Tax strategies for SMEs
Financial planners and accountants are no doubt starting to advise their small to medium-sized enterprise (SME) clients on ways to minimise their tax liabilities now and in the future.
However, especially in the current economic climate, they should also consider issues and strategies suitable to their own business and personal circumstances.
Below are five key tax issues particularly relevant to SMEs.
Small business entity rules
From the 2008 tax year, changes were made to the small business entity (SBE) rules allowing businesses with a turnover of $2 million or less to take advantage of a number of concessions. This has been the most significant change in the SME sector in recent years and has made it considerably easier for small businesses to access certain tax concessions that previously they did not qualify for.
These rules replaced the old simplified tax system and mean a business owner no longer has to nominate in advance that the business will operate as an SBE but can choose at any time to apply the rules to the current tax year. As long as the business meets the criteria, it can automatically access a number of benefits, including:
- 100 per cent tax deduction for assets with a value of less than $1000,
- 30 per cent depreciation for a whole year on assets over $1000, with an effective life of less than 25 years,
- immediate deduction for prepayments, subject to the service period not being greater than 12 months,
- no stocktake if value of trading stock is less than $5000 at year end, and
- accounting for goods and services tax on a cash basis.
It is not compulsory to apply all of these concessions, so business owners can pick and choose the concessions best suited to their circumstances.
Also, under the federal government's economic stimulus package, all businesses are eligible for a 30 per cent tax deduction on assets costing at least $10,000 and purchased between 13 December 2008 and 30 June 2009. This also applies to an improvement to an existing asset. For a small business entity, the limit drops to $1000.
Non-commercial loss rules
An individual or partnership carrying on a small business separately to their main income may be able to claim a business loss against other income if they satisfy one of the tests in the non-commercial loss rules. A common example is professionals on high salaries who are 'weekend farmers' and wish to claim farm losses in the business against their salary. The non-commercial loss rules were introduced to restrict the ability of individuals to claim business losses from what are really hobbies.
The relevant tests that must be satisfied include:
- gross revenue of at least $20,000 for the year,
- a history of profits in three of the past five years,
- real property used in the business with a value of at least $500,000, or
- other assets such as plant and equipment and trading stock held on a continuing basis during the year with a total value of at least $100,000.
If none of these tests are passed, the business loss cannot be claimed in the current year, but is deferred and may be offset against profits from that business in future years. The deferred losses may also become fully available if one of the tests is satisfied in a future year.
If the business being carried on is share trading (which would need to be substantiated), the non-commercial loss rules must be satisfied before the share trading loss can be claimed as deductible.
Unrecoverable business loans and debts
A capital loss can be claimed for the amount owing on an unrecoverable business loan, as long as it is not a trade debt (see below). The capital loss would arise at the time the debtor is officially released from their obligation, typically by executing a deed of release or similar document.
Before forgiving debts, especially those owed by related entities or individuals, any implications that may arise for the debtor under the commercial debt forgiveness rules in the tax legislation must be considered. Any potential implications for individuals or trusts under the deemed dividend rules in Division 7A must also be taken into account.
With unrecoverable trade debts, a deduction can be claimed as long as:
- the amount has previously been included in taxable income,
- it can be shown that all reasonable steps have been taken to obtain payment of the debt, that is, it is genuinely considered unrecoverable,
- the debt is written off as bad in the financial records of the business during the year of income. Raising a doubtful debt provision, or later posting a journal entry, is not sufficient - the debt should be physically written off prior to year end, and
- the statutory tests relating to either continuity of ownership or continuity of business (see below) are satisfied.
Collection activity for the debt need not (and often does not) stop and if any amounts are later recovered from the debtor, they are simply included as assessable income at the time of recovery.
The statutory tests mentioned above mean any company seeking to claim tax losses or bad debts must satisfy either the continuity of ownership test (COT) or the same business test (SBT).
The COT specifies that the company must show its underlying ownership (that is, tracing through interposed companies and other entities) has not changed by 50 per cent or more since the tax losses were incurred. Special rules exist to make the COT easier to apply and to satisfy for widely-held companies.
Alternatively, tax losses or bad debt deductions may still be available if the company can satisfy the SBT. This can be very subjective, but requires the company to show that the business is essentially the same before and after the change in ownership, and that it has not earned income from new types of transactions since the change in ownership.
Business structure
Those who invest through a family trust, or run a small business through a trust, generally have the opportunity to allocate income to other family members to help manage tax.
Another issue to consider when setting up or reviewing the business structure is which entities have or are likely to make tax losses, as the losses are generally trapped in the relevant entity.
Where there is a group of wholly-owned companies, some of which are profitable and some of which are loss making, it may be worth considering forming a tax consolidated group. The tax consolidation rules are quite complex and careful planning is required before making the decision to consolidate.
Small business CGT concessions
The small business capital gains tax (CGT) concessions offer significant opportunities for restructuring, with little or no immediate tax cost, including transferring assets between related entities, facilitating succession planning by transferring ownership of business entities or business assets (including real property) to the next generation of family members, and unlocking equity in business assets by borrowing to fund an asset transfer.
There are a number of conditions that must be satisfied when applying the concessions and it is important to ensure all the relevant conditions have been satisfied.
Also, while the CGT may be minimised or eliminated using these conditions, restructuring in these circumstances often involves a stamp duty cost that should be considered.
