How ready will your business be if the taxman, with his audit tools, knocks on your door this year? Garry Addison outlines some of the crucial tax questions you should have answered by June 30.
Small business owners are looking for ways to legitimately reduce their tax burden. Australia's largest accounting body, CPA Australia, answers tax questions most commonly asked by small business at tax time.
Do I have to keep a record of absolutely everything?
You are generally required to keep tax records for at least five years, but special requirements apply in some areas such as capital gains tax (CGT), fringe benefits tax (FBT) and the substantiation rules. Your accountant will be able to advise you further. You should ensure that your records are both adequate and complete to face an audit review. Check that you have all the relevant documentation for your business, such as bank statements, deposit books, cheque butts, cashbooks or accounting records such as your general ledger, trial balance, profit and loss statement, and balance sheet for the full year.
It’s not sufficient to simply make an estimate of your trading stock. Each year, you need to include a value in your accounts of stock in hand and work in progress at June 30. Closing stock can be valued at cost, replacement or market value or less if obsolete, but you have to document which method you use.
What about private company loans?
To ensure that a tax liability is not triggered, it is important to ensure that private company loans to shareholders and/or associates that extend beyond the end of the income year are properly documented. Adequate annual repayments of a properly documented loan are also required.
Note though that the Government has recently announced some relaxation in these rules, which will be backdated to some extent to benefit taxpayers. In view of these latest developments and the general breadth and complexity of these rules, you should see your CPA for full details.
Are bad debts deductible?
To make sure you get the full deduction for bad debts, ensure they are physically written off before June 30. To do this, the debt must have been brought to account as assessable income and you must have given up all hope and, more importantly, all action for recovery. It is a good idea to have a recorded action, in the form of a minute, writing off the particular debt. Other trade debtors’ details should be recorded with name, amount owing, and nature of debt.
Will I be liable for Capital Gains Tax?
Capital Gains Tax (CGT) may apply to any gain made on the sale of certain assets (such as shares or property) purchased since September 19, 1985. Assets purchased after that date must be fully documented for CGT purposes. For capital losses, make sure you keep a record, so that they can be carried forward to offset against future capital gains. There are special CGT concessional rules that apply to certain small business capital gains and can save you a lot of money, including the 50 percent exemption for individuals and trusts, and the small business CGT rollover relief and retirement exemptions. These concessions have recently been enhanced, including the relaxation of eligibility requirements, and are available for the 2006–07 income year.
How much substantiation do I need to provide for travel and vehicle costs?
Substantiation rules may apply to motor vehicles and travel expenses, so logbooks and odometer readings should be kept, as well as other records itemising travel expenses.
The key principle underlying these rules is that the relevant expense claims must be supported by written evidence such as logbooks, travel diaries, etc. Records must be kept for at least five years from the date of the relevant transaction or until any dispute with the ATO is settled.
Why should I review my assets?
It’s too easy to carry assets on your books that have no real value, are obsolete or have been scrapped. The only way to get a write-off deduction is to review your asset register and take the necessary action before June 30. You should be keeping a list of all items bought, sold, and disposed of, during the year including equipment, furniture and fittings. Special advantageous depreciation rules apply to an eligible small business that elects to be taxed under the simplified tax system (STS) regime.
Should I elect to be taxed under the Simplified Tax System (STS)?
An optional STS regime is available for very small business taxpayers such as those with annual turnover of less than $1 million. Its key attractions are the immediate write-off for depreciating assets costing less than $1,000 and accelerated depreciation on other business assets. The regime is becoming more attractive, as reflected in its recent extension to businesses that do their accounting on an accruals basis and the proposed reduction in the audit review period for such taxpayers from four to two years. Further concessions (including a relaxation of the eligibility rules) were announced in the last Federal Budget but these will not apply until the 2007–08 income year.
If you are not already in the STS, you may wish to consider if you qualify. To obtain the STS benefits for 2006, the necessary election must be lodged with the ATO when you lodge the income tax return for your business for the year ended June 30, 2006.
Most business taxpayers must pro-rata the deduction for prepaid expenses over the period to which the expenditure relates. Restrictions also apply to prepayments by investors in certain agri-forestry investments. However, individual non-business and STS taxpayers can prepay some expenses up to 12 months in advance.
Does Fringe Benefits Tax apply to my business?
