Tax basics for small business

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1 BUSINESS SMALL BUSINESS GUIDE NAT SEGMENT AUDIENCE FORMAT PRODUCT ID Tax basics for small business A guide to your tax obligations and entitlements when running a small business Visit

2 OUR COMMITMENT TO YOU The information in this publication is current at June 2004 and we have made every effort to ensure it is accurate. However, if something in the publication is wrong or misleading and you make a mistake as a result, you will not be charged a penalty. You may have to pay interest, depending on the circumstances of your case. You are protected under GST law if you have acted on any GST information in this publication. If you have relied on GST advice in this Tax Office publication and that advice has later changed, you will not have to pay any extra GST for the period up to the date of this change. Similarly, you will not have to pay any penalties or interest. If you feel this publication does not fully cover your circumstances, please seek help from the Tax Office or a professional tax adviser. Since we regularly revise our publications to take account of any changes to the law, you should make sure this edition is the latest. The easiest way to do this is by checking for a more recent version on our website at COMMONWEALTH OF AUSTRALIA 2004 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth available from the Department of Communications, Information Technology and the Arts. Requests and enquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Intellectual Property Branch, Department of Communications, Information Technology and the Arts, GPO Box 2154, Canberra ACT 2601 or posted at

3 CONTENTS Quick guide to tax issues for your business iii 01 GETTING STARTED 01 Are you carrying on a business? 02 Business structures 02 Features of different business structures 03 Registering your business 04 Non-profit organisations INCOME TAX 09 How income tax works 10 Tax rates for resident individuals, including sole traders, PAYG instalments 12 Simplified tax system 13 Capital gains tax 13 Non-commercial losses 14 Personal services income 15 Primary producers BUSINESS EXPENSES AND DEDUCTIONS 17 How deductions for business expenses work 18 Motor vehicle expenses 19 Fuel schemes 19 Working from home 20 Business travel expenses 21 Decline in value (depreciation) GST AND RELATED TAXES 23 GST 24 Taxes on wine and luxury cars EMPLOYEES AND OTHER WORKERS 27 Determine the status of your workers 28 PAYG withholding for employees 29 Contract workers 30 Superannuation 30 Eligible termination payments 31 Fringe benefits tax 31 Employees and child support RECORD KEEPING, REPORTING AND PAYMENT 33 Business records 34 Invoices you receive 35 Reporting and paying tax 37 Budgeting to pay your tax 38 Definitions 39 More information 41 Index 42 TAX BASICS FOR SMALL BUSINESS i

4 ABOUT TAX BASICS FOR SMALL BUSINESS This book provides a guide to tax issues for small businesses with an annual turnover of less than $2 million. Larger businesses may also find it useful. You can use Tax basics for small business to find out: c which taxes affect your business, and c where to get more detailed information. A good place to start is the quick guide to tax issues for your business on the next page. At the beginning of each chapter there is a subject-specific guide which helps you work out which tax issues affect your business and which sections you need to read. We then tell you where you can get more detailed information if you are interested in a particular topic, or you need to know how to do something. You will also find important notes throughout the book (look for the symbol) which will help you work out what further steps you may need to take, or key information you should note. When we refer to you or your business in this guide we are referring to you as a small business entity, for example, a sole trader, a partnership, a company or a trust that conducts a business. You can obtain additional forms, publications and more information on all topics in this guide from our website at or by phoning TAX BASICS SEMINARS Tax basics seminars are helpful if you ve just started a business or are thinking of starting one. The seminars run throughout the year and cover a range of tax topics. To find out more or to make a booking visit or phone ii TAX BASICS FOR SMALL BUSINESS

5 QUICK GUIDE TO TAX ISSUES FOR YOUR BUSINESS DOES YOUR BUSINESS... c have an Australian business number (ABN)? see page 04 c account for income tax? see page 09 c account for business expenses claimed as deductions? see page 17 c withhold 48.5% from payments to other businesses that don t quote their ABN? see page 36 c keep business records and report and pay tax? see page 33 If your business: c c c c has received a pay as you go (PAYG) instalment rate pay PAYG instalments towards your expected income tax liability see page 12 has turnover of $50,000 or more, or provides taxi travel register for goods and services tax (GST) see page 23 is registered for GST charge and account for GST see page 24 has employees withhold amounts from your employees wages or salaries using PAYG withholding see page 29 contribute a minimum level of superannuation support for your employees see page 30 pay fringe benefits tax (FBT) on non-cash benefits provided to employees. see page 31 If you represent a non-profit organisation: c you may be affected by special endorsement requirements and tax rules. see page 07 TAX BASICS FOR SMALL BUSINESS iii

6 iv TAX BASICS FOR SMALL BUSINESS

7 GETTING STARTED 01 If you re a new or intending starter, determine whether your activity is a business, employment or hobby, see page 02. See how different business structures are treated for tax purposes. This will help you apply the other tax rules in this publication, see page 02. Ensure your business has an ABN, see page 04. TAX BASICS FOR SMALL BUSINESS 01

