Anyone can earn income as an individual.  You will need to apply for a tax file number (TFN) and you will be asked to quote this to employers and financial institutions in order to avoid tax being withheld at the top personal rate of tax (currently 46.5% including Medicare levy).

The majority of taxpayers are salary and wage earners and they lodge their income tax returns using an I Form.

 

An individual taxpayer can also operate a business.  This is also called being a sole trader.  A person who operates a business needs to apply to the ATO for an Australian Business Number (ABN).  Depending on the type of business and the level of gross sales (turnover) they may also register for the Goods and Services Tax (GST).

 

A sole trader lodges their income tax return with the ATO using a Form I, and their business income is added to all other sources of income (salary, interest, dividends etc).

 

Individuals are able to claim income tax deductions that relate to their income.  These deductions mainly fall under the general deduction provisions of the Income Tax Assessment Act (1997).  These same principles of tax deductibility apply to all types of entities.  It is a widely held misconception that other types of business structures bring with them a greater range of tax deductions.

 

Trading as an individual is the simplest and cheapest business structure to establish, but in high risk industries where you are likely to be sued, your personal assets may be at risk.  If a taxpayer trades under a name other than their own name they must register that business name with the Department of Fair Trading for a small fee, but apart from that there a few establishment costs.  Tax is paid at normal individual tax rates.

 

The other common form of business structure is a company.  Companies can be either private (Pty Limited) or Public (Limited).  In Australia, companies are covered by the Corporations Act which is administered by the Australian Securities & Investments Commission (ASIC).  Each company has its own Constitution which sets out the scope of its operations and how the company is to be organised and managed.

 

A company is a legal structure that separates ownership of a business and business assets (and business debts) from the individuals who own the company.  A company has legal status of its own - it can enter into contracts, it is capable of suing other parties and is capable of being sued.

 

A company has an amount of issued capital represented by shares.  The owners of these shares "own" the company.  In the case of a private company, there can be from 1 - 50 shareholders.  If any one person owns more than half of the issued shares they will control the company.  The shareholders in a company can be any type of entity (individuals, trusts, companies, superannuation funds).  Shares can be transferred from one shareholder to another entity by completing a share transfer form.  Each "share" or unit of ownership in a company has an issue price.  Commonly this is $1.00 per share, but it can be any value.  The issue price is the amount that the initial shareholders (and any subsequent fresh allotments by the Company) are required to contribute in order to take up their shares.

 

A limited liability company (most companies) is designated by including the word "Limited" in their name.  This means that in the event of a winding up, the liability of members is limited to the issue price of their shares.  This can act as a protection of the personal assets of the shareholders and directors, but it should be noted that lenders and major creditors will usually require security and/or personal guarantees before advancing money to a limited liability company.  Directors may also become personally liable for company debts if they trade knowing that the company is insolvent.

 

A company can carry on business and is subject to income tax on its assessable income less allowable deductions.  Companies pay tax a flat rate of tax (currently 30%) on their taxable income, and lodge an annual income tax return with the ATO on a Form C.

 

If a company earns a profit for the year it may choose to distribute this profit to its shareholders by way of a dividend.  See separate Fact Sheet on dividends.

 

Australian companies require at least one resident director and one resident secretary, although this can be the same person.  People intending to take on a role as a company officer should be fully aware of their duties and responsibilities under the law before consenting to act.

 

Companies are a more expensive structure to establish and maintain.  A Pty Limited company costs a little over $1,000 to establish and there is an annual filing fee (currently $212) payable to the ASIC.  There is also the cost of preparing financial accounts and income tax returns.

 

Any group of entities (individuals, companies, trusts) can together form a partnership for the purpose of earning income or carrying on a business.  For example it is common for accountants to form partnerships as their business entity.

 

Partnerships are often governed by a partnership agreement.  This is a legal document that sets out how the partnership will be conducted.  This is particularly important for determining how new partners will be admitted and how retiring partners will be paid out.

 

A partnership agreement is not essential to having a partnership.  The registration of a business name in joint names and / or the operating of a joint bank account are sufficient evidence to establish that a partnership exists.

 

A partnership does not pay tax in its own right.  All income is distributed to the partners and each partner includes their share of the net partnership income in their own income tax return and they pay tax at their own rate.  The partnership lodges an income tax return on a Form P.

 

A joint venture is similar to a partnership, but is generally for a specific project and therefore a limited amount of time.

 

A simple partnership is easy to establish and is not costly to maintain, however is does not generally provide limited liability protection to the owners.

