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10 best tax strategies for SMEs

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25 / Jun / 2008

Business owners have limited options to save on tax – and they’re disappearing rapidly. We run through 10 of the best tax-saving strategies.

The best tax-savings strategies for SMEs in 2007-08 and beyond are spearheaded by the much-improved opportunities to save tax-effectively through super, to minimise or eliminate tax on the sale of small businesses, and to maximise the value from the successive cuts in personal taxes.

Crucially, business owners should be fully aware during their last-minute tax planning for this financial year that two of their most valuable chances to minimise tax are fast disappearing. These are the amnesty on shareholder loans that are in breach of stringent provisions in tax law, and the ability for members over 50 to make extra-large concessional (salary-sacrificed or deductible) contributions to super.

1… Take advantage of the shareholder-loan amnesty: Time is running out to meet the 30 June deadline for this amnesty that applies to past shareholder loans that are in breach of the much-feared division 7A of the tax act.

Tax commissioner Michael D’Ascenzo has given SME business owners this one-off opportunity to escape the hard-hitting provisions by bringing their past shareholder loans within the law. In short, this means bring any loan repayments, including interest, up to date – and ensure that there is a loan agreement that complies with the law.

Under the amnesty, the commissioner promises that private companies and their shareholders need “not be concerned about further inquiries” provided their past shareholder loans are brought within the law by his deadline. And as an extra condition of the amnesty, shareholders must ensure their tax returns are up to date.

Under division 7A, payments to shareholders are automatically deemed as unfranked dividends unless formal loan agreements are in place, and interest and capital payments meet stringent minimum standards by the end of each financial year. Interest plus penalties of up to 50% may also apply to loan arrangements that are in breach of the law.

Read the tax office’s practice statement on the amnesty for full details, including some excellent case studies.

Once the amnesty is over, some tax professionals expect the tax office to launch a crackdown on shareholder loans that are in breach of the law.

The provisions of division 7A are intended to meet a straightforward objective; to stop the profits of private companies being disguised as loans and distributed tax-free to shareholders.

2… Maximise big super contributions before the deadline runs out: As a transitional measure to introduce the new super system, fund members over 50 can make maximum “concessional contributions” (previously known as deductible contributions) of $100,000 a year until 30 June 2012, compared with an indexed $50,000 (for 2007-08) by members under 50. (Concessional contributions comprise salary-packaged contributions and tax-deductible contributions by the self-employed and investors.)

Don’t throw away this opportunity to contribute in the most tax-effective way – that’s if you have the money to contribute.

Keep in mind that from 2007-08, the self-employed are entitled to a 100% tax deduction for their contributions for the first time. This means that the self-employed no longer have to make bigger super contributions than employees to get the same size deductions.

3… Understand the much-more generous CGT concessions if selling your business: From the 2007-08 financial year, owners selling their small businesses benefit from a higher minimum asset threshold of $6 million, up from $5 million; and are, alternatively, eligible for the CGT concessions if their turnovers are under $200,000 – even if asset values exceed $6 million by a long shot.

Previously, business turnovers were not taken into account when assessing eligibility for the highly valuable CGT small business concessions.

The combination of the small business CGT concessions together with the standard CGT concessions available to all taxpayers may completely wipeout CGT on the sale of a business – whether held by individuals, trusts, companies or partnerships.

Consider the real life example of a farmer who had a $500,000 turnover yet has been offered $20 million for his farm. The farmer, whose land was rezoned as residential by the local council, is now eligible for the small business CGT concessions.

There would be a surprisingly high number of business owners whose properties used in their businesses have increased dramatically in value – despite their businesses having relatively modest turnovers. What an opportunity!

Proceeds from the sale of active small businesses that fall within the asset or turnover thresholds are either exempt from CGT, or qualify for CGT discounts or rollover relief. (The rollover relief applies if other active business assets are brought within two years.) See here for a rundown on the CGT small business concessions.

The assets that count towards the small-business assets threshold are the net value of the vendor’s business assets along with their personal shares and personal investment properties – together with those of their business partners, spouses, children under 18, and entities under their control. Personal-use assets and superannuation savings are not counted.

4… Contribute sale proceeds to super: SME vendors who are eligible for the small business CGT concessions could also consider, if appropriate for their circumstances, contributing as much as possible of the proceeds to concessionally-taxed super.

Eligible small business owners can contribute, as an after-contribution, up to an indexed lifetime cap of $1 million from certain proceeds from the sale of their businesses.

Proceeds that can be contributed to super under this special $1 million lifetime cap are those that qualify for the small business CGT exemptions – these are assets that attract the 15-year ownership exemption and gains that qualify for $500,000 retirement exemption.

