Sole Trader vs Company vs Trust: The Australian Decision
When to stay sole trader, when to incorporate, how discretionary trusts and bucket companies work, Division 7A loan traps, s.100A reimbursement risks, and a decision framework based on profit level, family situation, and liability exposure.
Sole traders pay personal marginal rates up to 45% plus 2% Medicare levy but enjoy simplicity, immediate loss offsets, and minimal compliance costs. Companies pay a flat 25% tax rate (base rate entities with aggregated turnover under $50 million and 80% or less passive income) and provide limited liability, but trap losses inside the company and create extraction complexity through Division 7A of ITAA 1936. Discretionary family trusts offer income-distribution flexibility to lower-taxed beneficiaries each year, but undistributed income faces the top marginal rate under s.99A, and the ATO scrutinises arrangements under s.100A and TR 2022/4. The right structure depends on profit level, family situation, liability risk, and whether you can genuinely leave profits in the entity.
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Guidance, not advice. We explain the rules, we don't assess your situation. Always seek financial or tax advice from your accountant, or contact ATO. Read our editorial scope →
Sole trader: simplicity, losses, and liability exposure
A sole trader is you trading in your own name with an ABN. There is no separate legal entity. All profits are taxed at your personal marginal rates under ITAA 1997. You report business income and expenses in your individual tax return and pay PAYG instalments once profitable. Setup cost is minimal (ABN registration is free), compliance is one set of accounts and one tax return, and you make all decisions without corporate governance overhead.
Advantages
Simple and cheap to establish and operate. Business tax losses generally offset your other assessable income in the same year (subject to non-commercial loss rules in Division 35 ITAA 1997). Full control over all decisions with no shareholder or trustee obligations.
Disadvantages
Unlimited personal liability: business creditors and litigants can pursue all your personal assets. High tax at scale: once profit exceeds roughly $120,000, you pay more than 25% average tax (the company rate). No income splitting: you cannot divert income to family members arbitrarily, and PSI rules further restrict this for personal-services businesses. Harder to sell: buyers generally prefer to purchase shares in a company, and sole-trader goodwill is tied to you personally.
Company (Pty Ltd): limited liability and tax capping
A proprietary limited company is a separate legal entity under the Corporations Act 2001. It enters contracts, owns assets, and pays income tax at its own rate. Base rate entities (aggregated turnover under $50 million, no more than 80% passive income) pay 25%. All other companies pay 30%.
Advantages
Limited liability: shareholders' exposure is generally limited to their share capital, insulating personal assets. Tax capping and deferral: profits retained in the company are taxed at 25%, allowing deferral of personal tax until salary or dividends are paid out. Capital gains concessions: selling shares in a qualifying trading company can access small business CGT concessions (50% active asset reduction, retirement exemption). Easier to scale: can issue shares, bring in investors, and the company has perpetual succession.
Disadvantages
Setup and ongoing costs: ASIC registration and professional setup typically $500 to $1,500, plus annual ASIC review fee of approximately $310. Compliance: separate company tax return, director minutes, registers, and financial records, in addition to your personal return. Trapped losses: company tax losses only offset future company income, subject to continuity of ownership and similar business tests. Extraction complexity: getting cash out requires salary, director fees, dividends, or properly documented loans, each with distinct tax consequences.