 

A trust is hang over from English law.  A "trust" is established when a person (called the settlor) gives an amount of money to another party (the trustee) to hold in trust for a nominated person or group of people (called beneficiaries).

 

A trustee of a trust is a separate legal entity and it can own assets, incur liabilities, carry on a business or own property.  The rules of the trust are set out in a legal document called a trust deed.  The trustee can be a company or individuals.

 

There are several different types of trusts.  A discretionary trust is one where the income of the trust is distributed to the beneficiaries at the total discretion of the trustee.  A fixed trust is one where the income of the trust is distributed to the beneficiaries in fixed shares.

 

Providing a trust distributes its income each year it does not pay tax.  Failure to distribute income results in the trustee being liable to tax at penalty rates.  Income distributed to minors (persons under 18 years of age) is taxed a special rates, with a much lower tax free threshold.

 

There are also special types of trusts created by particular circumstances.  A superannuation fund is a special trust set up to provide retirement benefits for its members.

 

When a person dies any assets that exist at the date of death are then held in trust by the executor of the deceased person pending distribution to their beneficiaries.  In the case of a deceased estate, it is possible for the trust to earn income before the assets are distributed to the beneficiaries.  Income earned during this period of administration is taxed as if it were the income of an individual (ie using the normal individual tax rates).  This situation can continue for a period of up to three income tax returns after the date of death.

 

It is possible for a person to specify in their will that they wish to have a trust established upon their death.  This is called a testamentary trust.  The advantage of a testamentary trust is that it can distribute income to minor beneficiaries (ie persons under the age of 18) while still enjoying the normal tax free threshold and individual tax rates.

 

A trust lodges an annual income tax return on a Form T.

 

Trusts have a similar set up cost to that of companies.  For some years now legislation has been proposed that will tax trusts in the same way as companies, but this has not happened yet.

 

A superannuation fund is a special type of trust, established to provide retirement benefits for members.  The rules of the fund are governed by a trust deed.  Superannuation funds are regulated by the Superannuation Industry Supervision Act (SIS Act) and funds receive concessional tax treatment, providing they comply with the provisions of the SIS Act.

 

If a fund has less than 5 members it can elect to be a self managed superannuation fund (SMSF).  The ATO administers SMSF's and the annual return information is combined with the Form F taxation return.  SMSF's have less onerous reporting obligations, but they are restricted in that all members of the fund must also be trustees.

 

If a fund has five or more members it is regulated by the Australian Prudential Regulation Authority (APRA) and the fund needs to lodge both an income tax return and an annual return with APRA.

 

Members are in either of two broad phases.  The accumulation phase - during which time members are accumulating funds through employer and / or employee contributions together with the earnings on those funds.  The other phase starts when a member reaches retiring age and elects to take their benefits in the form of a regular income stream (called a pension).  This is called pension phase.

 

During the accumulation phase, contributions that have been made by an employer or member contributions for which a tax deduction has been claimed are taxed in the fund at the rate of 15%.  Net investment income is also taxed at the rate of 15% during the accumulation phase.  If the fund has invested in shares or managed funds that carry with it an imputation credit this is allowed as a refundable offset against tax otherwise payable.  Since company dividends are franked at the rate of 30% most funds pay less than 15% tax as the excess imputation credits are offset against the 15% tax on other types of income.

 

When a member reaches pension phase the tax on investment earnings drops to nil as the assets are being used to fund a pension.  The pension received is taxable to the member, but comes with a 15% tax offset.  Any member contributions made during the accumulation phase where no tax deduction has been claimed (called undeducted contributions) are not taxable to the member.  The amount of undeducted contributions included in the pension amount is determined by reference to the ATO life expectancy tables at the commencement of the pension.

 

Upon reaching "retirement age" (currently 55 if you were born before 1 July 1960 or phasing out to 60 if you were born after 1 July 1964) you can choose to take your superannuation benefits as either a lump sum or as a regular income stream (pension) or a combination of both.  There is a tax free amount that you can withdraw as a lump sum and this amount is indexed each year.  There are powerful incentives to retain capital within the superannuation fund and draw a pension rather than take a lump sum.

 

From 1 July 2007 it is proposed that persons who have reached age 60 will be able to access their superannuation as either a lump sum or a pension and there will be no tax payable.  Previous limits on end benefits (called reasonable benefit limits or RBLs) are to be abolished although a cap on contributions is also part of the proposed legislation.