Long Term Tax Planning
This is an article about tax planning – long term tax planning. Most of you will be reading this article in July or August. The most recent tax year – the year ending 30 June 2012 – is not long past. In all probability you and your accountant would have discussed, and you would have taken before 30 June, steps to minimise or reduce your taxable income.
You may be wondering then about the relevance of an article on tax planning at this time of the year. It is very relevant because;
• Tax planning is something that should be considered all year round, not only in June each year; and
• Long term tax planning is far more effective, and will save far more tax, than will short term year-end tax planning measures.
Here are a number of long term tax planning measures that you should consider.
Maximise Business Profits
Minimising taxation and maximising profits may seem contradictory, and in truth it is, because the more profits you make the more tax you will pay. But when you think about it, the real purpose of tax planning and tax minimisation is to leave you with more after tax dollars. Maximising profits will do just this, irrespective of the tax you pay.
Other than in very unusual circumstances, the maximum amount that the tax man ever takes is 47.5 per cent (i.e. the maximum marginal tax rate for individuals including levies). That leaves you with 52.5 per cent. This means that for every extra dollar profit a business makes, it is left, at worst, with 52.5 cents.
Far too often I see business owners concentrating on saving tax rather than on maximising profit. The starting point should
be to maximise profit and then to work out how to minimise tax on those profits. The starting point should not be how to minimise tax.
Often I find business owners will consider spending a dollar on an unnecessary expense to save tax. It follows from the example above that, even with the tax saving, a business owner is worse off if the money has been unnecessarily spent. Tax of 47.5 cents might have been saved, but the business owner also does not have the 52.5 cents, after tax, to re-invest in the business.
Business owners should focus on maximising profits, not minimising tax.
Business Structuring – Capital Gains Tax
There may not at first sight be a clear link between choosing a business structure and tax planning, but there is. In choosing
a business structure, factors such as risk minimisation, asset protection and flexibility must all be considered, but so too,
importantly, must tax minimisation.
Consider Tax on Capital Gains
Concessions relating to the taxation of capital gains on the sale of a business are extremely generous in Australia. With the
correct structure, and by taking advantage of appropriate concessions, most small business owners can end up paying no tax on the capital gain they make. It is also possible to pay tax at 30 per cent or more on the gain on sale of a business. Much depends on having the appropriate business structure.
A business owner should therefore choose an appropriate business structure before the business is commenced in conjunction with an accountant.
Sometimes I find that a structure is not appropriate, sometimes because the law or circumstances have changed, and sometimes because a wrong structure was chosen in the first place. If there are good reasons to change the structure (including tax minimisation reasons), it is usually desirable to do so. This will often mean incurring costs, including tax costs (in many instances, a restructure will be treated by the tax office as a taxable transaction even though the business owner may regard it as an internal re-organisation). However, these costs of restructure are often small in relation to the saving that will be achieved when the business is ultimately sold to a third party.
Business owners should periodically review their business structure and consider changing the structure if it is not effective.
Business Structuring – Income Tax Minimisation
The amount of income tax that is paid by a business owner and related family members on profits each year may also depend greatly on the business structure. Just as it is sometimes necessary to amend a business structure to minimise capital gains tax, so is it sometimes necessary to amend a business structure to minimise income tax.
For example, a trust structure may enable distributions of income to beneficiaries at low marginal rates of tax, whereas a
company structure usually means tax of at least 30 per cent.
Conversely, use of a company can help to limit the tax rate to 30 per cent when income distributed to trust beneficiaries might be taxed at rates in excess of 30 per cent and up to 47.5 per cent if those beneficiaries have high marginal rates of tax.
Very often a combination of a company and a trust, or a combination of some other entities, produces the best income tax result. There is no one business structure that suits all businesses.
The moral of this story is, again, to choose the right business structure, and to change it if it is not right.
Despite recent changes announced to superannuation in the 2012 budget, superannuation still attracts very favourable tax concessions.
For many businesses, consideration of superannuation strategies therefore forms a major part of the year-end tax planning
strategies, and so it should.
However, it is important that longer term superannuation strategies are considered.
• Tax payers can contribute as much as $25,000 per year in concessional (tax deductible) contributions to superannuation.
If regular amounts are not contributed to superannuation each month, not uncommonly I find that at the end of the financial year, business owners do not have the cash flow to make a once-off contribution of $25,000. However, many business owners will somehow find the cash if they make monthly superannuation contributions of just over $2,000.
• The nature of contributions needs to be carefully considered. For example, if a taxpayer derives more than 10 per cent of their income from employment that is subject to superannuation guarantee contributions, then that person cannot make personal tax deductible contributions. For those taxpayers, any contributions above the nine per cent superannuation guarantee contributions must be made by salary sacrifice through their employer.
Without proper long term planning, many people get to the end of the tax year, wish to maximise their contributions, but find
themselves unable to do so as it is then too late to salary sacrifice through their employer.
Appropriate superannuation strategies should be set at the beginning of the year, not just considered when June comes round each year.
Many business structures involve the use of discretionary (family) trusts. There has been much publicity recently about family
trusts, much of it adverse. Trusts are still very effective vehicles for tax and business purposes. The ATO, however, wants to
ensure that they are not used to unfairly avoid tax and that relevant legislation is complied with.
As a result of some recent court cases, and recently enacted legislation, it is critical that every existing trust deed is reviewed, and, if necessary, amended to take into account this legislation and the decisions in the court cases. The importance of this cannot be overstated. Failure to ensure that trust deeds and trust distribution minutes are appropriately worded could result in all or some of trust income attracting tax at over 46 per cent. No short term, year-end, tax planning is going to help much if all income is to be taxed at that rate!
Any business owner who has not recently reviewed their trust deed should do so now.
Tim is a director of Lanyon Partners Chartered Accountants and heads up their franchising division. Tim provides tax, business and strategic advice to many franchise and non-franchise businesses.
Lanyon Partners has three divisions – accounting/tax, financial planning and insurance broking. Its emphasis is on developing strong relations with clients and clearly understanding their needs and goals.
Contact Tim at:
Phone: 03 9861 6140