than one, at least one must be an Australian resident.

A company's constitution (that is, its rules) will contain details of all of the above. Part 1.5 of the CA also contains a small business guide that acts as a useful guideline for proprietary companies

Advantages

The major advantages of a company are:
  • perpetual succession: unlike a partnership or sole trader, the business doesn't come to an end when the proprietor dies
  • its status as a separate legal entity: unlike a partnership or a business name, a company is legally an entity separate from its shareholders, so it can hold property in its own name, enter into contracts and sue and be sued
  • the limited liability of members (shareholders): in most circumstances, the liability of shareholders is limited to their capital contribution (the unpaid portion of their shares in the company); the shares in most proprietary companies are fully paid and the capital contribution of each shareholder is a nominal amount, such as $2.
With companies it is also easy to transfer a business interest from one person to another, and there are tax advantages. For example, a family can use a company to spread income among its members.

Disadvantages

Companies can cost quite a lot to form and maintain. Also the CA, the law that regulates companies, places ongoing complex and demanding requirements on company directors (see below) and other officers; certain documents need to be lodged regularly and accounts and registers kept in good order.

How to form a company

The procedure for forming or incorporating a proprietary company is slightly different to incorporating a company limited by guarantee (see Community organisations). ASIC, the body responsible for administering the CA in Australia, distributes a range of pamphlets that explain how to comply with routine requirements, including a step-by-step guide to incorporation. Alternatively, an accountant or solicitor can help. A list of these pamphlets is available on the ASIC website at www.asic.gov.au or can be obtained by ringing the ASIC Customer Contact Centre on 1300 300 630.

Company directors

Who can be a director?

There are rules set out in the CA about who can be a company director. A person must be at least 18 years of age to become a director and must first consent to the appointment (in writing) [CA s.201B(1)). A person who has been declared bankrupt is not allowed to act as a director or manage a company without the court's consent. Similarly, someone who has been convicted of certain offences, such as fraud or offences under company law (breaching duties as a director or insolvent trading are examples) must not act as a director. Anyone with such a conviction is unable to manage a company within five years of their conviction, or if imprisoned for one of these offences, for five years after being released. Also, ASIC can ban people from being a company director in certain situations. Under the CA, a person who is not allowed to be a company director, is also not allowed to manage a company.

People can report dishonest company directors to ASIC, which can take a number of steps against directors who fail in their duties. To find out how to report a company director contact the ASIC Customer Contact Centre on 1300 300 630

Responsibilities of directors

Each company's constitution or rules sets out the directors' powers and functions. Part 2D.1 of the CA sets out the most significant duties of directors, secretaries, other officers and employees of corporations. Other duties are imposed by other provisions of the CA and other laws (including the common law).

Company directors must exercise their powers and carry out their duties with care and diligence [CA s.180]. They must operate with good faith in the best interests of the corporation [CA s.181]. A company director is not allowed to use their position, or any information gained through their position to advantage themselves, either directly or indirectly [CA s.182 & s. 183].

Directors are required to keep up-to-date financial records that explain any company transaction and reveal the company's financial position and performance, and financial records are required to be kept for 7 years after a transaction has occurred [CA s.286]. Directors of a 'small proprietary company' (as defined in the section 45A of the CA) will generally not have to prepare the formal financial reports required under the CA each year. Large proprietary companies and public companies - even no-profit public companies - must prepare financial reports, have them audited, and lodge them with the ASIC.

Some of the basic financial records ASIC recommends a company should keep include:
  • a general ledger, recording all the company's transactions and balances (revenues, expenses, assets, liabilities and so on)
  • cash records, such as bank statements, deposit books, cheques butts, petty cash records
  • debtor and sales records
  • creditor and purchases records
  • wages records and superannuation records
  • a register of property, plant and equipment
  • inventory records
  • investment records
  • tax returns and calculations
  • deeds, contracts and agreements.

Shelf companies

A simple and quick method to establish a company is to buy what is known as a shelf company, an already incorporated body that can be purchased 'off the shelf' from large firms of accountants and solicitors. All that is required is to change the directors, shareholders and possibly the constitution. An accountant or solicitor can provide further information.

Franchises

Franchising is a type of business ownership which sees an individual, partnership or company establish an independent business under the banner of an already established business. A franchise agreement allows the purchaser (or franchisee) the right to use the name, trademark or logo and sell the goods or services of a particular franchise group. Common franchises include many well known food outlets. It is also possible to start a franchise from the very beginning of trading if a number of people are willing to operate under the one name at different locations.

Franchise rights usually cost a considerable sum of money. As well as the initial lump sum, a portion of every month's takings are paid to the franchisor as a royalty or commission. In some cases the franchisor may require orders and customer payments to be directed to the franchisor who will then deduct the agreed royalty and pay the balance to the franchisee. Every member of the franchise, although independently owned, must work to the rules set by the franchise. These rules are usually set out in an operations manual. The franchisee may have to conform to strict rules on such matters as shop layout, displays, price control, personnel appearance and many others.

There is a Franchising Code of Conduct that has been included in schedule 1 of the Competition and Consumer (Industry Codes Franchising) Regulation 2014 (Cth) which is the primary source of regulation of franchises (see Contracts and consumer protection). This code of conduct states that a franchisor must provide a disclosure document to a potential franchisee at least 14 days before an agreement, renewal or extension of a franchise. The information included in this disclosure document will cover issues such as:
  • whether the franchise is for exclusive or non-exclusive territory or limited to a particular site
  • whether the franchisor or its associates may operate a business that is substantially the same as the franchise in the franchised territory
  • whether the franchisor or its associate may establish other franchises that are substantially the same as your franchise outside the franchised territory
  • whether the franchisor may change the territory.
A franchisor cannot enter into, renew or extend the franchise unless it has received a written statement acknowledging the disclosure has been read and understood.

Joint ventures

A joint venture is a contracted agreement between two or more people to pursue an undertaking for joint profit by combining resources without necessarily creating a partnership or company. Each party has some degree of control over the venture. A mining project, property development or music concert would be examples.

The benefits of a joint venture are that each participant is not liable for the acts of the other participants in the way they are in a partnership, each participant can exploit taxation advantages and any interest in the venture can be disposed of or transferred easily.

Joint ventures are usually quite complicated, because many questions need to be asked and answered. Agreements should be in writing, though they don't have to be; a clearly drawn up written agreement can go a long way to preventing future problems.

Trusts

Trusts offer yet another structure for operating a business. Trusts are flexible but relatively complex to establish and operate. They can also offer significant tax advantages. The law relating to trusts is too broad to be dealt with in this handbook. Those considering using a trust in a business venture should consult an accountant or solicitor to determine the type that will best suit their needs (see Legal aid).

Useful Contacts

Australian Securities and Investments Commission (ASIC)

ASIC is the national regulatory body which oversees Australia's corporate and financial services and markets.

Customer Contact Centre
Tel: 1300 300 630
Website:http://asic.gov.au

Territory Business Centre (TBC)

TBC are run by the Department of Business to help facilitate initial business enquiries including but not limited to start up and planning.

Northern Territory
Tel: 1800 193 111
Email: territory.businesscentre@nt.gov.au
Website http://www.dob.nt.gov.au/business/tbc/Pages/default.aspx

The Australian Business Licence Information Services (ABLIS)

ABLIS provides assistance on finding government licences, permits, approvals, registrations, and other useful information.

Northern Territory
Tel;: 08 8982 1700 or freecall 1800 193 111
Website https://ablis.business.gov.au/pages/home.aspx

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