Fiona and Angelo had been friends since pre-school even though they came from very different backgrounds. Angelo’s family was wealthy. His ancestors were at the forefront of modernising farming techniques in the Po valley in the 1880s. Now the family is involved in businesses as disparate as textiles, engineering and shopping centres. His grandparents had come to Australia after the second world war and had thrived in the boom of the 1950s.
Fiona’s family was working class. Her father was a hospital orderly and her mother a housewife. As a child Fiona spent many happy hours in the family kitchen helping her mother and her mother’s mother cooking for their big family. The love in that kitchen spawned Fiona’s love of cooking. When she finished school, she took a job as a waitress in the hope that she could work her way up to a chef’s job. Although she could cook anything, Fiona especially loved cake-making. Her friends would ask her if she could bake cakes for their special occasions. Word of her talent spread and before long she was getting requests from strangers. Demand grew and soon Fiona was working forty hours per week in her waitress job and another forty hours baking cakes. It was not a burden because she was young with plenty of energy and she was doing work that she loved. However, she knew nothing about business and began to worry that she might be falling foul of laws she did not know existed, so she made an appointment to see an accountant. Fiona asked Angelo to accompany her because she was afraid that what she was told might go in one ear and out the other, whereas Angelo was totally comfortable in the world of commerce.
Michael was a CPA in a nearby accounting practice. He listened as Fiona told him her story. She ended with the question “Is there anything I should be doing”.
Michael told her that in his opinion she was past the hobby stage. The hobby rules were complex and in fact different for income tax and GST.
Michael said “In essence the Tax Office is not usually interested in you if you are small and making losses whereas as soon as you started making a profit the Tax Office wants to know.”
Because Fiona was indeed starting to make profits from cake-making, Michael advised her that she should apply for an ABN (Australian Business Number) but first she would have to decide which type of entity to use. The four mainstream options were sole trader, partnership, company and discretionary trust.
Fiona stated emphatically that she would not be able to cope with complicated entities, which seemed to rule out companies and trusts. Angelo offered to be her partner in a partnership but Fiona felt that in some way this might be taking advantage of his friendship and she did not want to do this. “Are you…..?” asked Michael, making a hand gesture to indicate “together”. They both smiled. “Everybody asks that” said Fiona. “No, we’re just good friends. We have been friends since pre-school”.
Michael digested this information. Platonic friendships brought their own issues, sometimes good and sometimes not. In any case it was important to know. An accountant needs to know much more about his client than the numbers if he is to give the best advice.
“Do you have much money?” Michael asked.
“Only enough to last me week to week” Fiona said.
“Do you own any assets?”
“I have an old car worth about $1000. Nothing much else”.
Michael said, “You can register an ABN in your own name. You would then be a sole trader, which really means that you are a sole owner of your business. You can use your existing tax file number. It does not cost anything to register as a sole trader. It is also the least complicated entity. You simply add your net business income to any other income in your tax return. You retain the benefit of the tax-free threshold. In the early days while you are spending to establish the business this should provide you with a tax benefit”.
“The biggest disadvantage of being a sole trader is that it does not provide any asset protection but since you have very few assets this is not really an issue right now. If you accumulate significant assets in the future or generate high levels of income it is not difficult to change to an entity which does provide you with some asset protection”.
Michael tactfully did not add that more than 60% of small businesses fail within the first three years. He thought it better not to inflict on Fiona the cost and complications of a company or trust until it was determined whether she was likely to fall in the 60% or the 40% category.
That night in bed Michael thought about his new client. He was comfortable with his decision to recommend sole trader status. In any case, 1.3 million of Australia’s 2.3 million businesses operated as sole traders so Fiona was in good company.
He would have to buy some of her cakes tomorrow.
Next time – the partnership
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