8 GETTING STARTED ARE YOU CARRYING ON A BUSINESS? You must declare any income earned by your business. You can generally claim an immediate deduction for expenses that you necessarily incur in carrying on a business, provided these expenses are not of a private, domestic or capital nature. (Some capital expenses are deductible over time.) To be able to claim business deductions you must be carrying on a business. If you aren t carrying on a business, your activities may in fact be a hobby in which case you don t declare the income and you can t claim deductions for expenses. The courts have provided some guidelines to help determine whether a business exists or whether it is, in fact, a hobby. There are no hard and fast rules. The Tax Office looks at all the circumstances of a case in determining whether a business exists. Guidelines adopted by the courts include the following: c Does your activity have a significant commercial purpose or character? c Do you have more than just an intention to engage in business? c Do you have a purpose of profit as well as a prospect of profit? c Is there repetition and regularity to your activity? c Is your activity of the same kind and carried on in a similar manner to businesses in your industry? c Is your activity planned, organised and carried on in a business-like manner? c What is the size, scale and permanency of your activity? c Is your activity better described as a hobby, recreation or sporting activity? EXAMPLE: CARRYING ON A BUSINESS Wendy sells wooden toys from a retail outlet. Her outlet is open the same hours as other retail outlets. She advertises in the Yellow Pages as well as regional toy magazines. She sells to clients within her region and to people who have seen her advertisement. She sells her toys at a price that enables her to make a profit. Wendy would normally be considered to be carrying on a business. EXAMPLE: CONDUCTING A HOBBY Tchen makes wooden toys at home. He works about six hours a week and sells the toys only to his family and friends. He intends the activity to remain small and is happy if all he does is cover his costs. Tchen would be considered to have a hobby. As such, he would not include the amounts he received in his income tax return. Consequently, he cannot claim any expenditure he incurred in relation to his hobby against any other income he earns. Visit our website at for more information about what constitutes a business. BUSINESS TIP: NON-COMMERCIAL LOSSES If you re an individual involved in a business activity that makes a loss, you will be able to claim that loss against your income from other sources (such as wages) only if you meet certain conditions. See page 14 for more information. BUSINESS STRUCTURES An important decision you need to make when starting a business is choosing the business structure that best suits your needs. There are four main types of business structure commonly used by small business in Australia: c sole trader c partnership c trust, and c company. The main features of these structures are described in the table on the next page. BUSINESS TIP: YOUR INCOME IN A COMPANY If you use a company to operate your business it s likely you ll be an employee or a director of your own company. In that case, the company will need to withhold amounts from salary or wage payments it makes to you as an employee, and from any amounts it pays you as directors fees, under the PAYG withholding system. 02 TAX BASICS FOR SMALL BUSINESS

9 GETTING STARTED FEATURES OF DIFFERENT BUSINESS STRUCTURES Structure Sole trader Partnership Trust Company Features Description: a sole trader is an individual who is trading on their own. That person controls and manages the business. ABN: a sole trader applies for an Australian business number for their business and uses this number for all their business dealings. TFN: a sole trader uses their individual tax file number when they lodge their income tax return. Who pays income tax: the income of the business is treated as the person s individual income, and they are solely responsible for any tax payable by the business. Business income is included along with any other income in the sole trader s individual tax return. Description: for tax purposes, a partnership is an association of persons or entities that carry on business as partners or receive income jointly (except a limited partnership, which is treated as a company). ABN: partners apply for an ABN for the partnership and use this number for all the partnership s business dealings. TFN: a partnership needs its own tax file number. Who pays income tax: a partnership doesn t pay income tax each partner includes their share of the profit or loss in their individual tax return. However, the partnership lodges a separate income tax return to report its income. Description: a trust is an obligation on a person to hold property for the benefit of others (who are known as beneficiaries ). ABN: a trust has its own ABN. The trustee needs to register for the ABN in its capacity as trustee of the trust. The trustee is taken to be an entity in that capacity. TFN: the trust must have its own tax file number, which is used when its annual income tax return is lodged. The trustee needs to register for the TFN in its capacity as trustee of the trust. Who pays income tax: except in special circumstances it is the beneficiary, rather than the trustee, that is taxed. Usually the beneficiary has to include their share of the trust s net income in their personal tax return (Form I). The trustee is liable to pay tax on income distributed to minor or non-resident beneficiaries, or on any income it accumulates. Description: a company is a legal entity separate from its shareholders. Companies are regulated by the Australian Securities and Investments Commission. For tax purposes, a company means a body or association, incorporated or unincorporated, but does not include a partnership or a non-entity venture.. ABN: a company needs to register for an ABN. TFN: a company needs to register for its own tax file number. Who pays income tax: a company pays income tax on its profits the general rate of tax is 30%. TAX BASICS FOR SMALL BUSINESS 03

