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Difference between a company and a sole trader?

Sole Trader vs Company

What’s the difference between a company and a sole trader?

Giving your business a formal structure is a transformative step that turns your dream into reality. While being a sole trader or establishing a company are popular setups in Australia, deciding which is best isn’t always easy.

  • a sole trader traders under an ABN in your personal name; and,
  • a company is a separate legal entity with its own ABN, ACN & TFN

So what is the difference between a sole trader and a company?

Does it really matter which one you choose?

sole trader vs company

What is a sole trader?

A sole trader in Australia refers to a self-employed individual who owns and runs a business.

Traditional tradespeople like electricians, gardeners and plumbers often operate sole trader businesses, as do many freelance consultants.

This business structure is popular because it’s quick and inexpensive to set up. It’s simple to understand and operate too — the key is just remembering that you and your business are treated as one and the same.

In contrast, a company has a life of its own. It’s considered separate from you even though you created it.

Your business structure matters because it has ongoing impact on how much money you take home and the financial risks you’re exposed to.

Sole trader setup and registration

Now, let’s talk about how you become a sole trader.

How do you register a sole trader business?

You start by applying for an Australian Business Number (ABN). This is free if you intend to run a business. An ABN is an identifier that you use for all your business dealings, from getting a bank account to invoicing a customer.

Next, you choose a business name and register it with the Business Registration Service. Note that you don’t have to register a sole trader business name if you plan to trade under your first name and surname.

There are just two main setup costs for sole traders: a business name at $37 a year (or $87 for three years) and bank fees if you choose to have a separate business bank account.

To apply for a business bank account, you’ll need to provide the bank with proof of your identity and address, business name, registered business address and information on your sole trader activities.

Establishing a company

By comparison, setting up a company is more expensive. While the ABN is still free and registering your business name will cost the same amount, you’ll need to register your company with the Australian Securities & Investments Commission (ASIC) at an initial cost of $417 to $506. There’ll be an annual review fee of around $273 thereafter.

A separate bank account is mandatory for companies, so you’ll be paying bank fees too.

How sole trader is taxed

If you’re a sole trader, then money you earn from your business is treated as your individual income.

When it comes to tax time, you simply include business income and expenses in the business sections of your individual tax return to arrive at your taxable income.

You can claim costs incurred in running your business and personal super contributions (after notifying your fund) as tax deductions. Although you can withdraw money from your business account as personal drawings, you can’t claim them or your own wages as tax deductions.

The way you calculate tax for a sole trader is to apply the same income tax rates for individual taxpayers to your taxable income. You can then reduce your tax payable with the small business tax offset if you’re eligible.

How to lodge tax return and pay tax as a sole trader

You’ll have to put money aside regularly to pay for your tax bill at the end of the financial year. The Australian Tax office may ask you to make quarterly Pay As You Go (PAYG) instalment payments so you can manage your taxes more easily.

You can use your individual tax file number (TFN) to lodge your tax return.

How are companies taxed

Companies pay tax on their taxable business income, which is its income net of expenses. You can’t just take money out as personal drawings — the company has to pay you wages but can deduct them as a business expense.

The company tax rate is 27.5% or 30% depending on the type of company you have. This tax rate applies to every dollar the business earns because companies are not eligible for tax-free thresholds.

Now, if individuals can claim the tax-free threshold but companies can’t, does this mean sole traders always pay less tax?

Interestingly, the answer is no because individual tax rates can go up to 47%! The best structure from a tax perspective really depends on your business specifics.

Sole trader vs. company liability

The biggest benefit of establishing a company is limited liability.

Since sole traders are legally responsible for all aspects of the business, you risk losing your own assets or even bankruptcy if you’ve been sued and are liable for damages.

But a company can borrow money, sue and be sued in its own right, as well as use company assets to settle outstanding debts. Because it is treated as separate from you, you’re generally exposed to less financial risk.

Other considerations for sole traders

There are other practical factors to consider if you decide to set up a sole trader business.

Insurance. What insurance do you need as a sole trader? This depends on the nature of your business. As a starting point, you might like to consider protection for personal injuries, disability and death, property or vehicle insurance, cover for public liability as well as professional liability.

Employing staff. Sole traders can hire staff, but you’ll need to provide Work Cover and fulfill legal requirements around superannuation, PAYG contributions and other employee entitlements.

Goods and Services Tax (GST) registration. You’ll need to register for GST if the annual GST turnover of your sole trader business is at least $75,000. You can register by phone, online, or through a registered tax agent like POP Business.

sole trader vs company

Superannuation. As asole trader, you’re responsible for making contributions into a superannuation fund for both yourself and any workers you hire.

As you can see, there are many differences between a sole trader and a company. If you’re not sure which setup is best for your business, our experts at POP are ready to help. We’ve supported many budding business owners just like you. Our company setup fee of $1,000 (plus GST) offers great value and includes the ASIC fee, company constitution, minutes and tailored advice to ensure your business venture is off to a flying start. Talk to us today!

What about risk?

If you get sued and you operate as a sole trader structure, your personal assets are at risk. sole trader vs company

What could go wrong in business? Everything that can, does go wrong at some point. Ask any business owner about the highs and lows of business and you’ll hear some battle stories.

In contrast, a company is treated as a separate legal entity and liability is generally limited to the company. There are times that a Director may be personally liable such as a case of unpaid employee wages, super, & PAYGW.

Overall, a company is great for asset protection and keeps your personal assets safe. 

If you are starting a business & not a hobby, the risk of a sole trader structure alone should push you towards incorporating a company within your group structure.

But I don’t have any personal assets you say?! 

What happens if you become liable for $100,000 in damages from a contract dispute, or loss of income from a trademark dispute or something else? 

You may be forced to become bankrupt which will limit your personal ability to get a loan. Apart from financial effects, the less talked about side (your mental wellbeing) is definitely not worth the risk.

What’s better for getting external investment?

company is best for external investment as it allows you to sell portions of your company via shares. Let’s say you have 100 shares in your company. You could sell 20 shares ie. 20% to get investment. 

It is important to note, if you are getting investment, make sure you get professional advice upfront from a qualified accountant or a reputable business advisor.

On the contrary to a company, a sole trader cannot share equity/ownership. In other words, a sole trader limits the ability to scale through external ownership.

Patrick Sargent

Patrick Sargent

Patrick Sargent is a Chartered Accountant and registered Tax Agent who is passionate about helping business owners and individuals achieve their goals, helping small businesses with a range of accounting services, including tax preparation, financial advisory, accounting and bookkeeping, and personal tax planning, as well as company, trust, and partnership tax returns and more.

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