Division 7A: loans to owners
Division 7A of ITAA 1936 prevents private companies from making tax-free distributions to shareholders or associates via loans, payments, or debt forgiveness. If the company provides a loan or payment that is not repaid in full or covered by a compliant Division 7A loan agreement by the earlier of the lodgement day or actual lodgement of the return, the unpaid balance is treated as a deemed unfranked dividend in the shareholder's personal return. WORKED EXAMPLE — director loan trap. Marco — Melbourne, VIC — runs Marco Plumbing Pty Ltd. His company has $80,000 sitting in its bank account after profit and tax. He needs $40,000 for a kitchen renovation. He transfers $40,000 from the company account to his personal account on 15 May 2026, intending to "sort it out at tax time." Without action by the company's lodgement day for the FY 2025-26 return (typically 15 May 2027 for tax-agent-lodged returns; earlier for self-lodgers), Marco has triggered Division 7A. The $40,000 is deemed an unfranked dividend assessable to Marco at his marginal tax rate. On Marco's $130,000 other income, the marginal rate is 37% — tax on the deemed dividend ≈ $14,800. The fix — document the transfer as a complying Division 7A loan. The loan agreement must (a) be in writing before the company's lodgement day, (b) use the ATO benchmark interest rate (FY 2025-26 benchmark is published annually — verify on ato.gov.au before drafting), and (c) have a maximum term of 7 years (unsecured) or 25 years (secured by registered mortgage over real property). Minimum yearly repayment under s 109E for a $40,000 unsecured loan, 7-year term, benchmark rate ≈ 8.77%: annual repayment ≈ $7,932 for 7 years. Marco pays the company $7,932 in the next income year (deadline: lodgement day of the year the loan was made). The company books the receipt as interest income (taxable) plus loan principal repaid. No deemed dividend. Statute: Division 7A ITAA 1936, ss 109B, 109E, 109N. Try the [Division 7A calculator](/division-7a-calculator) to model your own loan and minimum repayments.
Compliant loan requirements
A written loan agreement with the ATO's benchmark interest rate. Maximum 7-year term if unsecured. Maximum 25 years if secured by real property. Minimum yearly repayments by 30 June each year. Missing a single minimum yearly repayment causes the remaining balance to be treated as an unfranked dividend in that year.
Discretionary (family) trust: flexibility and distribution
A discretionary trust is a relationship where a trustee (individual or corporate) holds assets and carries on a business for the benefit of beneficiaries under a trust deed. The trust is a separate taxpayer under Division 6 of Part III of ITAA 1936, but it is not a separate legal entity. Each year the trustee decides how to distribute trust income among eligible beneficiaries, directing more to lower-income adult family members where consistent with the deed and the law.
Advantages
Income distribution flexibility: direct income to lower-taxed family members each year. Asset protection: properly structured trust assets are less exposed to claims against individual beneficiaries. CGT discount flow-through: the 50% CGT discount on assets held for 12+ months can pass through to beneficiaries. State land tax planning: some states allow each trust to access its own threshold.
Disadvantages
Losses trapped: net losses are carried forward in the trust, not available to beneficiaries. Top rate on undistributed income: income not distributed by 30 June can be assessed to the trustee at 45% plus Medicare under s.99A. Cost and complexity: setup with tailored deed, appointor provisions, and corporate trustee typically $1,500 to $3,000, plus annual accounts, trust tax return, and income distribution resolutions. ATO scrutiny: distributions to low-taxed adult children are a priority compliance area.
Section 100A and TR 2022/4: reimbursement agreements
Section 100A of ITAA 1936 is the anti-avoidance provision targeting arrangements where a beneficiary is made presently entitled to trust income but another person actually enjoys the benefit, with a tax reduction purpose. When s.100A applies, the beneficiary is deemed never to have been presently entitled, and the trustee is assessed at the top marginal rate.
What TR 2022/4 says
The ruling distinguishes ordinary family and commercial dealings (generally low risk) from arrangements where distributions to low-income members are made but cash is retained by controllers or redirected elsewhere (high risk). Beneficiaries who are made presently entitled must genuinely receive or enjoy their share of income. The practical takeaway: paper-based distributions where cash does not follow the entitlement are the primary target.
Trust with corporate trustee and bucket company
The most common Australian SME structure combines a trading discretionary trust with a corporate trustee and a separate 'bucket' company as an additional beneficiary. The trust provides income distribution flexibility. The corporate trustee provides limited liability. The bucket company absorbs surplus income at the 25% company rate, avoiding distribution to individuals at up to 45%.
How it works
The trustee distributes income needed for personal expenses to individual beneficiaries (taxed at their marginal rates). Surplus income is distributed to the bucket company, which pays 25% company tax. The retained funds sit in the company, available for reinvestment or later extraction as dividends. This caps tax on surplus at 25% while preserving trust flexibility for the rest.