10 GETTING STARTED REGISTERING YOUR BUSINESS You can register for an Australian business number (ABN), GST, a tax file number and/or PAYG withholding: c electronically at c on the same application form phone to obtain a form, or c through your tax agent. The Australian Company Number and the ABN On forming a company, you are issued with an Australian Company Number (ACN) by the Australian Securities and Investments Commission. When a company registers for an ABN, the number issued by the Australian Business Registrar is its ACN with two check digits at the beginning: ABN The ABN is the identifying number that businesses use when dealing with other businesses for example, you generally need to quote an ABN on your invoices or other documents relating to sales that you make to other enterprises to avoid having tax withheld from payments to you. You use your ABN in certain dealings with the Tax Office and other areas of government. If you re registered for GST, you also need to put an ABN on your tax invoices and adjustment notes. You can obtain an ABN even if you don t register for GST. Australian Business Register The Australian Business Register is a database of identity information provided by businesses when they register for an ABN. The ABR makes it easier for businesses and all levels of government to interact using a unique identifier the ABN. The ABR provides instant online access to ABN details and transactions at If you are a Corporations Act company or an entity carrying on an enterprise in Australia you are entitled to an ABN. If you re not sure about your entitlement, check the Tax Office website. c How to register for an Australian business number (NAT 2929) BUSINESS TIP: ENTERPRISES You will often see the term enterprise, especially in relation to the ABN and GST. Basically, the term enterprise covers commercial activities but does not include hobbies or employment. So businesses are enterprises for GST and ABN purposes, and so are activities by charities and religious institutions Carrying on an enterprise includes anything done in the course of commencing or terminating the enterprise. Often the date of commencement is before the business starts to trade. Companies don t have to quote both the ABN and ACN on documents. Under the Corporations Act, a company is required to show its ACN on all public documents and negotiable instruments. However, companies with an ABN can use the ABN in place of their ACN, on the condition that: c the ABN includes the company s ACN as the last nine digits, and c the company quotes the ABN in the same way it quoted its ACN. Registering your business name You may need to register a name for your business. Information about registering a business name can be obtained from the Business Entry Point at The Business Entry Point can also help you with more information about: c business structures c forming a company c accessing finance c business licences c payroll tax, and c workers compensation. BUSINESS TIP: PUT YOUR ABN ON YOUR INVOICES Put your ABN on your business stationery, especially your invoices. If you don t, other businesses may withhold 48.5% from any payment to you. 04 TAX BASICS FOR SMALL BUSINESS

11 GETTING STARTED GST You must register for GST if: c you are an entity carrying on an enterprise (if you are in business and not a hobby you probably meet this requirement), and c your annual turnover is at or above the registration turnover threshold of $50,000 (or $100,000 for a non-profit organisation). You may choose to register if you are carrying on a business and your turnover is below the registration turnover threshold. If you provide taxi travel in your business you must register for GST, regardless of turnover. Tax file number Partnerships, companies and trusts need their own tax file number. A tax file number can be obtained at the same time as the ABN, using the same application form. Sole traders use their individual tax file number in dealings with the Tax Office. PAYG withholding If you make payments from which withholding is required for example, wages to employees or payments to businesses that do not quote an ABN you must register with the Tax Office before you first withhold. For more information about PAYG withholding, see page 29. Registering for fringe benefits tax If you are an employer and provide fringe benefits to your employees, we recommend that you register for fringe benefits tax (FBT). For more information about FBT, see page 31. NOTE Does your business need to register for: c c c c c an ABN? GST? a tax file number? PAYG withholding? g You can register for any or all of these at the same time: on the same application form phone to obtain a form electronically at through your tax agent. Does your business need to register for FBT? g Use an FBT registration form: visit phone BUSINESS TIP: WHAT HAPPENS IF YOU DECIDE NOT TO CONTINUE WITH YOUR BUSINESS OR YOU STOP RUNNING YOUR BUSINESS If you decide not to proceed with your business or you close, sell or wind up your business, there are a number of tax matters you may need to attend to. These may include c cancelling registrations; c making certain GST adjustments on your final activity statement, and c calculating the: capital gains and capital losses on your CGT assets; gains and losses on your depreciable assets; and gross profit or loss on your trading stock. You should also check if your state or territory has any special requirements. For more information about government regulations concerning company and business name deregistration, employee payments, cancellation of tax registrations, and specific state or territory requirements, visit the Business Entry Point website at TAX BASICS FOR SMALL BUSINESS 05

