General Tax considerations for Small Business
As a company is a separate legal entity it needs to lodge a tax return under its own tax file number at the end of the financial year. Companies are taxed at a flat rate of 30% on taxable income (and doesn’t pay the Medicare levy).
Common Small Business tax mistakes:
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Source
Australian companies pay tax on all income regardless of where it is earned , whereas non Australian resident companies are only taxed on Australian sourced income.
Companies are generally regarded as Australian companies if
The business is run in Australia, or- The business is run in Australia, or
- Central management & control is in Australia, or.
- Voting power is controlled by shareholders who are residents of Australia
Cash flow considerations: Cash accounting vs. Accrual accounting
The ATO allows you to elect to recognize income under either method.
Once elected however, you cannot vary the basis.
Cash accounting is obviously far simpler from a bookkeeping perspective and the advantage is that you only pay tax when you have receive the cash, however for a larger business with larger working capital cycles, this will not provide a true measure of the performance of the business and it is important to get advice from your accountant on the matter.
Small Business concessions
If you have a turnover of < $2m per year you may qualify for certain small business concessions.
You will need to elect whether you want to adopt some / all of these and its important you discuss with your accountant:
- The business is run in Australia, or
- Small business CGT concessions. 4 concessions may be available
- CGT 15 year asset exemption
- CGT 50 % active asset reduction
- CGT retirement exemption
- CGT rollover concession
- Certain prepaid business expenses may be deductable in the year paid instead of the period to which they relate
- Simpler depreciation rules whereby you claim immediate deduction for assets costing less than $1,000 and pool assets > $1,000 and depreciate by 30% each year (provided life expectancy is < 25 years).
- Choose to account for GST on a cash basis
- Pay GST on a quarterly or annual basis instead of monthly.
- Annual apportionment of GST input tax credits on items purchased partly for private and business purposes.
- Simplified inventory valuation rules if your inventory valuations are unlikely to vary by more than $5,000 each year then you do not need to do a physical stock take and do not need to make any adjustments to your inventory valuation.
- The entrepreneurs tax offset (ETO) may be available if you elect to use the small business concessions and your net business income is <= $75,000, you can claim a 25% ETO on your tax payable if business income is <=$50,000 and a lesser amount if <= $75,000.
Maximizing your income tax deductions
Expenditure you incur in generating assessable business income is generally available as a deduction. This is laid out on the general deduction provision to which many specific interpretations and have been made which has provided further clarity to what is available as a deduction under this general concept. Under the general deduction provisions there needs to be a direct or necessary connection between your business activity and the expenditure incurred.
It is important to distinguish between capital and revenue items. Capital items are not deductable under the general deduction provisions. In general terms capital items can be described as expenditure incurred in improving, replacing, establishing enlarging or protecting the business structure. The income tax act allows certain capital items to be deducted (e.g. if < $1,000 and others to be depreciated over a period of time).
Specific deductions clarifying the general deduction concept:
- Bad debts can be deducted as longs as the debt is still owed to you (i.e. you have not already settled it or assigned it) and you write it off in your accounting records in the income year as it is definitely bad and not merely doubtful. You must have previously included the income to which the debt relates in your taxable income.
- Monetary Losses caused by theft, embezzlement, larceny, defalcation or misappropriation are generally deductable provided you previously included the money in your taxable income.
- Professional services – legal costs can be deducted as long as they are associated with running your business and are not entirely of a private/personal nature and not capital. A capital expense would include legal service assisting you to establish your business as opposed to services for ongoing business matters.
- Professional services – tax service expenses can be deducted as long as they are associated with assisting you in managing your tax affairs and they are provided by a tax agent or legal practitioner.
- Business losses are generally deductable and can be offset against other personal income you may have. Note that non commercial loss provisions prevent sole traders / partnerships claiming losses against other assessable income they may have outside of the partnership / sole trader. Losses need to be carried forward and can only be offset in the year that one of the four tests are passed to prove the business is commercial:
- You need to earn >$20,000 assessable income or
- The business activity must have resulted in taxable income in 3 of the last 5 years
- You need to have real property >= $500,000 or
- You need to have other, non motor vehicle assets >$100,000
- Loan interest and associated borrowing costs (e.g. loan establishment fees) are generally deductable provided they are not wholly for a personal nature and are intended to be used to produce taxable income (e.g. purchase income producing machinery or business inventory). For part personal and part business loans – the expense needs to be apportioned according to the use and appropriately recorded. Unlike interest, borrowing costs are often incurred upfront and need to be apportioned on a daily basis, from the start date of the loan, over the shorter of the life of the loan or 5 years.
