The 2016 federal budget gave small businesses a reason to be excited about the end of the financial year – a company tax cut to 27.5% with the threshold lifted to include businesses with less than $10 million turnover (up from $2 million). For profitable small businesses, that’s potentially thousands of extra dollars each year to reinvest back in the business.
The budget measures, which come into effect on 1 July this year, mean business owners need to start planning what needs to change about their tax strategies. Here are a few tips on how to optimise your small business tax planning by timing your income and expenses, and ensuring you make the most of the new tax measures.
Balance your expenses
The first and second rules of business, as always, are maximise income and keep expenses to a minimum. At tax time however, the rules reverse – you want minimise income and maximise expenses in order to reduce your assessable income and the amount of tax you ultimately have to pay for that financial year.
Care is needed to make sure you don’t forgo potential income or needlessly buy things that you don’t really need. But by timing these right – like bringing forward expenses into the current tax year and deferring income into the following tax year – you can reach an optimal outcome for your business and be left with a bit extra to reinvest.
Move from cash accounting to accruals
While most small businesses start out using cash accounting methods – a simple method that counts income and expenses when they are physically paid – accrual accounting can give you greater control over your end of year financial position.
Instead of recognising money as it physically comes in or goes out, accrual accounting recognises a business’s income and expenses when an invoice is issued or a bill is received.
While useful for managing your finances, it creates some complexity by creating debtors and creditors, so it’s a good idea to use online accounting software like Xero, which makes it easy for you to keep track of your business’s cash flow and its true financial position.
Maximising the impact of your expenditure
Forecast what regular expenses you have coming up in your business. Are there bills that need paying, equipment you need to purchase, or fees like insurance, rent and membership costs you need to pay? If so, it’s probably worthwhile bringing those expenses forward to before 30 June instead of waiting for them to fall in July or later.
And for those small businesses with less than $2m turnover you could prepay certain expenses (like rent for the next 12 months) and claim an immediate deduction for the full amount.
If you’re on accrual accounting, that doesn’t mean you need to physically spend the money before 30 June to get the deduction; just that the invoice has been issued to you before that date. Talk to your suppliers about bringing the invoice date forward so it’s before the end of the tax year and, even if you don’t pay it straight away, you can still get a tax deduction for the expense.
This is also important when it comes to the asset deductions the government introduced over the last two federal budgets. If your business turnover is less than $2 million, you can immediately deduct purchases under $20,000, even if they were incurred before 1 July, and the new rules that will come into effect. However, businesses with turnover of between $2 million and $10 million will need to wait until after 1 July to make use of the new asset deduction measures if the legislation is passed.
It is also important to note that with the reduction in the tax rate to 27.5% recognising your expenses in this financial year will give you a permanent gain, not just a timing difference as the effect of the tax deduction will be greater in the 2016 financial year compared to the 2017 financial year and beyond.
Don’t forget though, that the whole point of this strategy is to maximise your business’s cash by increasing tax deductions. Don’t go overboard and bring too many expenses forward as there’s little point in buying supplies or equipment you won’t use for months. Use this technique for those expenses you know are coming up soon, where a slight adjustment would be of benefit.
Get clients to pay later
It seems to go against any reasonable business owners’ instinct – why would you get clients to pay invoices later than they otherwise would normally? But when it comes to tax, legally deferring that income until after the end of the financial year means you can declare a lower assessable income, and therefore pay a smaller tax bill.
When on a cash basis getting your clients to pay you after 30 June means that tax is payable in the following financial year. When finalising jobs at year end, under the accruals system, as soon as you finish a job you become entitled to that income so it is important to time this so that invoices can legally be issued post 30 June 2016 which assist with minimising your revenue this year.
However, don’t delay too many invoices, or for too long, just for the sake of saving a few thousand dollars.
The same logic applies to asset sales, such as any property or goodwill you have. Any capital gains your business makes will be taxable, so think about deferring sales until the new tax year where legally possible.
Conversely, if you’re likely to make a loss on an asset sale, bringing forward the sale to the current tax year will let you offset that capital loss against other capital gains you may have made during the financial year, bringing down your tax obligations further. There are also tax concessions available to small business for the sale of some assets, so check with your accountant before you offload anything.
Don’t wait to plan your tax
It can be tempting to not think about your tax obligations unless you absolutely must. But once it hits 1 July, any chance you had of reducing your tax bill is lost, so it’s best to start planning now. By laying the groundwork now, you could benefit from some useful tax savings down the track and have more cash to spend on growing your business in the future.
James Solomons is Head of Accounting at cloud accounting provider Xero Australia