12 GETTING STARTED EXAMPLE Alex All Electrical On 1 July 2003, Alex starts his own business as a sole trader electrician. He either makes repairs on site or back at his workshop. c Structure: sole trader c Expected turnover: $40,000 c Staff: works alone Business registrations for All Electrical Tax file number ABN GST PAYG withholding FBT Alex can: Alex uses his own TFN Every business should have an ABN Alex doesn t have to register for GST because his expected turnover is less than $50,000, but he prefers to charge GST and claim GST credits Alex plans to work alone, with no employees; he can register later if he needs to (for example, if he needs to withhold from a supplier that doesn t quote an ABN) Alex has no employees c phone the Tax Office (on ) to obtain an ABN application form and use the same form to register for GST, or c use the online registration at the Business Entry Point at EXAMPLE Renee Fashion Pty Ltd On 1 July 2003, Renee starts her own clothing shop, Renee Fashions. At the same time she creates a company, Renee Fashions Pty Ltd, through which she runs the business. c Structure: company c Expected turnover: $190,000 c Staff: three (including Renee herself) Business registrations for Renee Fashions Pty Ltd Tax file number ABN GST PAYG withholding FBT TFN needed for the company ABN needed for the company Renee Fashions Pty Ltd is required to register for GST because its expected turnover exceeds the threshold of $50,000 Renee Fashions Pty Ltd will have at least one employee (Renee herself). In addition, Renee plans to employ two more staff. Renee does not plan to provide fringe benefits to any employees, but can register for FBT later if this situation changes. Renee can obtain a tax file number for the company and register it for an ABN, GST and PAYG withholding by: c phoning the Tax Office on to obtain an ABN application form, or c using the on-line registration at the Business Entry Point at 06 TAX BASICS FOR SMALL BUSINESS

13 GETTING STARTED NON-PROFIT ORGANISATIONS The Tax Office has a range of publications and services specifically for non-profit organisations (including charities). Are you a non-profit organisation? A non-profit organisation is an organisation that is not operating for the profit or gain (either direct or indirect) of its individual members. This applies both while the organisation is operating and when it winds up. Examples include churches, community centres, cultural societies, environmental protection societies, public museums and libraries, scholarship funds, sports clubs and traditional service clubs. Tax concessions for non-profit organisations There are various tax concessions for particular types of organisations in the non-profit sector. Some types of non-profit organisations are entitled to: c exemption from income tax c concessions in working out their income tax obligations if they are not exempt c exemption from fringe benefits tax (FBT) or a rebate to reduce the amount of FBT payable c deductible gift recipient status c refunds of imputation credits, and/or c concessions available for goods and services tax (GST). Tax deductible gifts and fundraising If your organisation wants to receive tax deductible gifts, you will need to familiarise yourself with: c the types of organisation that can qualify c maintaining a gift fund c information to be recorded on receipts for donations, and c the types of gifts that are tax deductible. State and territory government regulations and the impact of GST should also be considered when conducting fundraising. c Visit the For non-profit organisations section of our website at c See Tax basics for non-profit organisations (NAT 7966). c Obtain a fax by phoning c Phone Income tax There is an endorsement process for charities under which they apply to the Tax Office to be income tax exempt. Other organisations can self-assess their income tax status. Non-profit organisations that are not exempt may receive concessions in calculating their taxable income and lodging income tax returns, and/or special rates of tax. TAX BASICS FOR SMALL BUSINESS 07

14 GETTING STARTED 08 TAX BASICS FOR SMALL BUSINESS

15 INCOME TAX 02 Account for income tax for your business: sole traders, see page 10 partnerships, see page 11 companies, see page 11 trusts, see page 11. How you account for income tax depends on whether your business: has received a PAYG instalment rate pay PAYG instalments, see page 12 has average turnover of less than $1 million you may be eligible to enter the simplified tax system and use special rules to work out your taxable income, see page 13 has a capital gain or capital loss (by disposing of a capital asset, such as land or goodwill) capital gains tax affects you, see page 13 makes a loss, and consists of you as an individual (alone or in partnership with others) you may not be able to claim the business loss against your income from other sources, such as wages, see page 14 has income that is mainly a result of your personal effort or skills the income may be treated as your income for tax purposes and the deductions you can claim may be limited, see page 15 is a primary production business special tax rules affect you, see page 16. TAX BASICS FOR SMALL BUSINESS 09

