Year End Tax Planning Strategies For Business Owners

Year end tax planning is the use of legitimate strategies to accelerate deductions and to defer the recognition of income. Where the business owner has elected to adopt the “Simplified Tax System” (STS), there are a different set of rules applying to some of these strategies.

The most common tax planning strategies that business owners should consider prior to 30 June 2007 include:

Simplified Tax System

The Simplified Tax System (STS) is designed to minimise the compliance burden on small businesses by applying either “cash” or “accrual” accounting rules for income and deductions as well as simpler rules in recording trading stock and depreciation.

For the 2006/07 year, a small business with a three year average turnover of $1M or less GST exclusive and depreciating assets (other than land & buildings) with a written down value of less than $3M can elect to use the STS. From 1 July 2007, the turnover test increases to $2M GST exclusive and the $3M depreciable asset limit will be removed altogether.

Businesses entering the STS this financial year have a choice to record income on either a “cash” or “non-cash” basis depending on which method is the most appropriate to their particular circumstances. These businesses can also claim a deduction for certain expenses that have been “incurred” but not paid by 30 June 2007 (see below) even though they are required to account for income on a cash basis. This provides business owners with a further incentive to enter the STS this financial year.

Small businesses that entered the STS prior to 1 July 2005 year can choose to opt out of the cash accounting rules from the 2007 year (this does not involve leaving the STS). If an STS small business chooses to opt out they can never re-apply the cash accounting rules. There are 2 possible outcomes from opting out:

• The business will continue to record income on a cash basis (because it is the most appropriate method) and will now be able to claim deductions on an incurred basis; or
• The business will commence to record income on an accruals basis (because it is the most appropriate method) and will now be able to claim deductions on an incurred basis.

Deferring Income

• STS and non STS small businesses that return income on a cash basis are assessed on income as it is received. A simple end of year tax planning strategy is to delay “receipt” of the income until after 30 June 2007.
• STS and non STS small businesses that return income on a non-cash basis are generally assessed on income as it is derived or invoiced. Income may be deferred in some circumstances by delaying the “issuing of invoices” until after 30 June 2007.
• Realising a capital gain after 30 June 2007 will defer tax on the gain by 12 months and can also be an effective strategy to access the 50% general discount which requires the asset to be held for at least 12 months. The date of the contract is the realisation date for capital gains tax purposes.

Maximising Depreciation Claims

• Non STS small businesses can claim an immediate deduction for assets costing less than $100 GST inclusive (e.g. minor tools). An STS small business can claim an immediate deduction for assets costing less than $1,000 GST exclusive.
• Non STS small businesses can scrap or sell depreciable assets for less than their written down value to realise a tax deduction loss. This does not apply to STS small businesses as they are subject to pooling arrangements for assets costing $1,000 or more GST exclusive.
• Where an STS small business purchases assets costing $1,000 or more GST exclusive, they are included in an asset pool. A full depreciation deduction of 15% (30% thereafter) can be claimed for 2007 regardless of when the assets were acquired during the income year.
• Non STS small businesses can allocate assets costing less than $1,000 GST exclusive to a “low value pool” and claim depreciation of 18.75% for 2007 (37.5% thereafter) regardless of when the assets were acquired during the income year.

Claiming Deductions for Expenses Not Paid At Year End

• Small businesses that entered the STS prior to 1 July 2005 and who have not opted out of the cash accounting rules, can only claim a deduction for expenses when they are paid. Therefore to claim an immediate deduction the business should pay for the expenses by 30 June 2007
• Non STS small businesses and small businesses that entered the STS from 1 July 2005 (including those who have opted out of the cash accounting rules) are entitled to an immediate deduction for certain expenses that have been “incurred” but not been paid by 30 June 2007 including:
  • Salary and Wages. A tax deduction can be claimed for the number of days that employees have worked but have not been paid until after 30 June 2007.
  • Directors Fees. A company can claim a tax deduction for directors fees it is “definitely committed” to at 30 June 2007 and has passed an appropriate resolution to approve the payment. The director is not required to include the fees in their taxation return until the 2008 year when the amount is actually received.
  • Staff Bonuses and Commissions. Like directors fees a company can claim a tax deduction for staff bonuses and commissions that are owed and unpaid at 30 June 2007 where it is “definitely committed” to the expense.
  • Repairs and Maintenance. A deduction can be claimed for repairs undertaken and billed by 30 June 2007 but not paid until the new income year.

