Sole Trader vs Company: The Tax Difference

The most common tax question I get from people starting a business is some version of this: should I set up a company to pay less tax? The company rate is 25 percent, the top personal rate is 47, so a company must save money. I understand why it looks that way. It is also the wrong way to think about it, and believing it has cost people real money.

What I tell clients. I had a client who incorporated the day after a mate told him companies pay 25 percent. He was proud of that number right up until two things happened. First, he kept pulling cash out of the company account to cover his mortgage, the way he always had as a sole trader, and Division 7A quietly turned those drawings into an unfranked dividend taxed in his own hands. Then he sold the business and found the company could not use the 50 percent CGT discount he would have had as an individual. The 25 percent rate was real. It just never did what he thought it did. A company is a good structure for the right situation. It is not a lever you pull to pay less tax.

Here is what the headline rate hides. A company does pay 25 percent, or 30 percent if it is not a base rate entity, on its profit. But that profit belongs to the company, not to you. To live on it, you have to move it into your own hands, and the moment you do, it is taxed again at your marginal rate. What the lower company rate actually buys is deferral: you can leave profit in the company at 25 percent and delay the second layer of tax until you take it out. That is genuinely useful if you are reinvesting. It is not a saving if you need the money to live on, because you pay the top up eventually.

Same profit, two paths. The company rate is lower, but the money is taxed again on the way into your hands.

The one difference that is not just timing

There is one difference that is not about timing at all, and it catches people at the worst moment. As an individual, if you hold an asset for more than 12 months, you generally get the 50 percent CGT discount when you sell. A company does not get that discount. So when you eventually sell the business, or a large asset inside it, a structure you chose for a few percent on annual profit can cost you half the discount on a big capital gain. That is a permanent difference, not a deferral.

One caveat to watch. The 50 percent discount is current law, but the May 2026 Federal Budget announced changes to how capital gains would be taxed, moving towards cost base indexation with a minimum rate. Those changes are not yet law and are intended to start from 1 July 2027. Plan around the rules as they stand today, and keep an eye on that reform.

Getting the money out is the real catch

The other trap is the one my client fell into. When the business is you, taking money out is just spending your own after tax income. When the business is a company, taking money out is a transaction. It has to be done as salary or a dividend, or as a proper Division 7A loan. Draw cash informally and the law treats it as an unfranked deemed dividend, taxed in your hands with no credit for the company tax already paid. People who move to a company and keep their sole trader habits are the ones who get a nasty assessment a year later.

So when is a company actually worth it?

None of this makes companies bad. They are the right answer for plenty of businesses. The question is whether your situation fits, not whether the rate looks lower.

Match your circumstances to the side that fits. You can always incorporate later, once the numbers justify it.

Choose the structure for the business you are running, not for a number on a tax table. If you want to see how the two would play out on your own figures, Tax Assistant can model it. And whichever way you go, keep your records in order from day one, because both paths depend on it.

The technical detail

Sole trader. Business income is taxed at individual marginal rates and reported in your own return; there is no separate business tax return. Tax free threshold 18,200 dollars; the top marginal rate is 45 percent plus 2 percent Medicare levy. You and the business are the same legal person, so you carry personal liability.

Company. A separate legal entity. Company tax is 25 percent for a base rate entity (aggregated turnover under 50 million dollars, base rate entity passive income 80 percent or less) or 30 percent otherwise. Profit reaches the owner as salary, as a franked dividend under the imputation rules (Division 207 ITAA 1997), or via a complying Division 7A loan (Part III ITAA 1936; benchmark interest rate 8.77 percent for 2026-27). Informal drawings are a deemed unfranked dividend.

CGT discount. Individuals and trusts qualify for the 50 percent CGT discount on assets held more than 12 months (Division 115 ITAA 1997). Companies do not. The May 2026 Budget proposal to replace the discount with cost base indexation and a minimum tax is announced but not yet law, intended to apply from 1 July 2027.

Records. Both structures must generally keep records for 5 years under section 262A of the Income Tax Assessment Act 1936.

Current as at July 2026. General information only, not personal tax advice.