This article appears in the May/June 2014 issue of Business Franchise Australia & New Zealand
Would you like to make sure you minimise the tax you pay on the profits of your franchise business?
Here are some tips.
Tip # 1
Companies pay tax at a flat rate of 30 per cent of profit. Individuals pay tax at differing rates depending on their level of income – for example, for incomes up to about $18,000 no tax is payable and for incomes above $180,000 tax of 46.5 per cent is payable (including medicare levy). Trusts do not usually pay tax as income is usually distributed to beneficiaries, but if they do pay tax it is at 46.5 per cent. Capital gains are taxed in individuals’ hands at rates between 0 per cent and 46.5 per cent, and in companies’ hands at 30 per cent.
Why, you might ask, am I giving you all this detail? The reason is that the tax you pay will depend to some extent on the business structure you set up in the first place – so your ability to minimise tax is partly dependent on your business structure, and partly dependent on how you utilise your business structure.
When you bought your franchise then you should have in conjunction with your accountant or lawyer carefully chosen the appropriate business structure. If you are about to buy a franchise you should carefully choose the appropriate structure. A number of factors need to be taken into account in choosing a structure – including flexibility, simplicity, costs and asset protection – but often the major factor is the tax and capital gains tax that will be paid.
In some cases, if your business structure is not appropriate (because of poor advice, because of not seeking advice, or because tax laws may have changed) it may be possible and financially worthwhile to change that structure. There will usually be costs to be incurred if you change your existing structure – including possibly tax, legal, accounting and other fees – but the benefits may outweigh the costs.
Assuming you have the correct structure, it is still necessary to work out how to best utilise that structure each year to minimise income tax.
For example, if you have a company running your franchise business, then the company will pay tax on profits at the rate of 30 per cent. As I have already indicated, individuals pay no tax at lower levels of income, so you would want to make sure that you pay yourself a salary up to the tax-free limit. Then consider whether the company should pay tax on the balance of the profits.
Another example is when a discretionary trust is involved. Discretionary trusts are able to distribute different amounts of income to beneficiaries each year and this may well require some detailed planning to work out what income each beneficiary can receive at favourable tax rates. And if you fail to validly distribute the income to beneficiaries prior to the end of each tax year, you may find yourself in a situation where the trust that owns your franchise business pays tax on all of the income at 46.5 per cent – a highly undesirable outcome.
You need therefore to ensure that your business is structured correctly to minimise tax, and then to ensure that the appropriate decisions are made to ensure that tax within the structure is minimised.
Tip # 2
Appropriate use of superannuation concessions and contributions is an important part of many taxpayers’ tax planning strategy.
Superannuation guarantee contributions must be paid by employers for every employee to whom they pay salaries and wages. However, compulsory superannuation guarantee contributions will for most people be far less than the maximum contributions they are allowed to make. The maximum amount that most individuals are allowed to contribute to superannuation this year is $25,000, and for many people over the age of 59 is $35,000. Superannuation contributions are taxed at the rate of 15 per cent. If you are earning more than $37,000 a year but less than $80,000, you are paying a tax rate of 34c on every dollar that you earn and you are keeping 66c. For every additional dollar you contribute to superannuation, the superannuation fund will pay 15c in tax leaving you with 85c. I am sure you would rather keep the extra 19c. There are always some ‘ifs and buts’ to superannuation contributions.
• Your superannuation may not be able to be accessed until you reach the age of 65 (depending on circumstances some may be able to be accessed from the age of 55).
• You have to be able to afford to put the extra money into superannuation.
• If you are an employee, you have to be careful as to how the money goes into superannuation. For most employees, to get a deduction their contributions will need to be made through salary sacrificing, and this needs the co-operation of their employers.
Superannuation generally, and maximising the deductions and benefits of superannuation, is complex. You will need to seek professional advice from a qualified person. However, it is an area that should be carefully examined because significant tax savings can be made, and those savings become more attractive the closer you get to retirement age.
Tip # 3
In some cases there may be the opportunity to bring forward your tax deductions by ensuring you incur expenses before 30 June (the end of the tax year) rather than after 30 June.
