With 30 June upon us, taxpayers are looking for opportunities to reduce their tax liabilities for the fiscal year, and according to Institute of Public Accountants senior tax advisor Tony Greco, small businesses should also not overlook the cash flow benefits of tax deferral opportunities.
For the first time in many years, there are no tax cuts to look forward to in the new financial year. For some, the flood levy (which starts in July) will produce an effective increase in the tax rate. The new flood levy is 5 cents for each dollar over $50,000 up to $100,000, and $250 plus one cent for every dollar over $100,000.
Small to medium sized enterprises may also consider bringing forward income to the 2010-11 year in light of the flood levy reversing the usual strategy and benefits of deferring income. Most will ignore the impacts of the levy for tax planning purposes as the impact is relatively minor.
There are also other tax reduction strategies and housekeeping matters that small businesses should consider before 30 June:
1. Reduce or eliminate tax losses. In some cases, taxpayers will be looking to take the opposite approach and increase their taxable income in the current year. If your business has some carried forward tax losses to use up then strategies to reduce taxable income may not be suitable. Carried forward tax losses can be carried forward indefinitely but they should be utilized just in case circumstances change and you are unable to take advantage of them. There are also adverse taxation consequences if a trust has no income capable of being distributed.
2. This financial year will be your last chance to split income with children or claim the dependent spouse rebate. Trust distributions to children has been very tax effective but this is about to change. The low income tax offset for children meant that a business run through a trust could distribute $3,333 to children tax free and retain the funds within the business to fund working capital. In the future children will only be allowed to earn $416 tax free.
3. Review your debtors’ ledger and physically write-off any bad debts before the end of the financial year. Do not forget to claim a refund of the GST paid to the ATO on the sale which is often overlooked. This strategy is for taxpayers who report income on an accrual basis. Income from business activities will generally be returned on an accruals basis and will ordinarily be derived for tax purposes when a recoverable debt arises (i.e. generally when the invoice is raised).
4. During the end of year stocktake identify slow moving or obsolete stock. Either write-off the stock and physically dispose of the items or write-down the carrying value of such items. The closing value of trading stock effectively forms part of assessable income. Accordingly, if the closing value of particular items of trading stock on hand at the end of the year can be reduced for tax purposes, a deferral of taxation will arise. Trading stock can be valued for income tax purposes at cost, market selling value or replacement value. There is also a special valuation basis available for obsolete stock but you must meet the requirements as set out by the ATO before using this basis. As a different valuation basis can be adopted for each individual item of stock and the valuation basis used may change from year to year, this strategy offers considerable flexibility.
5. Self-employed business owners have the ability to make deductible superannuation contributions within the allowable limits. Special eligibility rules apply such as the 10 per cent rule which can catch people out. Income from employment must be less than 10 per cent of total assessable income, reportable fringe benefits and reportable employer superannuation contributions.
6. Superannuation contributions (assuming they otherwise meet the requirements for deductibility) are only deductible in the year they are made. Accordingly, if you want a deduction for superannuation contribution in the 2011 income year the contribution must be made by 30 June 2011.
7. Take advantage of the small business write-off for assets costing less than $1,000. From the 2012/13 income year this write-off threshold increases to $5,000. For assets costing more than $1,000 they can be added to a low asset cost pool and depreciated at half the normal rate irrespective of the actual purchase date (15 percent of the cost in the first year and 30 percent in subsequent years). For assets with an effective life more than 25 years, the pooled rate is 2.5 percent in the first year and 5 percent in subsequent years. If businesses do not or cannot take advantage of the small business tax concessions for depreciating pooled assets; they can claim the depreciation on each asset individually. The depreciation rate varies for assets depending on the effective life prescribed to them by the ATO. Under this method you can physically write-off obsolete equipment before year end and receive a tax deduction for the unclaimed amount. Where you are entitled to a capital works deduction (generally a 2.5 percent annual deduction for capital works including buildings and structural improvements), the destruction of the capital works before 30 June will generally give rise to a balancing deduction equal to the undeducted construction expenditure less the excess (if any) of insurance or salvage recoveries over demolition costs.
8. Don’t forget capital gains deferral. There are special rules governing the timing of capital gains tax (CGT) events, but in the simple case of the sale of an asset to which the CGT provisions apply, the time of the CGT event will generally be the time of entry into the contract for sale. If deferral of CGT liabilities beyond 30 June is desired (and you will not be using an available CGT rollover or concession which has that effect), consideration may be given to deferral of entry into the contract until after 30 June. If that is not commercially desirable, a similar outcome may be achieved through the use of put and call options. Alternatively under an arrangement that includes conditions precedent to the formation of the contract where those conditions precedent will not be met until after 30 June.
9. Trusts and business. If the business is run through a trust and has a corporate beneficiary, then you will need to familiarise yourself with various legislative changes that may require adoption of different practices. Trusts can no longer make corporate beneficiaries entitled to income and keep the funds within the trust. Also the streaming of different types of income has been restricted under interim measures.
Entrepreneur tax offset (ETO) which gives small business a 25% tax cut is to be abolished. The ETO provides small businesses, with turnover under $50,000, a tax offset equal to 25% of the income tax payable on business income, but stopped once the business income hit $70,000. SME’s should ensure that they take advantage of this benefit whilst it remains in operation.
10. Prepay business expenses. One of the most effective tax deferral strategies is to prepay expenses for the following fiscal year. Small business entities and non-business individuals can generally obtain a full deduction for payments made in the income year of payment for a pre-payment made where the eligible service period in respect of which the prepayment relates is not more than 12 months and ends before the end of the following income year. Businesses should review which expenses can be prepaid and whether they have adequate cash flow to take advantage of this strategy.
11. Lastly, the FBT rules for employer sponsored cars have changed. Throw out old rules as new method is a game changer and will require employers to reassess the way cars should be packaged going forward. As there are a number of variables involved (such as cost of the car and more) an individual analysis will be required.
As a general rule taxpayers should consult with their IPA accountant prior to year end to discuss the best possible tax deferral strategies for your business situation.
-Tony Greco is senior tax adviser with the Institute of Public Accountants.