As a business owner, managing your finances effectively is crucial for long-term success and one aspect of that is to legally minimise and/or defer your tax liabilities. One way to do that is to look at the timing of your income and expenses for tax efficiency. By deferring income and accelerating expenses, you can potentially reduce your taxable income and therefore tax for the current financial year. It’s essential to understand the rules and regulations surrounding these strategies as well as the impact on your cashflow so consult with a tax professional or accountant, like us here at DFK Everalls, to ensure you’re maximising your benefits. We recently spoke about why you need a year end tax planning review, we now move onto the next stage, looking at profits. In this article we move onto the next part of that process. We’ll discuss the importance of timing income and expenses and what you can do with your profit to legally minimise your tax.
However, a warning before we go into the detail to be careful – Cash is King so watch your cash flow carefully. You need to understand that deferring income and bringing forward expenses may reduce your taxable income but has obvious impacts on your cashflow. It can also correspondingly reduce your profit for the year which might have other consequences such as making your Annual Financial Statements not as attractive to banks (for lending purposes) or to potential purchasers of your business in due course.
Understanding the Rules and Regulations
Strategically planning the timing of your income and expenses can significantly impact your business’s tax liabilities. Apart from the obvious business management issues of maintaining cash flow and profitability it’s important to be aware of the Tax Office rules and regulations surrounding income and expense timing.
- Cash basis businesses: For eligible small businesses taxed on a Cash Basis, where the factor is the date cash changes hands rather than the date on the invoice, this can be as simple as deferring receipt of customer payments or investment income until the new financial year so that it’s not taxable until then. Correspondingly, those Cash Basis business are eligible to claim a deduction in the year an expense is paid rather than the year the expense relates to. Therefore, prepaying expenses in June that relate to the new financial year (and not more than 12 months’ worth) can bring the tax savings from that expense forward to the current year when paid.
- Accruals basis businesses: For businesses taxed on an Accruals Basis, deferring income requires deferral of the customer invoicing to post 30 June. Correspondingly, accelerating deductions involves incurring expenses (getting an invoice or receipt) before year end instead of after. Again, be confident of your cashflow before proceeding and make sure your customers & clients are OK with you delaying your invoices as they would probably prefer your invoice on time so that they can claim!
- Type of business: Different size businesses (turnover) have different rules; and different industries may have specific requirements, for example Personal Services Income businesses like consultants;
- Prepayments: There are different rules for different size businesses but they are also limited to 12 months’ worth (ie any part that relates to beyond the end of the next financial year is not deductible till then).
- Plant & equipment: The deductions for purchasing equipment & cars are particularly tricky. Items are required to be installed and ready for use before they can be claimed. The Depreciation rules for the particular financial year with turnover caps, price limits and depreciation rates change from time to time for different size businesses.
- Trading stock: It is also important to note that there is no tax deduction for stock purchases until they are sold or written off (so don’t necessarily ‘stock up’ before 30 June); and
- Related employees: There are also rules about how much you can pay related employees ie market value.
Ensure you are fully compliant and get the right tax deductions for your expenses by consulting with a tax professional or accountant, such as our team at DFK Everalls.
Strategies for Timing Income and Expenses for Tax Efficiency
So, here are a few strategies to consider after taking into account the above issues:
- Defer income: Delay invoicing clients or receiving payments until the next financial year. This reduces your taxable income for the current year and correspondingly lower your tax liability.
- Accelerate expenses: Make purchases or payments before the end of the financial year to increase your deductible expenses, reducing your taxable income. This can include prepaying expenses, such as loan interest, rent, subscriptions, training or insurance; purchasing necessary equipment; or even simply stocking up on consumables such as stationery and staff amenities before the end of the year.
- Super payments/Top ups: Make additional superannuation contributions before the end of the financial year to lower your taxable income and take advantage of available tax deductions. We recommend that these payments be made before June 15th to ensure that they are processed in time for tax purposes.
- Director bonuses: Paying director bonuses before the end of the financial year can also reduce your taxable income.
What to Do with Your Profit
Once you’ve successfully timed your income and expenses, it’s time to decide what to do with your profit. Consider reinvesting in your business so you can expand your operations; or improving cash flow by using your profits to increase working capital, pay down debt, or increase your emergency fund. Also, make sure you consider rewarding your team members bonuses for value that they have added by going ‘above & beyond’.
Then, another strategy to consider to minimise your tax liabilities is to move it so that it is taxed by someone on a lower marginal tax rate but obviously there are strict restrictions on this too.
Examples of these strategies include:
- Super payments/Top ups: Topping up super contributions to the cap so only paying 15% tax (or 30% if your adjusted tax able income is more than $250,000pa). We recommend making these payments before June 15th to ensure timely processing for tax purposes.
- Director bonuses: Paying bonuses before year end for the directors/employees so that the profit is taxed at their marginal tax rate instead of the company rate of 25%;
- Fringe benefits: Consider paying exempt fringe benefits before the end of the financial year (laptops, phones) or at least ones that are concessionally taxed (company car expenses);
- Trust Distributions: What is the most appropriate but tax effective way to distribute the Trust’s profit between the beneficiaries this year? Remember this must be documented before June 30; and
- Dividends: Declaring dividends before or after 30 June; hopefully with franking credits that might even be refundable depending on the shareholders marginal tax rate for that year.
The timing of income and expenses and what you do with your profit each year is a vital aspect of managing your business finances and minimising tax liabilities. By understanding the rules and regulations and working with a tax professional or accountant, like us at DFK Everalls, you can ensure you’re taking full advantage of these strategies and maximise your after tax profit while still protecting the cash flow of your business. Now is the time to review and put into action your year end tax planning strategies.
To get started, talk to our team, today.