16 02 INCOME TAX HOW INCOME TAX WORKS Income tax is levied on a person s or business taxable income, which is worked out using this formula: assessable income less allowable deductions equals taxable income c Assessable income is generally the income the business earns. It does not include GST payable on sales that you make, nor does it include GST credits. For an individual taxpayer (such as a sole trader or a partner in a partnership), assessable income includes business income and income from other sources, such as personal investments or wages from another job. c Allowable deductions are deductions for certain expenses necessarily incurred in relation to the business for example, tools, expenses for business premises and motor vehicles, business stationery and employee wages. GST that you pay and are entitled to claim as a GST credit is not an allowable deduction. c Taxable income is the person s or business s assessable income less their allowable deductions. Income tax works on a self-assessment principle. This means the information you provide to the Tax Office is initially accepted as true and accurate, and your tax liability is calculated on this basis. Later, you may be asked to show records to support your information. It is important that you keep records (for five years) to verify your claims. BUSINESS TIP: BUSINESSES MUST LODGE INCOME TAX RETURNS You must lodge an income tax return for any year in which you carry on a business, even if you expect to have no income tax liability. Remember, activity statements are different from income tax returns. Even if you report your pay as you go (PAYG) instalments and other obligations on activity statements, you must still lodge an income tax return. Individuals and sole traders A sole trader is an individual taxpayer and is subject to the same income tax rates that would apply to a wage or salary earner. Sole traders don t need to complete a separate return for their business they use their personal income tax return (Form I) to report their business income and deductions. TAX RATES FOR RESIDENT INDIVIDUALS, INCLUDING SOLE TRADERS, Taxable income scale Tax rate $0 $6,000 0% $6,001 $21,600 17% $21,601 $58,000 30% $52,001 $70,000 42% $70, % *At the time of printing this table is expected to be effective from 1 July 2004 Note: Medicare levy may also be payable and is calculated as a percentage of taxable income. Special rules apply if you have recently left full-time education and entered the workforce, or have recently become an Australian resident. EXAMPLE Alex All Electrical (sole trader) In , Alex has the following income and deductions: c business income: $34,000 c investment income: $2,000 c deductions: $10,000 Alex includes these amounts on his individual income tax return. His taxable income for the year is calculated as follows: assessable income $36,000 allowable deductions $10,000 taxable income = $26,000 To work out the tax he has to pay, Alex applies the marginal rates of tax for individuals to each relevant bracket of his taxable income. On the first $6,000 of his taxable income the tax rate is 0%; on the next $15,600 (that is, the taxable income from $6,001 to $21,600) the rate is 17%; and so on until he reaches $26,000. Alex s tax is calculated as follows: Marginal tax rates $70,001 $58,001 $21,601 $6,000 47% $0 x 47% = $0 42% $0 x 42% = $0 30% $4,400 x 30% = $1,320 17% $15,600 x 17% = $2,652 0% $6,000 x 0% = $0 Tax on $26,000 = $3, TAX BASICS FOR SMALL BUSINESS

17 02 INCOME TAX See TaxPack (NAT 0976) for information on income tax for individuals and how the Medicare levy is calculated. Partnerships All assessable income earned by a partnership and deductions claimed for expenses incurred in carrying on that business must be shown in a partnership tax return (Form P). A partnership (except a limited partnership, which is treated like a company for tax purposes) does not pay tax on its income. Instead, each partner pays tax on their share of the partnership s income. Each partner must include their individual share of the net partnership profit or loss in their personal tax return (see Individuals and sole traders on page 10). c Partnership and trust tax return instructions (Nat 2297) EXAMPLE Katchin Consulting Pty Ltd In , Katchin Consulting Pty Ltd earns $165,000 and has $152,000 of allowable deductions. These amounts are included on the company s company tax return. The company s taxable income for the year is calculated as follows: assessable income $165,000 allowable deductions $152,000 Taxable income = $13,000 To work out the company s income tax liability, the company tax rate of 30% is applied to all taxable income: 30% company tax rate X $13,000 taxable income = $3,900 tax to pay Companies A company is a distinct legal entity with its own income tax liability, separate to your personal income tax. However, the treatment of any personal services income may be different (see the business tip below). The company must lodge a company tax return (Form C), which shows the income and deductions of the company and is used to calculate the income tax that the company should pay. As with individuals, the income tax of companies is calculated on taxable income, which is the assessable income earned by the company less any allowable deductions. A company s income tax is calculated as a percentage of the taxable income earned by the company during the financial year. The general company tax rate for the income year is 30%. (This rate is applied equally to all taxable income of a company unlike individuals, companies do not have marginal tax rates or tax-free thresholds.) Companies must also lodge an annual return with the Australian Securities and Investments Commission. Employees of the company (which usually includes the owner/ director) must include their wages or salaries in their personal tax return (see Individuals and sole traders on page 10). c Company tax return instructions (NAT 0669) Trusts If a trust is carrying on a business, all income earned by the trust and deductions claimed for expenses incurred in carrying on that business must be shown in a trust tax return (Form T). Except in special circumstances it is the beneficiary, rather than the trustee, that is taxed. Usually the beneficiary has to include their share of the trust s net income in their personal tax return (see Individuals and sole traders on page 10). Distributions to minor beneficiaries are assessed to the trustee, which also pays the tax assessed on their behalf. c Partnership and trust tax return instructions (NAT 2297) c PAYG instalments working out your proportion of partnership instalment income (NAT 3494) BUSINESS TIP: PERSONAL SERVICES INCOME If you earn income mainly for your personal efforts or skills, your income may be taxed at your personal tax rate even if it is paid to a company, partnership or trust and not directly to you. See page 15 for more information. TAX BASICS FOR SMALL BUSINESS 11

