One of the biggest changes in mindset when setting up a new business is that you are responsible for your own income tax. If you have previously been an employee of another business, you have never had to worry about paying your tax through the year. It was done for you and you simply lodged your tax return at the end of the year and expected a modest refund.
This new responsibility for paying tax can be quite daunting when looking at your cashflow for a new business – how much to put aside, when to put it aside, when you need to pay it and how do you know how much to pay.
In this article, we are only going to consider Income Tax as it gets quite complex when also taking into account GST.
What happens if I don’t make a profit in my first year?
In most startups, it isn’t uncommon to make a loss in your first year of operation – this may be due to tax write-offs (especially with the current instant asset write off rules), or it may be a “real loss” due to having significant outlays in the initial phase of your business. Broadly speaking, there are rules that require that any losses incurred are carried forward to a later year in which you make a profit. For example, in your first operation you might make a loss of $10,000. This loss is “trapped” so to speak and can be used to offset your profit in a later year. If you went on to make a profit of $20,000 in the second year, you would only be taxed on $10,000 being the net of the profit less the loss in the prior period.
New laws recently introduced allow you to “carry back” losses to a prior year. For example, if you madee a profit in the first year and then make a loss in the second year, there are new provisions introduced due to COVID-19 that may mean that you can claim a tax offset in the subsequent year equal to the amount of the previous income tax liabilities. This legislation is not quite finalised at the writing of this article but if this is something that affects your business, please get in touch with your advisor to discuss further.
What happens if I do make a profit?
So, what happens if your new business is amazing and makes a profit – how do you pay the tax related to that profit? When do you need to pay it? There may be what you may have heard referred to as a “tax holiday” for those moving into a new business as there is no taxing consequence straight away. It can be delayed by nearly two years from the time in which you earn the income. If we use this financial year as an example, if you set up a business say on 1 July 2020, the financial year that you are operating in ends on 30 June 2021. The due date of your tax return for this period can be as far away as May 2022 if you go through a tax agent to lodge your return.
I have seen first-hand this delay and unexpected amount of tax catch a lot of clients off guard when we prepare their first business tax return and they haven’t considered the tax on their profits. The hard part of this uncertainty is also working out exactly how much money you should put aside for your tax in the future.
Giving away my tips of the trade here, when I am talking to clients in new ventures, or even in existing ventures, we generally would advise the clients to put aside about 30% of their profit for income tax. This rule of thumb amount works in most structures, regardless of whether you are operating in a company or even as a sole trader-
What potential complications do I need to keep in mind?
The other complication with income tax other than the tax due on lodgment of your tax return is the provisional tax payment system or PAYG Instalment System. Once you are in a tax paying position (and over a certain amount), the ATO requires that you pay your income tax in advance each quarter.
For example, if you have a tax payable on lodgment of your return of $500 or more (generally speaking), you would be required to enter the PAYG Instalment System. This requires that you pay approximately the same amount as what you paid for the prior year in advance towards the 2021 financial year in quarterly instalments. Where this can cause cashflow problem is in relation to the ‘tax holiday’ I mentioned above is that you might find a situation whereby you are paying tax for the 2020 financial year in May/June, and then tax for the 2021 financial year in July.
To better explain this concept, lets use some numbers – assuming that your profit is $40,000 in 2020, and $60,000 in 2021 and you are trading in a company.
|Date||2020 Financial Year||2021 Financial Year||2022 Financial Year|
|May 2021/June 2021||$11,000|
|May 2022/June 2022||$13,750|
The other item to consider, which this article will only briefly touch on, is the R&D Tax Incentive Scheme. This is, broadly speaking, a tax offset in relation to expenses incurred on Research & Development Activities. It is regulated by a government department called AusIndustry. It encourages investment by business into developing new products, services and ideas and is a great way to get “reimbursed” for this investment. It is a highly regulated area of the tax legislation however so if you believe this may apply to your business, please get in touch with us and we will review your individual circumstances.
The above concepts are a very brief overview of what the likely income tax payments may look like if you set up your own business – as mentioned above, if you need advice specific to the cashflow circumstances of your business, contact your local William Buck advisor.