Please do not interpret this tip as meaning that you should spend a dollar that you would not otherwise have spent. To do so will never make sense, because even if you are paying the maximum marginal rate of 46.5c, then after tax you are still left with 53.5c. So spending money unnecessarily will leave you out of pocket, no matter what the tax deduction.
What I am suggesting here is that you should bring forward expenditure that would otherwise be incurred later. Do you have repairs to equipment or vehicles that need to be done? Then do them in June and not in July. Do you need to purchase consumables or pay membership fees? If you do, think of doing this in June and not in July.
For some businesses, making pre-payments of items such as interest on loans or insurance may result in tax benefits, in that the full amount of the payment may be able to be deducted when you pay it, notwithstanding that much of the expenditure relates to the following period. However, there are different rules for different size businesses, so it is important that you seek professional advice from your accountant before making any prepayment, if you hope to gain a tax advantage from the prepayment.
Tip # 4
Make sure you maximise your deductions for motor vehicle expenses. This may seem obvious – who would not want to maximise their deductions? – but many taxpayers fail to keep adequate records and as a result do not maximise their deductions (or find themselves in trouble and not able to claim expenses when an audit is done by the Tax Office).
For most people, a claim for motor vehicle expenses will be maximised if the deduction is based on logbook records. To be entitled to claim a deduction, a valid logbook must be kept. It may be that in practice the business use of your vehicle is 100 per cent, but in the absence of a valid logbook the maximum claim you will be able to make is 1/3 of the expenses incurred. I find that many, many people do not keep valid logbooks that comply with ATO requirements (even though they have kept logbooks of some sort) and do not prepare a new logbook when required to do so by law. If you are not already aware of the requirements for a logbook to be valid, you should make yourself aware of those requirements and if necessary prepare a new, valid, logbook.
There are ways of claiming motor vehicle expenses other than using the logbook method, including methods based on a statutory formula and the cost of the car. As a taxpayer you are entitled to choose the method that gives you the maximum deduction. However, you will not be able to claim the maximum deduction unless you have maintained the necessary records.
Another commonly used method of claiming motor vehicle expenses is to claim based on the number of business kilometres travelled during the year (up to a maximum claim of 5,000 kilometres). This method does not require the keeping of a valid logbook, but it does require the keeping of adequate records to prove that you have travelled the business kilometres claimed for.
Tip # 5
To be able to claim a tax deduction for expenses, you should keep adequate records of all business expenditure and ensure that in general you comply with record-keeping requirements. There are a number of points to consider here.
• As a general rule, if you cannot produce a valid invoice for an expense you have incurred, then you will not be able to claim an income tax deduction for it.
• If you are registered for GST, and you intend to claim back the GST paid on that invoice, then you need to have a valid tax invoice.
• If you are paying amounts to employees or contractors, then you need to ensure you keep adequate records.
• If you are paying salaries and wages, then you need to ensure that employees complete Tax File Number Declarations so that you can deduct the correct tax (PAYG). If an employee does not give you a tax file number then you must deduct tax at the maximum marginal rate and if you do not then the ATO will not view that transgression lightly – you might end up paying the money out of your own pocket.
• If you are paying a person as a contractor, then that contractor must have supplied you with a valid Australian Business Number. If a contractor does not, then once again you are obliged to deduct tax at the maximum marginal rate and pay that over to the Australian Taxation Office.
• Do ensure that you keep adequate records of all business expenses that you incur using your personal funds or personal bank accounts. Expenditure incurred for business purposes is deductible no matter whether the expenditure is paid by the business entity or by a person on behalf of the entity. However valid records need to be kept. I find many instances when business owners have paid expenses out of their own pocket but have not kept adequate records and therefore do not or cannot claim the amount as a business expense.
We all want to pay as little tax as we legitimately can. A little planning and a little forethought can go a long way to ensuring that money ends up in your pocket rather than in the pocket of the Australian Government.
Tim is a director of Lanyon Partners Chartered Accountants and heads up their franchising division.
Tim has provided advice to, and acted for, many franchisees and franchisors, and is particularly active in advising on the purchase and set up of businesses.
Contact Tim at
Phone 03 9861 6140