The tax opportunities and implications of running a small business

tax hotspots, audit

Small business is the engine room of the Australian economy and with the numbers of small businesses growing rapidly, allied to the explosion in the “gig” or “sharing” economy, 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?

Save tax and get your business structure right

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 26 per cent (provided the company’s aggregate turnover is less than $50m). The company can then distribute profits to shareholders in the form of franked dividends which are taxable to the shareholders less a credit for the tax already paid by the company.

In some cases, companies retain the profits, 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 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.

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, even if the business doesn’t go ahead).
  • Government fees and charges relating to setting up an entity (eg stamp duty).

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

There are also many examples of people, particularly in the sharing economy, who argue that they’re not really in business at all but are undertaking a “hobby”. They aren’t. The sharing economy is causing a big increase in the number of small businesses as people move into offering services through sharing economy facilitators.

Other major 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).
  • Not focusing on keeping records leading to missed BAS and tax return deadlines, missed tax payments and poorly kept records.

Mark Chapman, Director of Tax Communication, H&R Block