18 02 INCOME TAX PAYG INSTALMENTS Pay as you go (PAYG) instalments is a system for taxpayers to pay instalments of their expected tax liability on their business and investment income for the current income year. By providing for your expected tax liability, PAYG instalments help you minimise any amount you may have to pay when your next annual income tax return is assessed. Companies and superannuation funds are usually required to pay PAYG instalments, while individuals are generally required to pay PAYG instalments only if the business and investment income reported in their annual income tax return is $2,000 or more. The Tax Office will notify you by letter if you are required to pay PAYG instalments and tell you how often to pay. PAYG instalments are generally paid quarterly (four times per year), although some taxpayers pay two instalments per year and some have an annual instalment option, depending on their circumstances. Most taxpayers have the option of paying instalments worked out by the Tax Office or instalments they work out themselves based on their instalment rate and instalment income. When your instalments are due, the Tax Office will send you an activity statement or notice, which you complete and return. Whether you pay instalments annually, two times a year or four times a year, you are still required to lodge an annual income tax return at the end of the income year. Any PAYG instalments you ve paid for the income year will be credited to your income tax assessment. You then pay any additional income tax owing, or receive a refund. NOTE Have you received a PAYG instalment rate from the Tax Office? g Pay your PAYG instalments with your activity statements (or, if eligible to pay annually, you ll receive a PAYG instalment notice). Your letter from the Tax Office and your activity statements will tell you about your options for paying PAYG instalments. This information is available on our website: Introduction to pay as you go income tax instalments (NAT 4637) PAYG instalments for individuals (NAT 4269) PAYG annual income tax instalments for individuals (NAT 7324) PAYG instalments for companies (NAT 7331) PAYG annual income tax instalments for companies (NAT 7322) PAYG instalments for primary producers and special professionals (NAT 4352). Partnerships and trusts Partnerships are not liable to pay PAYG instalments. Instead, the individual partners may be liable to pay PAYG instalments on their proportion of income from each partnership of which they are a member. Similarly, trusts are not liable to pay PAYG instalments. Instead, the beneficiaries or trustees may be liable to pay instalments. c PAYG...working out your proportion of trust instalment income (NAT 3495) BUSINESS TIP: PAYG INSTALMENTS FOR NEW BUSINESS STARTERS New businesses usually don t pay PAYG instalments until after they ve lodged their first income tax return. They pay their entire tax liability for the first year when their income tax return is assessed so in the first year of business it s important to put aside money to pay your end-of-year tax liability. If you wish, you can provide for your income tax liability by making voluntary payments. For more information, phone us on TAX BASICS FOR SMALL BUSINESS

19 02 INCOME TAX SIMPLIFIED TAX SYSTEM The simplified tax system (STS) is an alternative method of determining taxable income for eligible small businesses with straightforward financial affairs. It began on 1 July The STS has three main elements: c an STS accounting method that recognises most business income and expenses only when received and paid c simplified trading stock rules where businesses only need to conduct stocktakes and account for changes in the value of trading stock in limited circumstances, and c simplified depreciation rules where depreciating assets costing less than $1,000 each are written off immediately. Most other depreciating assets are pooled and deducted at a rate of 30%. In addition, STS taxpayers can claim a full deduction for certain prepaid expenses. Participation in the STS is optional. If you choose to enter the STS you must use all three elements where they apply. Eligibility Most small businesses are eligible to enter the STS. Broadly, you are eligible to enter the STS for an income year if: c you carry on a business in that year c your STS average turnover for that year is less than $1 million, and c your business and related businesses have depreciating assets with a total adjustable value of less than $3 million at the end of that year. NOTE CAPITAL GAINS TAX As a small business operator, you will most commonly make a capital gain or capital loss if you sell one of your CGT assets used in your business for example, your business premises or goodwill. If you conduct your business through a company or trust, you may make a capital gain or capital loss if you sell your shares or trust interest. Basically, a capital gain or capital loss is the difference between the sale proceeds you receive for the asset and its purchase price. Capital gains tax affects your income tax liability because your assessable income includes any net capital gain you made for the income year. Your net capital gain is the total of your capital gains (not just those you made from your business CGT assets) for the year, reduced by your total capital losses for the year or earlier years and any relevant concessions. There are a range of capital gains tax concessions that reduce capital gains made by small business operators. Capital gains tax does not generally apply to depreciating assets, such as tools or motor vehicles, that you use only in your business. Gains from these assets are included in your income; losses from these assets are deductible. BUSINESS TIP: KEEPING RECORDS FOR CAPITAL GAINS TAX You must keep records of any act, transaction, event or circumstance that might reasonably be expected to be relevant to working out a capital gain or capital loss even if the capital gain or capital loss hasn t yet happened. Otherwise you may incur extra expense to reconstruct the information later. Penalties can apply if records are not kept. Do you want to enter the simplified tax system? g Confirm your eligibility (see more information below). g To enter, tick the STS box on your income tax return. g Use STS rules for accounting, trading stock and depreciation for the income year. c Guide to capital gains tax (NAT 4151) c Guide to capital gains tax concessions for small business (NAT 8384) c The simplified tax system: a guide for tax agents and small businesses (NAT 6459) TAX BASICS FOR SMALL BUSINESS 13

