What is tax planning?
Tax planning is the process of arranging your business’ finances to legally keep your tax liability, i.e., the amount you pay in taxes, to a minimum. Through effective tax planning, you can increase the amount of capital within your business, which you can reinvest in its growth, and improve short-term cash flow. Not to mention, by keeping on top of your tax obligations, you can make better strategic decisions and won’t feel rushed or pressured come tax season.
With this in mind, this post explores five fundamental tax planning strategies for businesses.
Effective tax planning strategies for businesses
Understand tax deductions and credits
Claiming the maximum amount of tax deductions and credits available is an essential tax planning strategy for businesses, as both reduce your tax obligation.
Tax deductions, or deductible expenses, are subtracted from a business’ total income to arrive at its taxable income. Consequently, the more deductions applied, the lower the taxable income.
Common tax deductions include:
- Employee wage
- Employee superannuation contributions
- Rent or lease costs payments
- Repairs and maintenance
- Utility bills (electricity, gas, phone etc.)
- Office supplies and stationery
- Marketing costs
- Business travel and accommodation
- Staff training and professional development
- Business-related insurance costs premiums (policies)
- Depreciation and amortisation
- Bad debts
- Consultancy fees (accountants, lawyers, etc.)
Tax credits, on the other hand, are directly applied to a company’s tax liability to lower it. Credits provide a dollar-for-dollar tax liability reduction, e.g., a $500 credit directly reduces your tax bill by $500, as opposed to deductions which depend on your company’s tax rate.
Common tax credits include:
- Research and development (R&D) tax incentive
- Green tax incentive
- Small business income tax offset (SBITO)
- Hiring tax incentives
- Apprenticeship and traineeship incentives
As tax legislation is complex and consistently changing, it’s crucial to consult an accountant to determine your available deductions and credits. Their knowledge of the tax rules and regulations will ensure you don’t miss out on potential savings you weren’t aware of (plus, the cost of their services is also tax deductible).
Choose the correct business entity
It’s important to select the best business entity, or structure, for your business – not just for operational purposes, but as a tax planning strategy– as different entities pay different tax rates. You need to select the most beneficial business entity in light of your business’ current needs and performance – while keeping your future goals and growth objectives in mind.
Here’s a summary of each business entity:
An individual who runs a business as its sole owner. As a sole trader, your business isn’t a separate legal entity, so you must report company income and expenses on your individual tax return – and are taxed at personal income tax rates.
A sole trader is easy and cost-effective to set up and run and generally has minimal tax planning requirements. However, the owner has full personal liability for the business debts’ and a sole trader is limited in their ability to raise capital, unlike other structures.
See more: Income protection for sole trader
A business entity that sees two or more people own and operate a company. Like a sole trader, partnerships aren’t separate legal entities, so each partner must report their share of income or losses on their tax return.
Again, much like a sole trader, partnerships offer simple tax planning strategies – with the added benefit of shared controls and resources and diverse skills and expertise. The main downside of a partnership is that the partners share full liability equally.
Proprietary limited company (Pty Ltd)
Generally referred to as a company or a Pty Ltd, a proprietary limited company is a separate legal entity from its one or more owners – or shareholders. Consequently, a company is taxed at the corporate tax rate on profits. Shareholders receive their share of profits through dividends, on which they pay the personal income tax rate.
Companies offer several advantages, with the main being limited liability protection for shareholders, i.e., not being fully responsible for the business’ losses or debts. Additionally, it’s easier to raise funding for expansion, product development, etc. Conversely, a Pty Ltd is more complicated and costly to establish and maintain and requires more detailed tax planning strategies.
A legal structure in which a trustee manages assets for the trust’s beneficiaries. Like sole traders and partnerships, trusts aren’t separate tax entities, so the generated profit is distributed to beneficiaries, who then pay personal income tax on their share.
Trusts offer asset protection, i.e., from creditors, and potential estate and tax planning benefits, e.g., a discount on capital gains tax on certain assets and the ability to carry forward losses. They can also be utilised alongside other business entities for optimal tax planning strategies. However, trusts are often complicated to run and must comply with various legal and administrative requirements.
It can be difficult to determine which business entity will be best when first setting up your business – and hard to know when the right time to change business structure. Consequently, your accountant will help you choose the ideal tax entity for your company and advise you when to change your business structure to minimise your tax burden.
Leverage depreciation and amortisation
Depreciation and amortisation are the gradual decrease in value of a business’ assets over time. While depreciation applies to tangible assets, such as machinery and vehicles, amortisation refers to the depreciation of intangible assets, like patents and trademarks can be amortised. Subsequently, by properly leveraging depreciation and amortisation as a tax planning strategy, your business can minimise its tax obligation.
Additionally, eligible businesses can qualify for instant asset write-offs: a tax planning strategy that allows businesses to claim an immediate full deduction on certain assets – as opposed to over time through depreciation. Generally, to qualify, your company must have an annual turnover under $10 million, and each asset tax must have a maximum value of $20,000. However, as the threshold is applied per asset, you can claim instant write-offs on multiple assets.Employ international tax planning strategies
If your company conducts business overseas or deals with cross-border transactions, getting professional help with your international tax planning is crucial for navigating complex international tax laws and minimising your tax liability.
International tax planning strategies can include:
- Transfer pricing refers to the price of products and services between different countries. Complying with different transfer pricing rules in different jurisdictions is crucial to avoiding disputes with local tax authorities.
- Tax treaties: agreements between countries that prevent double taxation and provide tax benefits for international businesses operating in a particular tax jurisdiction. Understanding (and keeping up with) the details and implications of tax treaties in each location is vital to international tax planning.
- Foreign tax credits: determining which foreign income tax offsets (FITOs) your business is eligible for helps reduce the tax paid on income generated overseas.
See more: Tax accountant for small business
Tax planning with K Partners, top-rated accountants based in Melbourne
To discuss how to apply any of the above tax planning strategies to your business, speak to the knowledgeable team at K Partners. Whether you want to know more about SMSFs, instant asset tax write-offs, or other small business tax advice, we have the expertise and experience to reduce your tax burden and increase your company’s cash flow and profitability.
Please note that all the while the information provided above is factual in nature, it’s also intended to apply generally, and to a broad audience. Subsequently, the information hasn’t taken your personal circumstances or goals into consideration.