End-of-year tax tips

With the end of the financial year fast approaching, our tax expert TERRY HAYES has six tips to help businesses minimise their tax bill.

By Terry Hayes

With the end of the financial year fast approaching, here are six tips to help businesses minimise the tax bill.

The 2008-09 federal budget has now come and gone. But 30 June awaits and it’s time to consider a little year-end tax planning for small and medium sized businesses. 

We all know about the tax cuts that will apply from 1 July 2008. For example, the upper threshold for the 15% tax rate will increase to $34,000 and the upper threshold for the 30% rate will increase to $80,000. The 40% tax rate will apply to taxable income between $80,001 and $180,000. These changes have an impact on tax planning.

Remember that business income is generally assessable in the year in which it is derived. Income from property such as interest, rental income and dividends, is deemed to be derived when it is received.

Here are a few tax planning tips to consider.

Defer income and bring forward expenses

Conventional wisdom says that when tax rates are reduced (as will apply from 1 July), income should be deferred until after the rate reduces, so as to ensure it is taxed at the new lower rate, and expenses should be brought forward, so they are tax deductible at the existing higher rate – which is to say, they are worth more before the tax rate reduces. But bear in mind that there are tax rules that govern such deferrals or bring-forward.

If the taxpayer reports on a cash (or receipts) basis, amounts are assessable when they are received. If the accruals (or earnings) basis is used, amounts receivable are recognised as income – income may not be assessable in a financial year if the legal obligation to receive it occurs in the next financial year.

In tax ruling TR 98/1, the Commissioner of Taxation states that the cash basis is likely to be appropriate for business income “derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services” – for example, a sole practitioner.

However the situation may be different where:

• The taxpayer’s income-producing activities involve the sale of trading stock.
• The outgoings incurred by the taxpayer, in the day-to-day conduct of the business, have a direct relationship to income derived.
• The taxpayer relies on circulating capital or consumables to produce income.
• The taxpayer relies on staff or equipment to produce income.

The Commissioner considers that if any of the above factors is present “to a significant degree”, the accruals method may be the most appropriate basis of reporting income.

Prepay expenses

Prepayment of expenses by an SME can provide an immediate tax deduction, thereby maximising the deduction if tax rates are to be lowered. Generally, prepayments of deductible expenses less than $1000 each can be claimed as tax deductions in the year the prepayment is made. However, beware that the tax office will look closely where two or more such prepayments are made, and may apply anti-avoidance rules.

Where the prepaid expenditure is in respect of a period of more than 12 months, the deduction will need to be apportioned. For example, a prepayment of interest on a loan will be deductible over the period to which the interest relates.

Trading stock

The 1 July tax cuts mean that reducing assessable income for the year ending 30 June 2008 will mean less income taxed at the higher rates. In that case, a perennial year-end tax planning point that would become even more important concerns the valuation of trading stock.

If the value of closing trading stock on hand at the end of the year exceeds opening stock, the excess amount will be included in the assessable income of the business. Therefore, a reduction of closing stock on hand will reduce assessable income. There are several methods for valuing trading stock and SMEs should discuss with their accountant the method that best suits their circumstances.

Capital expenditure

Business-related capital expenditure is generally deductible under the tax law on a straight-line basis over five years. This can cover expenditure to establish a business structure, expenditure incurred to convert a business structure, or expenditure to raise initial and additional equity for a business.

SMEs that choose to apply certain capital allowance rules in the tax law (contained in Division 328 of the Income Tax Assessment Act 1997) are eligible for an outright deduction for the taxable purpose proportion of the adjustable value of a depreciating asset in the income year they first start to use the asset, or install it for a taxable purpose, if:

• The SME starts to hold the asset when it is a small business entity.
• The asset is a “low cost asset” – its cost is less than $1000.

It would be wise to seek advice from your accountant about this deduction.

Bad debts

All businesses have bad debts, so don’t forget to actually write them off in your books of account. A debt that is written off as “bad” in an income year is an allowable deduction under the tax law, provided:

• The amount owned was either previously brought to account as assessable income in the current or a former income year.
• There must be a debt in existence at the time of writing off.
• The debt must be bad.
• The debt must be written off as bad during the income year in which the deduction is claimed.

Talk to your accountant

These are just a few of the tax planning issues that SMEs should keep in mind. A quick call to your accountant or adviser might produce some very useful tax savings.

Of course, tax planning should not solely be a year-end activity, and it is always prudent to be continually thinking about ways to keep the tax expense at a legal minimum. And of course, tax planning of any nature should not ignore the possibility of the application of the anti-avoidance rules. Again, your accountant can advise you about this.

Read more on tax planning and tax tips.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.