20 02 INCOME TAX NON-COMMERCIAL LOSSES If you re an individual involved in a business activity that makes a loss, you may be able to claim that loss by offsetting it against your income from other sources, such as salary or wages. However, there are tax provisions that may restrict your ability to claim the loss. What are the effects? If you are affected by these provisions in a particular income year, a loss incurred by your business activity in that year is deferred and cannot be claimed against income from other sources. It may be possible to claim the loss against other income in a future year. Does this affect you? These provisions may affect you if: c you are undertaking a business activity as an individual, whether alone or in partnership with other individuals or entities c the business activity makes a loss c you have income from other sources, such as salary or wages, and c the business activity does not meet any of four tests set out in the provisions. (The tests relate to levels of income, profit, real property and assets. If your business activity does not meet any of the four tests you can ask the Tax Office to use its discretion to allow you to deduct the loss.) These provisions do not apply if: c the activity is being run by a company or trust, rather than by you personally c you are undertaking a primary production business or a professional arts business and you make less than $40,000 (excluding any net capital gains) in an income year from other sources, or c the losses arise from passive investments in shares, rental property or infrastructure bonds (unless your investment activity is really a business, rather than a passive investment). This means you can still negatively gear these passive investments. NOTE Are you potentially affected by the provisions for non-commercial losses? g You may not be able to claim a loss from your business activity against income from other sources instead, you may need to defer claiming the loss to a future year. See Non-commercial losses: overview (NAT 3379). Visit Talk to your tax agent. 14 TAX BASICS FOR SMALL BUSINESS

21 02 INCOME TAX PERSONAL SERVICES INCOME There are specific tax rules relating to personal services income earned by contractors and consultants. Are you affected? Personal services income is income that is mainly a reward for, or the result of, your personal efforts or skills. Income is not personal services income if it is mainly: c for supplying or selling goods c for granting a right to use property c generated by an income-producing asset, such as income derived from the use of a truck, or c generated by a business structure (for example, a large accounting firm). Your personal services income will not be affected by these rules if you are conducting a personal services business, either on your own or through a company, partnership or trust. A business qualifies as a personal services business if it meets any of four tests relating to responsibility for results, level of income from any one client, business premises and employment of others. If your business does not meet any of the four tests, in some circumstances you can seek a Tax Office determination that you are conducting a personal services business. What are the effects? If you earn personal services income, the deductions available against this income may be limited. If the personal services income is earned through a company, partnership or trust (called a personal services entity ), the income may be treated as your income for tax purposes, unless the entity is conducting a personal services business. The entity may also have PAYG withholding obligations regarding the income. You will be affected by these rules only to the extent that your income, or the income of an entity, is your personal services income. Note that even if your business qualifies as a personal services business, the general anti-avoidance tax rules may apply if you operate through a company, trust or partnership for the purpose of reducing your income tax liability (by income splitting, for example). NOTE Are you potentially affected by the rules for personal services income? g You may need to seek a Tax Office determination, to find out more about these rules. See Alienation of personal services income: important information for contractors and consultants (NAT 4788). Visit Talk to your tax agent. TAX BASICS FOR SMALL BUSINESS 15

22 02 INCOME TAX PRIMARY PRODUCERS The tax laws include special provisions to help primary producers, such as accelerated depreciation for some items, special deductions for water conservation and landcare, and ways to deal with fluctuating income. Are you a primary producer? To use these provisions you need to check that you meet the Tax Office s definition of carrying on a business of primary production. Some of the factors the Tax Office may consider include: c the size or scale of the activities c whether the activities are profitable if not, whether the person genuinely believes the activities will be profitable, and c whether the activities are carried on in the same manner as that type of activity is ordinarily carried on. Examples of primary production activities include farming, fishing and aquaculture. Tax averaging If you are a primary producer, tax averaging enables you to even out your income and tax payable over a maximum of five years to allow for good and bad years. When your average income is less than your taxable income excluding capital gains you may receive an averaging tax offset. When your average income is more than your taxable income excluding capital gains you may be required to pay a complementary amount of tax, which is included in the tax assessed. Income averaging applies automatically to primary producers unless you choose otherwise (that is, notify the Tax Office in writing). If you choose to opt out of the averaging system your decision is irrevocable. You do not need to register to be a primary producer. Averaging of income will apply automatically when your primary production income is shown at the primary production question in your tax return. NOTE Are you a primary producer? g Find out more about the special provisions for primary producers (and the eligibility criteria for being a primary producer). See Information for primary producers (NAT 1712). Visit Phone or Talk to your tax agent. 16 TAX BASICS FOR SMALL BUSINESS

23 BUSINESS EXPENSES AND DEDUCTIONS 03 Claim deductions for your business expenses when you lodge your income tax return, see page 18. To claim deductions for your business expenses when you lodge your income tax return you need to know how to claim, as well as some specific rules relating to whether your business: has motor vehicle expenses claim deductions for these expenses, see page 19 uses diesel fuel you may be eligible for grants or rebates, see page 19 is based at your home you may be entitled to deductions for expenses relating to the area you use, see page 20 has travel expenses, such as fares, car hire and accommodation these can generally be claimed as deductions, see page 21 uses plant, such as machinery, tools or computers you can claim a deduction for the decline in value (depreciation) of this plant, see page 22. TAX BASICS FOR SMALL BUSINESS 17