Writing Off Bad Debts

Where both STS and non STS small businesses account for income on a non-cash basis and have previously included the amount in assessable income, a deduction for a bad debt can be claimed in 2006/07 so long as the debt is declared bad by 30 June 2007.

The business will need to show that it has made a genuine attempt to recover the debt by year end to prove that the debt is bad. Its important that this decision is made in writing (e.g. a board minute).

Note the business can claim back the GST paid on debts that have been written off as bad.

Prepayment of Expenses

• STS small businesses can claim an immediate and without limit deduction for prepayments that extend into the 2008 income year provided that the eligible service period does not exceed 12 months and ends no later than 30 June 2008. Subject to cash flow requirements, the most common expenses that an STS small business should consider prepaying by 30 June 2007 include lease payments, rent, business travel, insurances, business subscriptions, etc. Note that an immediate deduction for prepayments is not allowed simply where the STS small business makes a voluntary payment and there is no option or requirement under the contract for the payment to be made.
• Non STS small businesses may be able to claim a deduction for certain prepayments that are: 
  1. less than $1,000 GST exclusive; or
  2. incurred under a law of the Commonwealth, State, or Territory. Common examples are motor vehicle registration and compulsory third party insurance and Workcover premiums and statutory licences. Note the ATO require not only for there to be a legal requirement to pay the expenditure in advance, but also that the expenditure is required to be paid in advance; or
  3. paid under a contract of service (e.g. prepayments of salary and wages, bonuses and commissions).

Superannuation Contributions

 
• Both STS and non STS small businesses can claim a deduction for aged based limit superannuation contributions made on behalf of employees that have been paid by 30 June 2007. The aged based limits for 2006/07 are as follows:

• Where the small business owner operates as a sole trader or in partnership the deduction is limited to the first $5,000 of contributions plus 75% of the contributions in excess of $5,000 and the person's aged based limit. Therefore to obtain the above aged based deductions, the person needs to make the following contributions by 30 June 2007:

A number of changes have been made to the superannuation contribution rules that apply from 1 July 2007, including the abolition of the aged based deductible limits which are to be replaced by a $50,000 deduction limit for individuals. However under transitional rules, contributions of $100,000 can be made for individuals aged 50 or more up to 30 June 2012, upon which the $50,000 limit will apply.

There is also a one-off opportunity for individuals to make an “undeducted” superannuation contribution into their fund of up to $1M by 30 June 2007 which is in addition to the deductible aged based limits. From 1 July 2007, this amount will reduce to a maximum of $450,000 over a three year period.

2007 Small Business Budget Changes

The following changes were proposed in the recent Federal Budget to apply from 1 July 2007:

1. The turnover threshold for compulsory GST registration will be increased from $50,000 to $75,000 and from $100,000 to $150,000 for non profit bodies;
2. Businesses who are under the $75,000 registration threshold but choose to register for GST will have the option to remit GST on an annual basis instead of either on a monthly or quarterly basis. Also from 1 July 2008, these businesses will be able to able to meet their PAYG instalment obligations on an annual basis (instead of quarterly) subject to the existing eligibility tests;
3. An approved tax invoice will only be required for purchases that exceed $75 GST exclusive to claim a GST credit. The current threshold is 50; and
4. Businesses with an annual turnover of less than $2M that make mixed supplies or purchases (i.e. both taxable and non taxable) will have the option of using a simplified method to calculate their GST obligations.

Other Tax Issues

• Where a private company has advanced funds to a shareholder or an associate of the shareholder, there are rules that may deem such loans to be an unfranked dividend paid by the company unless certain rules are complied with. It is important that a proper loan agreement has been executed within the appropriate times frame and that minimum repayments of principal and interest are made in the relevant income year.
• Where individuals incur losses from business activities, the non-commercial loss rules should be considered as such losses may not be eligible for offset against other assessable income during the year.
• Business owners should review their operating structure to ensure that it is still appropriate taking into account issues such as asset protection, changes in marginal tax rates, capital gains tax discount (CGT) and the recent changes to the small business CGT concessions.

About The Aurthor

Joe Kaleb is a Chartered Accountant and CEO of www.australianbiz.com.au, a website that provides up-to-date tax information, management tools and other services to assist business owners to better manage their business and income tax obligations.

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