“Year-end tax planning” – you hear it so many times that you’d think the two were synonymous. It is important, but the reality for business owners is that effective tax planning starts 1 July.
Tax planning is about being smart with how you arrange your tax affairs. It requires a thorough understanding of your business, your tax profile and your commercial objectives. For the best outcomes at tax-time, tax planning should be an ongoing exercise that you work on throughout the year, not just at year-end.
Here are some ideas to start your thinking.
Maximising the extent of your deductible debt is tax planning 101.
For business debt, it can sometimes be better to hold the debt at the shareholder level rather than in the entity that conducts the business and so the shareholder claims the interest deductions. This is particularly the case where the business may be generating losses, however it can also be effective where the shareholder has other sources of income and a marginal tax rate that is greater than the business entity. To claim the tax deduction, it is important to make sure the shareholder has a fixed interest in the business (like ordinary shares, units, etc) and is in a position to control distributions from the business entity.
Most business owners are familiar with the potential benefits of a discretionary trust where distributions can be allocated to the beneficiaries with the lowest marginal tax rates. This is one of the reasons why the most common structuring option for an SME business is a discretionary trust as shareholder of a private company.
Where the company has the ability to pay franked dividends, and the trust has losses or significant other deductions, an “overfranked” distribution can be created. This is a situation whereby the trust has a low amount of taxable income, but a large amount of franking credits. As the franking credits significantly exceed the tax payable by the beneficiaries, the beneficiaries can receive a refund of the excess credits. It is critical to review the trust deed and ensure the trust has positive income otherwise it may not be able to make a distribution at all.
There are a range of tax rates to be aware of. The company tax rate is now 25% for most SME businesses, and 30% for larger companies. Foreign dividends can be exempt for companies but are taxable to individuals. Individuals have a 4.5% marginal tax rate from $45,000 in taxable income, but it is not until around $180,000 that their effective (average) tax rate is greater than 30%. Only half of a discount capital gains is subject to tax, but only individuals and trusts can make discount capital gains. For an individual on the highest marginal tax rate, the top up tax on a fully franked dividend is roughly the same as the tax on the equivalent dollar value discount capital gain.
This highlights the importance of understanding the tax profile of all the entities in your group, and the tax profile of the different types of income or gains that will be made across your group. This informs decisions on the appropriate legal structure, and the most effective distribution strategies. If your legal structure is not allowing you to achieve a flexible and tax efficient approach to distributions it might to time to revisit your structure.
Incentives come in many shapes and forms.
The R&D Tax Incentive can be of significant benefit to SME businesses undertaking genuine research and development activities and provides a 43.5% refundable tax offset. Documentation is fundamental to both maximising your R&D claim and minimising the risk that the ATO will disallow it on review. Documentation is something you need to maintain as you undertake the R&D. It is not something you can just put in place at year end.
The “instant asset write-off” in its various forms is another, albeit temporary, tax incentive that can have a dramatic impact on your tax position. The trick with this concession is determining the eligibility criteria that apply at the particular time, as the incentive has been amended and extended numerous times.
It is important to think through the implications of accessing a tax incentive. For example, if you are using franked dividends to manage Division 7A loan repayments, a big instant asset write-off claim may mean insufficient franking credits to fully frank the necessary dividends and so a higher tax rate for the shareholder.
Selling your business is one of the more significant events in your life and in your tax planning. For SME business owners, the tax carrot is accessing the small business CGT concessions. In the best case, this can make a multi-million dollar capital gain tax free.
There is planning that needs to happen in the lead up to a potential sale, but there is also planning that needs to happen years before. Having private assets, investment assets or Division 7A loans in a company that you plan to sell, could mean you aren’t eligible for the small business CGT concessions. Flexibility in how a trust distributes income is great, but this also impacts on how the small business CGT concessions are applied. With careful planning of distributions, the benefit of the $500,000 retirement concessions can be doubled, without careful planning the concessions may be lost.
For SME business owners, effective tax planning is an ongoing exercise. The approach needs to be tailored for the particular circumstances of each group, but for those that put in the effort, some very tax effective results can be achieved.
For more information on the benefits of year-round tax planning and what else you might need to consider, contact your local William Buck tax advisor.