Fringe benefits tax may be applicable to entertainment expenses such as business lunches, tickets for sporting events, company motor vehicles, some directors’ loans or other benefits received by employees and directors. Details of all such benefits should be recorded.
The grossed-up value of most fringe benefits is also required on an employee's payment summary. It may also affect the employee's liability for Medicare levy and/or superannuation surcharge, as well as entitlement to the family tax benefit and health insurance rebates.
From April 1, 2006 the FBT rate has been reduced from 48.5 percent to 46.5 percent in line with the reduction in the top personal marginal tax rate.
Employers must ensure they have made sufficient superannuation contributions (currently 9 percent) for each of their employees, including casual staff, on a quarterly basis throughout the financial year. Otherwise, they risk incurring a penalty under the Superannuation Guarantee Charge (SGC) regime. Your CPA should review all superannuation payments made before year-end to ensure that adequate contributions have been made for all employees, based on all of their relevant wages and bonuses.
To be tax deductible and to avoid penalty, superannuation contributions for the upcoming June quarter must be paid by June 30, 2007. Book entries alone are not enough. Tax deductions are limited to contributions for employees based on age-based limits. Even if you miss the June 30 deadline for deductibility, you must make the payment by July 28, 2007 to avoid the SGC late payment penalty.
Self-employed business owners can make annual contributions on their own behalf, with a full deduction up to $5,000 and a deduction for 75 percent of the amount above this. The maximum deduction available is equal to the taxpayer's age-based limit.
Most of the Government’s proposed ‘simplified superannuation’ reforms will not apply until July 1, 2007 but, under transitional arrangements, people who are eligible to contribute to superannuation can make undeducted contributions up to $1 million before that date.
Personal Services Income (PSI)
The PSI measures are designed to limit the level of deductions available to certain contractors whether operating as a sole trader or through a company, trust or partnership, and to also extend the PAYG withholding rules in such cases. A taxpayer who meets certain specified tests, such as the ‘results’ test, will be treated as carrying on a personal services business and will be able claim a wider range of deductions. The ATO may still seek to limit the taxpayer’s ability to retain income in a company or split income between lower income beneficiaries.
An exemption from the rules applicable to certain related party at-call loans is available for small businesses with an annual turnover of less than $20 million. The exemption applies from July 1, 2005, which follows the end of the earlier transition period.
The main features of current arrangements in this area:
• immediate write-off for non-business assets costing $300 or less
• special arrangements for STS taxpayers (see above)
• immediate deduction for business expenditure of $100 or less
• pooling of assets costing less than $1,000
• note that write-off rates for most business assets are based on the ‘effective life’ of the particular asset as determined by the ATO (you may elect a different rate but would need to be able to justify this to the ATO if necessary), and
• improved write-off rates for depreciable assets apply to business assets acquired on or after May 10, 2006.
For a business to be commercial under these rules, it needs to meet certain prescribed tests. If the tests are not met, any losses arising from the activities will have to be carried forward and offset in a later year against future income from the same type of source.
Entrepreneurs’ tax offset
A 25 percent entrepreneurs’ tax discount is available for small businesses in the simplified tax system (STS) with an annual turnover of $50,000 or less. It is aimed particularly at new home-based businesses. Where annual turnover exceeds $50,000 but is less than $75,000, the offset will phase out for every $1 over $50,000.
Aggressive tax planning
Taxpayers should be more alert than ever to year-end tax schemes. There is now much more information in the market on this type of higher risk investment, such as the product ruling system, and taxpayer alerts which are early warning notices issued by the ATO. You should stick with products that have ATO product rulings, but note that these are not intended to be any guarantee of the profitability of the investment. Also, they may not be worth much if the investment venture is not aligned with the business plan as set out in the original prospectus. Check the ATO website for further details including the investment checklist at http://www.ato.gov.au/atp.
Is there anything I’ve forgotten?
A commonly overlooked item is interest earned on bank accounts, cash deposits and other sources, as well as a schedule of non-business deposits. All these should be declared, as must ‘other expenses’, such as cash payments, including the nature of the payment and how the funds were provided.
The mature age workers’ tax offset of up to $500 for those aged 55 or more is not just confined to wage and salary earners. It is also available to taxpayers with personal services income and taxpayers who carry on a business as a sole trader or in partnership and who also meet the other eligibility criteria.
There is no substitute for good business advice and planning. Your CPA can help with much more than filling in your tax return.
Garry Addison is senior tax counsel for CPA Australia.