Business Tax Planning

Business Tax Planning

Good tax planning needs to make financial sense, be consistent with overall business objectives and not run foul of either specific or general anti-avoidance provisions of the tax legislation.

To be really effective, tax planning should be an ongoing process, starting preferably at the beginning rather than end of a financial year, and focusing on both tax strategies and legal structures.

The Right Foundations

Tax planning should initially concentrate on your business structure – operating as a sole trader, partnership, trust or company are the main options. All produce different tax results. The choice of structure will depend on a number of factors, particularly the characteristics and size of the business, however, tax implications will also play an important role in the decision.

It may be cheap and simple to set up a business and run it as a sole proprietor, but the profits will be taxed at the proprietor’s personal rate, which may be much higher than the prevailing company tax (currently 30%). However, if the income being derived is personal service income (PSI), it may not be possible to access the company rate due to potential restrictions on retention of PSI in the company. Similar restrictions may also apply to the use of a company or other entity to split PSI with, say, other family members.

In the long term, however, the main disadvantages of operating as a sole trader relate to the inability to split business or investment income with other family members and the lack of opportunities for appropriate retirement and succession planning.

The Alternatives

You could set up a business as a partnership (e.g. with a spouse) to enable you to split the income and ease the tax burden, but personal tax rates could still be higher than the company rate. Partnerships also have other problems in that they lack flexibility and do not provide limited liability.

A trust might be a suitable vehicle in certain circumstances, such as, where the business is likely to produce high profits from low overheads (this is because trust beneficiaries cannot claim deductions for any tax losses incurred by the trust). The trustee of a discretionary trust can distribute income to nominated beneficiaries and is able, therefore, to reduce the tax burden by spreading it among family members.

Then there is the option of a company. Profits are taxed at only 30% but this is a flat rate and thus the usual benefits associated with the tax-free threshold and the lower marginal tax rates are foregone. It is essential, therefore, that the advantages available from dividend imputation can be fully utilised and that superannuation deductions for owner-employees are maximised. Losses incurred by a company may be less flexible than a trust and more costly to set up and administer.

In practice, it appears that an appropriate combination of company and trust structures may be the best way to maximize both tax and non-tax advantages. In making your final decision, you should consider the nature of the business and any pending tax changes.

Tax Strategies

Effective planning needs to deal with a range of taxes including income tax, GST and FBT.

More traditional planning activities will also remain relevant and can involve deferring income to ‘manage’ the tax burden: -

  • Deferring the realisation of assets that will produce a taxable profit.

  • Investing funds so that the interest is not derived until after year end.

  • Deferring the raising of accounts for interim fees for incomplete work.

If cash flow is healthy, planning may involve bringing forward deductions to the current year: -

  • Pre-paying for services such as insurance, rent and advertising, subject to meeting the 13 month rule.

  • Identifying bad debts that can be written off.

  • Selling assets that may have decreased in value to derive capital losses to offset against any capital gains.

Your Tax Planning Checklist

  • Do you have a business plan that can determine the most appropriate structure for your business or proposed business?

  • Is your present business structure working effectively?

  • Are you investing your surplus cash tax effectively?

  • Are your records of acquisition and disposal of taxable assets up to date?

  • Can you adequately substantiate all expenditure so that all possible deductions may be claimed?

  • Are you aware of the tax (including GST) implications involved in buying and selling a business?

We can help you set up an appropriate business structure and effective tax plan. Contact John Hong CPA today for a no obligation free consultation. Please click here now to arrange your free consultation.