The small business limits are in addition to the contribution limits that apply to other super fund members.

One of the biggest attractions of super savings is that lump sums and pensions paid to retirees over 60 are now tax free.

5… Consider contributing business property to super – with great care: Business owners who contribute privately-owned business properties to their DIY super funds can gain a series of tax benefits – including potentially eliminating CGT arising from the transfer of ownership.

Self-employed business owners – excluding those who operate through companies – can claim tax deductions for their personal contributions up to maximum annual caps for concessional contributions of $50,000 for those under 50 (the maximum for 2007-08), and $100,000 for those over 50.

Fund members are likely to contribute the premises accommodating their family business in the form of concessional (deductible) contributions and non-concessional (non-deductible) contributions.

(In 2007-08, the maximum for non-concessional or undeductible annual contributions is $150,000. Note that the legislation allows members to bring forward three years’ worth of non-concessional contributions to make a total of $450,000 in contributions in a single year.)

Often couples jointly own their business premises. Where this is the case, a couple over 50 could contribute their business premises valued at up to $1.1 million in 2007-08 as concessional and non-concessional contributions, yet remain within the annual caps.

Under superannuation law, business real estate – or “business real property” as it is labelled in the legislation – is one of the few assets that self-managed super funds are permitted to acquire from their members. Business real estate is one of the few assets that funds can lease to related parties, including the members’ businesses, without a limit on its value under in-house asset limits applying to DIY funds.

Amendments to superannuation law, in force from September last year, that allow funds to borrow through such means as instalment warrants may encourage more self-managed funds to acquire their members’ business premises.

On the positive side, the holding of your business premises in your DIY fund means that your business will pay a commercial rent to your fund and that rent, in turn, is taxed at concessional superannuation rates. Assets held in super funds are not accessible to trustees in bankruptcy in the event of a future financial setback suffered by a member – unless the contributions were made to cheat creditors.

Beware that the contribution of the premises of your business premises to your DIY fund has potential traps:

Your business may go through a difficulty period and have trouble paying rent to your super fund. This would cause somewhat of a dilemma for your fund would be obligated to pursue the debt.

Your DIY fund’s portfolio could become dominated by a single, high-value investment, namely the members’ business premises, and have little left for diversification in share, bonds and cash – if appropriate for the members’ circumstances.

A business property cannot be sold with the same ease as, say, listed shares in order for your fund to meet its obligations to pay member retirement and death benefits if needed.

Acquisition of business real estate should fit within your fund’s written investment strategy, which is required under superannuation law.

6… Defer private company dividends: Consider deferring private company dividends until after 30 June. In this way shareholders may pay less tax following the latest tax cuts confirmed in May’s federal budget.

7… Defer other personal income and capital gains until personal taxes fall again from 1 July: Methods to defer tax liabilities include putting off the issuing of invoices, delaying the sale of assets – if also appropriate for non-tax motives – until the new financial year, and, of course, not chasing up unpaid bills for a few weeks.

8… Accelerate personal deductions before taxes fall again on 1 July: Consider prepaying interest on investment loans for 12 months, carrying out last-minute deductible repairs and maintenance on investment properties, and prepaying premiums for your income-protection insurance.

9… Plan for 2008-09: Look at ways to reduce your taxes in the financial year ahead. Longer-term strategies to think about, if appropriate and effective for your circumstances, may include income-splitting with a lower-earning spouse, and taking a pre-retirement or transition-to-retirement superannuation pension.

Income-splitting by holding assets in the name of a lower-earning spouse is becoming more and more attractive with the successive rounds of personal tax cuts.

A strategy that is become highly popular for fund members in the final decade or so before retirement involves taking a pre-retirement pension, available only to fund members over 55, while simultaneously maximising salary-sacrificed super contributions.

Aside from potentially boosting super savings, the tax advantages of the pre-retirement pension strategy include; the taxable portion of the pension is taxed at marginal tax rates with a tax rebate of up to 15% until the member reaches 60 when it becomes tax-free, and the assets of the super fund that are backing the payment of the pension are exempt from income tax and CGT. Also the salary-sacrificed or deductible (known as concessional) contributions are not subject to income tax but the 15% superannuation contributions tax within the funds.

10… Confront the threat of Project Wickenby: “It could be time for small businesses that have taken part in these [tax-evasion] schemes to ‘fess up’,” says tax lawyer Robert Richards.

Apart from Operation Wickenby, the tax office is putting much more resources into attacking tax-evasion. Don’t be too smart with your tax strategies. There are plenty of legitimate ways to minimise tax.

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