Choosing between a sole trader and a company is one of the first major decisions a business owner makes. It is also a decision that is often based on one number: the company tax rate.
That can be a costly mistake.
Tax is important, but it is only one part of the decision. Your structure also determines who is responsible for business debts, how you can withdraw money, how losses are treated, what happens when you sell the business and how much administration is involved.
A sole trader structure can work well for a new or relatively straightforward business. A company may become more appropriate as profits, risks, employees and growth plans increase. Neither structure is automatically better. The right choice depends on how your business actually operates.
How Does a Sole Trader Structure Work?
A sole trader is an individual carrying on a business. Legally, there is no separation between the owner and the business.
You report the business income and expenses in your individual tax return and pay tax on the resulting net profit at your individual marginal tax rate. You can employ staff, but you cannot employ yourself.
The main attraction is simplicity. Establishment costs are relatively low, administration is generally easier and there is no separate company tax return or ASIC annual review.
The trade-off is personal liability. Because you and the business are the same legal person, you are personally responsible for the business’s debts and losses. If the business cannot meet its obligations, your personal assets may be exposed.
How Is a Company Different?
A company is a separate legal entity. It can own assets, enter contracts, employ staff, incur debts and lodge its own tax return.
This separation may provide some protection for an owner’s personal assets, particularly where the business employs people, signs substantial contracts or operates in a higher-risk industry. It is not complete protection, however. Personal guarantees, breaches of directors’ duties, insolvent trading and certain unpaid tax and superannuation liabilities can still expose a director personally.
Companies also carry more responsibility. They must maintain corporate and financial records, complete an ASIC annual review, lodge a company tax return and properly document important decisions and transactions.
Comparing Sole Trader and Company Tax Rates
A sole trader’s net business profit is added to their other assessable income and taxed at individual marginal rates.
For the 2026–27 income year, an Australian resident entitled to the full tax-free threshold pays no income tax on taxable income up to $18,200. The rate from $18,201 to $45,000 is 15%, followed by marginal rates of 30%, 37% and 45%. The Medicare levy is additional.
A company qualifying as a base rate entity is generally taxed at 25%. Other companies are generally taxed at 30%. Eligibility for the 25% rate must be assessed each year and depends on the company’s aggregated turnover and the amount of passive income it earns.
This does not mean that incorporating automatically reduces the owner’s tax to 25%.
If company profits are later paid to an individual shareholder as dividends, the shareholder may have additional tax to pay after receiving credit for any company tax already paid. A company can provide a tax-timing advantage when profits are genuinely retained to fund equipment, employees, working capital or expansion. The advantage may be much smaller when the owner needs to withdraw most of the profit for personal living expenses.
What Happens When You Take Money Out?
A sole trader can transfer money from the business account for personal use. These transfers are called drawings. They are not wages and they do not create a tax deduction.
The sole trader is taxed on the net business profit, irrespective of whether the money remains in the business account or is withdrawn.
A company is different. The money in its bank account belongs to the company, not to its director or shareholders. Funds generally need to be taken as salary, director fees, dividends, genuine expense reimbursements or properly documented loans.
For example, if a shareholder uses the company credit card to pay for a family holiday and the transaction is not treated correctly, Division 7A may apply. Subject to its detailed rules and exceptions, the private payment may be treated as an unfranked dividend.
This is one of the most common areas of confusion when a business changes from a sole trader to a company. The owner may still control the business, but they can no longer treat the company bank account as their personal account.
Personal Services Income Can Change the Result
Using a company does not automatically allow income generated from one person’s labour or expertise to be retained at the company tax rate or distributed among family members.
Personal services income, commonly called PSI, is generally income that is mainly a reward for an individual’s personal efforts or skills. This can be relevant to consultants, contractors, medical practitioners, IT professionals, engineers and other service providers.
If the PSI rules apply, the income earned through a company may be attributed to the individual who performed the work unless an exception applies. The rules can also restrict certain deductions.
This is why incorporation should not be viewed as a simple income-splitting strategy.
Business Losses Are Treated Differently
A sole trader may be able to offset a business loss against other assessable income, such as salary or investment income. However, the non-commercial loss rules may require the loss to be deferred until a later year.
A company’s loss remains in the company. Shareholders cannot usually claim it in their personal tax returns. The company may be able to carry the loss forward and use it against future taxable income, provided the relevant company loss tests are satisfied.
This distinction can be particularly important for a new business expecting losses during its establishment phase.
Do Not Overlook Capital Gains Tax
Capital gains tax can materially affect the choice of structure, especially if you intend to build and eventually sell the business.
An Australian resident individual may generally receive the 50% CGT discount on an eligible asset held for at least 12 months. Companies are generally not entitled to this discount.
The small business CGT concessions may provide additional relief where the detailed eligibility conditions are satisfied. However, they are not automatic. Turnover, net asset value, active-asset requirements and ownership conditions may all need to be considered.
The likely exit strategy should therefore be discussed before deciding which entity will own the business, its goodwill and other valuable assets.
What About GST?
Whether you operate as a sole trader or company, GST registration is generally required when GST turnover reaches $75,000.
Special registration rules apply to certain activities, including taxi, limousine and ride-sourcing services. Businesses registered for GST must also consider BAS lodgements, tax invoices and record-keeping requirements.
So, Which Structure Should You Choose?
A sole trader structure may make sense when you are testing a new business idea, commercial risk is relatively low, profits are modest and simplicity is important.
A company may be worth considering when profits are growing, the business can retain some income, staff are being employed, substantial contracts are being signed or additional owners may be introduced.
The answer should not be based on tax rates alone. In practice, we consider:
- expected business profit;
- the owner’s other income;
- how much cash is needed personally;
- whether the PSI rules may apply;
- commercial and legal risks;
- expected startup losses;
- plans to retain and reinvest profits;
- ownership and succession plans; and
- the possibility of selling the business later.
Frequently Asked Questions
Q1. Is a company always more tax-effective than a sole trader?
No. The 25% company rate applies only to eligible base rate entities, and additional tax may arise when profits are distributed to shareholders. A proper comparison needs to consider the owner’s total income and how company profits will be used.
Q2. Can I change from a sole trader to a company later?
Yes, but transferring an existing business may have income tax, GST, CGT, duty, licensing and contractual consequences. The restructure should be planned before transferring goodwill, equipment, contracts or other assets.
Q3. Does a company completely protect my personal assets?
No. A company can provide a level of separation, but personal guarantees, directors’ obligations and certain unpaid liabilities may still result in personal exposure.
Q4. Can I use company money for personal expenses?
Company funds should not be treated as personal money. Private payments and withdrawals must be correctly recorded and may need to be treated as salary, dividends, reimbursements or complying loans.
Q5. Need Help Choosing the Right Business Structure?
Choosing between a sole trader and company requires more than comparing two tax rates. Kintax Accountants can review your expected income, risks, cash-flow requirements and long-term plans to help determine an appropriate structure.
Contact Kintax Accountants
Phone: 0399393692
Email: info@kintax.com.au
Office: Level 1, 287A Spring Street, Reservoir VIC 3073
Enquiries: Request a consultation
Based in Reservoir, Kintax Accountants assists business owners across Melbourne’s northern suburbs and greater Melbourne with business structuring, company registrations, taxation, accounting, bookkeeping and ongoing compliance.
Important Information: This article contains general information only and does not constitute tax, financial or legal advice. Business structures involve tax, legal and commercial considerations that depend on your circumstances. Obtain professional advice before establishing or changing a business structure.
