Should I Set Up a Company?

The maths at four profit levels

The only reason to incorporate is to pay less total tax after compliance costs. If you withdraw all profit as salary, a company structure changes nothing except adding expense. The advantage appears solely when you retain surplus profits taxed at the 25 per cent base rate entity rate, or when you can legitimately stream franked dividends to family members on lower marginal rates (subject to PSI rules).

Compliance and running cost drag

A proprietary company in Australia carries fixed annual costs that a sole trader does not. These costs apply regardless of whether the structure produces any tax benefit.

Trust plus bucket company as a third option

The common structure for established self-employed professionals and family businesses is a discretionary (family) trust running the business, with a corporate beneficiary (bucket company) receiving surplus distributions. A corporate trustee often sits above for asset-protection purposes. The trustee distributes income to the main working individual (and spouse if applicable) up to their lower brackets, then streams surplus to the bucket company at 25 per cent.

Division 7A: the director's loan trap

Division 7A of the Income Tax Assessment Act 1936 exists to prevent shareholders treating company money as personal funds without paying tax. If you take money from your company as a loan, payment, or debt forgiveness without a complying arrangement, the ATO treats the amount as an unfranked deemed dividend taxable at your highest marginal rate with no franking credits attached.

PSI: why a company might give zero tax benefit

The Personal Services Income rules in Part 2-42 of the Income Tax Assessment Act 1997 stop individuals routing personal exertion income through entities purely for rate arbitrage or income splitting. Income is PSI if more than 50 per cent of what you receive for a contract is really payment for your personal labour, skills, or expertise. If PSI rules apply and you are not a Personal Services Business under the ATO tests, the ATO attributes the income back to you personally and denies certain entity-level deductions.

When sole trader is better

Three scenarios clearly favour staying as a sole trader. First, consistent income below approximately $100,000 where you need most of it to live: your marginal rate is not far above 25 per cent, and any small differential is consumed by compliance costs. Second, losses are likely during a startup phase or volatile work period: as a sole trader, business losses can offset other assessable income immediately, while company losses are trapped until future profits arise. Third, maximum simplicity: one TFN, one tax return, no ASIC, no Division 7A risk, cheaper accounting.

The classic mistake: incorporating too early

The most common structural error in Australian small business is forming a company at $80,000 to $90,000 of essentially personal services income, pulling all money out as salary or drawings, paying ASIC annual review fees every year, and paying an accountant for the company return, director minutes, and ASIC compliance work. The net effect is no real tax saving (and none at all if PSI applies), but several thousand dollars of annual friction and the risk of Division 7A or administrative slip-ups. Do not form a company because it feels more legitimate. Form it because the reduced tax on retained profits, investor-readiness, and liability protection clearly justify the very real ASIC and accounting bill.

Statute references

• Income Tax Assessment Act 1936, Division 7A (deemed dividends from private companies)
• Income Tax Assessment Act 1997, Part 2-42 (Personal Services Income)
• Corporations Act 2001, Part 2A.2 (ASIC registration and annual review fees)
• Income Tax Rates Act 1986, Schedule 7 (base rate entity company tax rate)

Frequently asked questions