Its June, and everyone is madly thinking how to reduce their tax bill. Media publications, accounting bodies, finance gurus are all posting on legal ways to reduce tax. Apart from a few options, most involve spending more money. But is reducing tax, at the expense of everything else, really the right approach to financial security?
EOFY Spending Craze
In the last month of the financial year, everyone seems to be having EOFY sales. Harvey Norman is discounting PCs, Milwaukee is offering cash backs for their tools, and fashion labels seem to be clearing out stock. The only difference this year is that with ongoing COVID supply chain issues and the world wide resource crunch, car dealers don’t have any stock to discount.
Are all these sales because these companies feel like being generous? No – its because they need a sales bump to report to their shareholders. Make no mistake – they’ll be paying tax on those extra sales, but to those companies, higher sales = happier shareholders, happier banks and happier staff. Tax is merely an expense that needs to be accounted for as part of their profit.
We too might be tempted to go out and grab a bargain – but is that what our business needs? Only recently, did someone ask me whether they should go out and buy a truck for $110k to reduce their tax. I asked them “do you need it”… which was answered with “no, but I don’t want to pay tax”. As business owners, we’ve been taught that tax under all circumstances is bad, rather than understanding that tax is a by-product of making a profit. In this case, the clients didn’t realise the most they will get back is $37,500 – and that the business is still out of pocket $72,500 for an asset they didn’t really need.
The changing roles of accountants
2 years ago, the main topics we discussed at EOFY meetings is how to lower the end of financial year tax. 1 year ago, that topic was how much more JobKeeper or Cashflow Boost can I get and whether my business will survive the COVID pandemic. This year, more and more, I see the words “wealth”, “retirement”, “security” in my EOFY meeting notes.
No longer are accountants judged on whether they can minimise tax the best or keep the ATO at bay. No longer do clients find visiting their accountants an annual chore. We’re now being asked to help with personal budgets, set goals for the future, discuss cashflow, design buffer budgets and in a few recent cases plan cash flows for business owners expecting time off for maternity leave (and how best to manage their interaction with Centrelink and smooth out their taxable income).
Legally minimize taxes
There is nothing wrong or illegal with managing or legally minimizing tax. This could be through using the right structure to income split and lower overall tax, using a corporate entity which holds profits and is taxed at a lower rate, contributing to super (moving from one bucket to another).
Other strategies include prepaying expenses to obtain tax relief in this current financial year (small business corporate tax rate reducing on 1 July), restructuring into a different entity, paying out bonuses early or bringing forward any NEEDED asset purchases.
Having the right entity can make a huge difference when it comes to sell or retire from your business – the goals should be laid out and updated regularly.
Focus on the average tax rate, not the amount
One thing I’ve been working with clients this year, especially those who have had a bumper year and are receiving tax bills higher than ever before, is to focus on the average tax rate. Vary rarely do we see clients go over the 30% average tax rate across their personal/business/super income. Those clients are managed very carefully.
Now consider these examples… which one would you rather be:
a) Earning $200,000 and paying tax at 20% = $40,000; or
b) Earning $1,000,000 and paying tax at 30% = $300,000.
Personally, I would love to be in a position to pay $300,000 tax as I would have $700,000 in my bank.
Reinvest in yourself
Take the previous example of the business owner consider that truck purchase. Rather than buying the truck that didn’t need to be bought, I proposed that we pay the tax and the remaining $72,500 can be reinvested into themselves/business:
– a new employee to take some the stress of running the business and focus on growing the business or go on holidays
– a new fit out to improve staff productivity
– hold onto it and start looking at buying a commercial property rather than renting
– look at purchasing an investment property and generate passive income for retirement
Successful businesses all pay tax. If they didn’t, what is the point?
Higher income = higher taxes = higher borrowing power
Own a small business and want to buy a house – good luck! Since COVID, the hurdles for business owners wishing to borrow have been raised to high jump levels. Banks are now tending to focus solely on taxable income (with adjustments for depreciation etc.) rather than strict financial statement income and are applying far greater scrutiny to all financial information. The banks’ reliance on taxable income is because business owners can shift accounting income, but tend not to push the ATO too much, which requires a level playing field. Cashflow Boost is an example between accounting income and ATO taxable income – many businesses received up to $100,000 profit boost just from the CashFlow Boost, but for income tax purposes and bank serviceability, this was not counted as income.
COVID has delayed purchasing the new family home or investment property, and now we have families needing to move just as prices are increasing. Selling high, buying hopefully not too much higher is now a reality for most upsizers. Take the previous example of delaying the truck purchase of $110,000. The payment of $37,500 of tax, gave a 3x multiplier in borrowing capacity of the foregone expenditure – adding an extra $300,000 in borrowing capacity and being able to purchase a larger home while locking in record low interest rates: ATO happy; Family happy; Bank happy.
Social contract
Previously the idea of a great accountant has been one that will make sure you pay as little tax as possible. Now, the accountant is responsible in assisting business owners meet their social contract – providing employment, being a good corporate citizen and paying suppliers, complying with the law in respect to health and safety, taxes etc. – and being rewarded with not only thankless long hours and risking everything… but a few tax concessions (exempt fringe benefits, income splitting). More and more, the role of the accountant is to work with clients not just towards 30 June, but discussing their family, retirement, and lifestyle goals.
It would not be a complete article if I didn’t mention why we pay taxes. Australia, on the whole is a great place to live. While we all whine at the Sunday BBQ of paying too much in tax, we forget how lucky we are to have a (at most times) functioning Government, health system, education system, and that our wealth is protected (protected by law, the police, the courts and even from rampant inflation).
So the next time you’re concerned about paying too much tax, look at your average tax (not the dollars), look at whether the expenditure is actually needed, and whether you can leverage the profit to build wealth outside of the business.
Michael Konarzewski is a partner of Jigsaw Tax and Advisory.