Division 7A risk in bucket company structures
If trust income distributed to the bucket company remains as an unpaid present entitlement (UPE) rather than being physically paid, the ATO increasingly treats UPEs as financial accommodation subject to Division 7A. If the UPE amount is later advanced back to individuals, a compliant loan agreement is required to avoid deemed dividend treatment. Clean cash management between the trust and bucket company is essential.
Decision framework: profit, family, and risk
The right structure depends on three variables: profit level, family situation, and liability exposure. No single structure is universally optimal.
Family situation overlay
With adult spouse and children who genuinely work in or support the business, a discretionary trust is often optimal for income distribution flexibility. Watch s.100A: distributions must reflect real economic benefit to the beneficiary. Without family to distribute to, a company is simpler than a trust and achieves the same tax-capping benefit.
Liability risk overlay
High-liability trades (construction, professional advice, large-value contracts) should use a company or trust with corporate trustee from day one regardless of profit level. The liability shield protects personal assets from business claims, provided you do not sign personal guarantees that override the protection. Separating operating entities from asset-holding entities adds another layer of protection.
Partnerships: when they work and when they do not
A partnership is two or more people carrying on business together. The partnership lodges its own tax return but is not taxed; each partner includes their share of net income in their personal return. Partnership losses flow through to partners, which is an advantage over companies and trusts. However, each partner has joint and several liability for all partnership debts, the profit split is fixed per the agreement (no year-to-year flexibility like a trust), and introducing or removing partners can trigger CGT or stamp duty. Partnerships work well for two tradespeople combining capacity and equipment on a relatively equal basis, but are generally inferior to trusts or companies for long-term structures.
Statute references
- Income Tax Assessment Act 1997 Division 6 (individual tax rates)
- Income Tax Assessment Act 1936 Division 6, Part III (trust taxation: ss.97, 99, 99A)
- Income Tax Assessment Act 1936 s.100A (reimbursement agreements)
- Income Tax Assessment Act 1936 Division 7A (loans from private companies)
- Corporations Act 2001 (company formation and director duties)
- ATO TR 2022/4 (Commissioner's view on s.100A reimbursement agreements)
- ATO PCG 2022/2 (practical compliance for s.100A)
- Bywater Investments Ltd v Federal Commissioner of Taxation [2016] HCA 45 — a company's tax residency turns on where central management and control is actually exercised, not where it is registered or where directors formally sit. Decisive for Pty Ltds with offshore directors or non-resident owners.
- Eichmann v Federal Commissioner of Taxation [2020] FCAFC 155 — land used to store tools and equipment can be an 'active asset' for the small business CGT concessions even where the storage is not directly part of day-to-day operations (Full Federal Court rejected a 'direct functional relevance' requirement under s 152-40(1)(a) ITAA 1997).
- Greig v Federal Commissioner of Taxation [2020] FCAFC 25 — shares purchased with a dominant intention of short-term profit-making (e.g. targeting takeover bids) can be on revenue account; losses deductible under s 8-1 ITAA 1997 (Full Federal Court applied the Myer Emporium principle to a senior executive's substantial share-trading losses).
- Aussiegolfa Pty Ltd v Federal Commissioner of Taxation [2018] FCAFC 122 — relevant where an SMSF sits inside the structure stack: investments routed through related trusts can satisfy the in-house asset rules, but the sole purpose test remains the binding constraint.
- TR 2023/4 (employee vs independent contractor) and CFMMEU v Personnel Contracting Pty Ltd [2022] HCA 1 — written-contract-first classification, with direct consequences for engaging staff through any structure.
- PCG 2023/1 (as amended) — Commissioner's compliance approach to the fixed-rate method for home office expenses. 70c/hour from 1 July 2024 (FY 2024-25 and FY 2025-26); 67c/hour for FY 2022-23 and FY 2023-24.
Frequently asked questions
At what profit level does incorporating as a company start to make sense?+
What is Division 7A and why does it matter?+
Can a discretionary trust distribute income to my children to reduce tax?+
What is a bucket company and when would I use one?+
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