The tax opportunities and pitfalls of running a small business – how to get it right

With the Great Resignation upon us and the number of small businesses in Australia growing fast, many brand new business owners may miss out on some great tax opportunities – or fall into some small business tax traps – without even knowing it, writes Mark Chapman, director of Tax Communications with H&R Block Australia.

The opportunities and implications of small business tax

Small business is the engine room of the Australian economy and with the numbers of small businesses growing rapidly – allied to the explosion of workers who have been affected by the COVID-19 downturn and have decided to go off and do their own thing – there are thousands of Aussies confronting the challenge of getting a business off the ground for the first time.

So, if you’re a budding entrepreneur, what do you need to know about the tax opportunities and pitfalls that starting a new business brings?

Here are four key areas all new business owners should focus on:

1. Save tax and get your business structure right

Choosing the right legal structure for your business is crucial. If you opt to operate as a sole trader, you’re taxed at your normal individual tax rates. The same generally applies if you run your business through a trust, though there may be opportunities to save tax by distributing profits to beneficiaries with lower incomes and lower tax rates.

You could also operate your business through a company. This is a separate legal entity to the people who run it, meaning that the company lodges its own tax return and pays tax on its profits at the company tax rate – currently 25 per cent (provided the company’s aggregate turnover is less than $50 million). The company can then distribute profits to shareholders in the form of franked dividends. These dividends are taxable to the shareholders, less a credit for the tax already paid by the company.

In some cases, companies don’t pay out profits to shareholders; they retain them, possibly for future investment in the business. In that sense, companies can be regarded as tax shelters since the rate of tax payable by the company (25 per cent) is significantly lower than the higher rates of personal taxation. That is only part of the story of course; ultimately the cash in the company needs to be extracted and at that point tax will need to be paid, so the tax is deferred rather than avoided.

2. Get an early tax break

It’s quite common to incur costs relating to a proposed business even before you start trading. Certain costs that you incur can be claimed even before the business starts.

These can be claimed by whoever incurs them, even if the business ends up in a different entity (you incur a cost personally but end up running the business through a company).

Examples of what could be claimable include:

• Payments to accountants and lawyers for structuring advice, setting up entities, due diligence and business plans (deductible even if the business doesn’t go ahead)
• Government fees and charges relating to setting up an entity (e.g. stamp duty)

3. Avoid tax traps

For small businesses operating through a company, the biggest tax trap is failing to distinguish the company’s money from the individual business owner’s money.

Small businesses owners often fall into the trap of taking money out of their company and failing to account for it properly as either salary or a dividend. In that case, the ATO can deem the amount taken out to be a loan and tax it as an unfranked dividend if the situation isn’t rectified (either by repaying the outstanding amount or putting in place a complying loan agreement).

The same treatment can be applied where business owners use company assets at no cost – for instance, a company owned property or boat.

There are also many examples of people – particularly in the sharing economy (e.g. Uber drivers) – who argue that they are not really in business at all, but are undertaking a ‘hobby’. They aren’t – they are in business.

The sharing economy, through sites like Uber, Airtasker and others, is causing a big increase in the number of small businesses as people move into offering services through sharing economy facilitators.

Other major tax trap issues include:

• ‘Cash only’ businesses failing to correctly record all turnover.
• Not realising you need to register for GST (particularly common for taxi drivers and Uber drivers, because they need to register from the first dollar earned).
• Not focusing on keeping records (for example, because you are too busy running the business) leading to missed BAS and tax return deadlines, missed tax payments and poorly kept records.

4. Don’t forget to keep records

When it comes to running a small business, keeping on top of your paperwork may be the last thing on your to-do list, but it is important to avoid a panicked rush at tax time.

While you focus on running and growing your business, an experienced business tax agent can help with getting your records in order and discovering the right deductions, as well as helping you navigate the accounting and tax responsibilities that come with running a business.

They can advise you on the best structure to set up your business and also assist you in the setting up of a Company, Partnership, Trust or Self Managed Super Fund.

However you manage it, don’t leave your paperwork to the last minute!

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