24 03 BUSINESS EXPENSES AND DEDUCTIONS HOW DEDUCTIONS FOR BUSINESS EXPENSES WORK Under income tax law, a person carrying on a business can generally claim an immediate deduction for outgoings that are incurred in carrying on their business to produce assessable income, provided these expenses are not of a private, domestic or capital nature. Capital nature means the expenses of establishing, replacing, enlarging or improving the business structure, as distinct from working or operating expenses. Some capital expenses are deductible over time see Decline in value (depreciation) on page 22. Some expenses may not be deductible if the tax rules relating to personal services income apply to you see page 15. The following are examples of common expenses that can generally be deducted from gross income: c rent or lease of business premises c hire or lease of plant and equipment c trading stock c decline in value of depreciating assets (depreciation) c tools c employee expenses c registered tax agent fees c interest on borrowed money c motor vehicle expenses c repairs c telephone expenses c bank fees and charges c transport and freight, and c light and power. Record keeping For all business deductions it is important that you are able to substantiate your claim. Income tax works on a selfassessment principle, which means the Tax Office initially accepts your information but may later ask you to show records to support your claims. Records to verify claims for deductions include: c business books c evidence of transactions (such as invoices and receipts), and c evidence of usage (such as motor vehicle logs and airline tickets). Keep records of your business transactions for five years, or five years after you last used them to prepare a return. For example, a log book may be relied on for up to five years after it was last used to prepare a return. Minor expenses of individuals and partnerships For certain work, car and business travel expenses it is not always possible to get a receipt. In such cases, you can claim the expense as long as you record your expenses (in a diary, for example), each expense is no more than $10, and they add up to no more than $200. If it was unreasonable to expect to get a receipt and the expense was more than $10, you can still claim the expense as long as you record it. This type of expense is not counted towards the $200 overall limit for small expenses. Each expense entry in the diary must contain all the details that would be required of a valid receipt and you must sign each entry. c Record keeping for small business (NAT 3029) Prepaid expenses A prepaid expense is expenditure incurred for something that will not be wholly provided during the current income year for example, a 12-month subscription or insurance premium that overlaps the end of the income year (30 June for most taxpayers). An immediate, full deduction may not be allowed for such prepaid expenses instead, part of the deduction may need to be apportioned to each income year of the service period. However, there are transitional concessions that allow a larger deduction in the first year if the service period ends within 13 months of the expense being incurred If your business is in the simplified imputation system (STS), you can generally claim an immediate, full deduction for prepaid expenditure if the service period is 12 months or less (even if the 12 months overlaps the end of the income year). c Deductions for prepaid expenses (NAT 4170) c Prepaid expenses taxpayers in the simplified tax system (NAT 7545) BUSINESS TIP: GST AND INCOME TAX DEDUCTIONS You can t claim an income tax deduction for the GST included in the price of something you purchased if you can claim it as a GST credit in your activity statement. See TaxPack (NAT 0976) for information about business expenses and deductions. 18 TAX BASICS FOR SMALL BUSINESS

25 03 BUSINESS EXPENSES AND DEDUCTIONS MOTOR VEHICLE EXPENSES Sole traders and partnerships All expenses for business purpose vehicles are generally deductible. These are vehicles such as trucks or vans that have a dedicated business use, and some smaller vehicles (such as utilities or panel vans) where private use is restricted to home-towork travel. Special substantiation rules apply to claims for car expenses. The car must be owned, leased or hired under a hire purchase agreement by the taxpayer, and have a carrying capacity of less than one tonne and fewer than nine passengers (this may include certain panel vans and utility trucks). You may choose one of four methods to calculate car expenses: c cents-per-kilometre method c 12% of original value method c one-third actual expense method, or c log book method. The following do not qualify as a car for these purposes: c motorcycles or similar vehicles c taxis taken on hire, and c motor vehicles hired intermittently. FUEL SCHEMES The energy grants credits scheme The energy grants credits scheme provides a grant for eligible fuel used in eligible activities including road transport, mining, agriculture, forestry, fishing, rail transport, marine transport, electricity generation for residential premises, the operation of hospitals, nursing and aged care homes and other medical institutions as well as other activities. Eligible fuels include diesel fuel and some alternative fuels. Petrol is not an eligible fuel. NOTE Do you use diesel or alternative fuels in your business? g You may be eligible for energy credit grants. For more information or to register for the energy grants credits scheme. See Energy grants credits scheme (NAT 8890). phone If you wish to claim expenses for such vehicles, you will have to comply with the general work-related expense substantiation rules (see page 18). Companies and trusts The above methods of calculating income tax deductions for motor vehicles do not apply for companies and trusts. Companies and trusts don t have private expenses, so all vehicle costs are tax deductible to the business. Private use of vehicles owned by a company or trust is generally subject to fringe benefits tax (see page 31). If you are a director of your own company you are an employee for fringe benefits tax purposes. BUSINESS TIP: TRAVELLING FROM HOME TO WORK Except in certain limited situations, travel between your home and place of business is not deductible. See TaxPack (NAT 0976) for information about motor vehicle expenses. TAX BASICS FOR SMALL BUSINESS 19

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