Deduct or Pay your Company Tax?
Ah, tax time!
Every business owners least favourite part of the year. Your accountant comes to you with a big sheet showing you a whole mess of figures and says "you need to buy something fast so you don’t have to pay tax!". But why? And perhaps more importantly, should you do this?
Where did this tax bill come from?
Let's say your business ‘Joes Copying’ sold $100,000 worth of photocopying services last year. To do this you spent $10,000 on toner and $15,000 on copy paper. These are business expenses, your business purchased them so they do not form a part of your profit. The ATO only taxes the profit a business makes (as compared to your personal income, where everything is taxed).
So after your costs of toner and paper are applied ($100,000 - $15,000 - $10,000), you are left with $75,000. You paid yourself $60,000 as a wage (and paid personal tax on that as an individual), leaving $15,000 ($75,000 - $60,000) as ‘profit’ on your accounts. As a company you have to pay 25% of your profit as company tax to the ATO - $3750!
No one likes to pay tax!
You don’t have $3750 lying around. Even though according to your books you should, that’s not how the world works. Maybe it got spent on next months bills, or it hasn’t been paid to you yet (your customers are on credit), or it's been used to pay back a loan (loan payments are not tax deductible). Still, you could scrape it together in a couple of weeks if you had to. But there is another option….
ATO vs the accountant
If you can find a legitimate business expense to spend money on, and if that expense equals (or exceeds) the profit you have on paper, then you can reduce your tax bill to zero. You still get your wage, the business spends more money and on paper doesn’t make a profit, but gets to invest the profits back into the business in the form of supplies, equipment or anything that relates to the running of the business (sorry, you can’t buy a dirt bike to reduce your company tax!)
The catch
To avoid paying the $3750, you would have to spend the entirety of your profit, $15,000! Sorry you can’t just spend the $3750 you would have paid the ATO, life isn’t that simple. And if you were having trouble finding $3750, you certainly can’t pick $15,000 off the ground. Come to think of it, what would you spend it on?
If you do have a need for something worth that much or more (maybe a better photocopier), and your business has sufficient cashflow, you could get a loan. By spending the loan on the piece of equipment for the business, you can claim a deduction of the $15,000, making your paper profit $0 and then avoid paying company tax. Great!
Buuuuttt, to do this your company has to:
Take on more debt - remember you have to service the loan (or pay the principal and the interest). This will cost you more than the tax bill.
Find the loan repayment money each month (which, as stated earlier is not tax deductible).
So now your balance sheet, this is the list of your companies assets (equipment, supplies, accounts receivable) and liabilities (accounts payable, loans, debts) looks worse. The company has less cashflow each month (you have to pay the bank back), but it didn’t have to pay tax. Not one cent! Plus you get that shiny new copier which can output more work for the company, earning more (hopefully enough to offset the loan)
So is it the right choice?
Look it really depends. It depends on your needs (how old is your existing copier, is it still working fine?), your cashflow (if your bank balance isn’t healthy and you can’t pay your suppliers, going further into debt is generally not a good idea) and macroeconomic factors (if the copying business is slowing down and you are looking to diversify to online business services, then investing a lot of money into a shrinking part of your business wouldn’t be smart).
And remember, this big expense only counts for the one financial year (unless it is more than the profit - carrying forward losses are for another time). Next year you are going to be faced with the same dilemma. Unless you actually need to buy something, it may be better for the business and you to pay the tax.
As a general rule, if you have a need for something and you have the means to get it, then it’s a good idea. If you can’t afford it or it’s not going to make you more money, then it’s not. Sometimes things are just that simple.
Sometimes it’s best to sigh and cut the cheque to the ATO, knowing that even though it hurts to just give that money away, it’s better than spending everything (or borrowing), to avoid it.
Need help understanding tax debt? Feel free to contact us today.
Disclaimer
This information is intended to be general in nature and is not personal financial advice. It does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided having regard to your objectives, financial situation and needs.
