blakes go guides small business and tax

7/31/2019 Blakes Go Guides Small Business and Tax

1/66

BlakesGOGUIDESS i m p l e g u i d e s t o a c o m p l e x w o r l d

SMALLBUSINESS

T

AX

Lyndal Taylor

Your Easy Guide to:Paying the right amount of taxClaiming all eligible deductions and rebatesUnderstanding GST, CGT and FBTYour tax rights and obligations

and

Updated for the200607 tax year


2/66


3/66

Copyright Pascal Press 2003Revised editions 2004, 2005 and 2006

ISBN 1 877085 26 X

Pascal PressPO Box 250Glebe NSW 2037(02) 8585 4044www.pascalpress.com.au

Publisher: Vivienne Petris JoannouEditors: Jane Tyrrell and Emma DriverSeries editors: Emma Driver and Ian RohrPage design, layout and cover bydPty LtdPhotos by Comstock, Ingram Publishing and PhotoDiscPrinted in Australia by Printing Creations

Apart from any fair dealing for the purposes of study, research, criticism or review, aspermitted under the Copyright Act1968, no part may be reproduced by any processwithout written permission. Inquiries should be made to the publisher.

Please note: No person should rely on the information provided in this guide withoutfirst obtaining professional advice. This guide has been prepared and is published forthe purposes only of providing guidance in relation to the subject area covered and issold on the understanding that: (i) the authors, the publisher and all other personsinvolved in the preparation and publication of this guide are not engaged in renderinglegal, accounting or other professional services; (ii) the information contained inthis guide is current at the time of publication of this guide and is subject to changeat any time without notice; (iii) no warranty or representation is made with respectto the information contained in this guide or its accuracy, except those warrantiesor representations which are not permitted to be excluded under applicable laws,

including in relation to the content of any websites referred to in this guide; and(iv) the authors, the publisher and all other persons involved in the preparation andpublication of this guide are not responsible or liable to any person (whether or nota purchaser or user of this guide) for any error or omission in this guide, for anyconsequential loss or damage in connection with the use or reliance on any or all ofthe information contained in this guide, or otherwise in connection with the use orreliance on any or all of the information contained in this guide.


4/66

S M A L L B U S I N E S S a n d TA X

i i iS M A L L B U S I N E S S a n d TA X

A N O T E F R O M T H E P U B L I S H E R

We make a lot of crucial decisions about our taxation, legal and investment

issues with very little comprehensible information at hand. We are often

dealing with people like lawyers, accountants and real estate agents whoknow a lot about these topics. This puts the average person at a big

disadvantage, and can lead to you getting the worse end of the deal.

That is why I decided to extend the Go Guide series into the areas

of tax, law and investment. I wanted to provide people with enough

information to be able to at least ask the right questions and to avoid the

pitfalls that are so easy to fall into.

As readers of the previous Blakes Go Guides on computer topics will

know, our goal is to break through the information overload and provide youwith only the really useful material that you will need in every day life.

If you have any comments or ideas on how these books could be improved

further then please dont hesitate to email me at [email protected].

Matthew Blake

Publisher

A B O U T T H E A U T H O R

Lyndal TaylorBA LLM UQ LLM Bond Grad Cert H Ed UNSW, Solicitor ofthe Supreme Court of Queensland and High Court of Australia, is a Senior

Lecturer in the Faculty of Law at the University of Technology, Sydney,

and coordinates the postgraduate Master of Taxation Law and Master of

Financial Services Law courses at UTS. She has been a tax and commerciallaw teacher for over 16 years and has written a number of articles in the

area of taxation law and commercial law. She is also a member of the

Consumer, Trader and Tenancy Tribunal (NSW).


5/66

iv B l a k e s G O G U I D E S

T A B L E O F C O N T E N T S

Introduction ................................................. vi

Are you in business?.......................................

7What sorts of evidence do small business operators need to satisfythe ATO that they are in business?

Business income ............................................ 9Find out what is included in a businesss taxable income and thedistinction between capital gains tax and income tax. How will yourprofi t be assessed?

Business deductions ...................................... 11What expenses are deductible as a business expense?

Types of business entities .............................. 13How do the rules relating to your business structure affect you andyour business? Are you operating as a sole trader, partnership, trustor company?

Sole traders and partnerships ...........................16Discusses the advantages and disadvantages of each structure.

Trusts ......................................................... 19Fixed trusts and discretionary trusts are explained and how tochoose a trustee.

Companies...................................................

22How a corporate structure can protect family assets, and the effectof the new Simplifi ed Imputation System.

Personal services income regime ...................... 27How do you tell whether your business is a personal services business?

Fringe benefits tax ........................................ 29

Categories of fringe benefi ts, whats exempt, when you should payyour FBT and how to calculate your FBT liability.

Capital allowances ........................................ 37Calculating depreciation on your business assets.


6/66


7/66

vi B l a k e s G O G U I D E S

I N T R O D U C T I O N

Taxation is an area which intimidates and confuses many small

businesspeople. Often wed prefer to leave it to our financial professionals

and let them work the magic. But, understanding the basic principles oftax and how they affect your business is invaluable if you want to stay on

top of your businesss financial affairs. Of course you cant do it without

a professional, but you can at least understand the terminology and the

rules, and by doing so can save yourself money in the long term.

This book covers a wide range of tax issues that affect small businesses

in Australia. How does the structure of your business affect how much tax

you pay? What sort of things are deductible to save you money? How does

depreciation work? How do fringe benefits tax, GST and capital gains taxaffect your business?

It aims to give you basic background knowledge on how taxation

issues are affecting your business, and to explain the important terms and

concepts you will hear about through your tax adviser or from the Australian

Tax Office. Armed with this knowledge, you will be in a better position to

make more informed decisions about tax issues in your business, and will

save yourself plenty of headaches along the way.

With the right knowledge and a qualified financial professional to assist

you, theres no reason to be baffled by taxation again. But, remember that

it is essential that you consult a qualified tax professional to give youspecific advice for your own situation. Dont think you can do it alone.


8/66

7S M A L L B U S I N E S S a n d TA X

A R E Y O U I N B U S I N E S S ?

Accessing the tax system for businessThe Australian tax system operates differently for wage earners and

business operators. To access the tax system for business, you mustsatisfy the Australian Taxation Office (ATO) that you are in business. To do

this, you will need evidence of the following:

w a profit motive

w system and organisation

w record-keeping

w dedicated office space

w recurrent and regular activityw possibly trading stock

w possibly employees.

Even if you are a small business or not currently making a profit, it does

not mean that you are not in business. You could still be entitled to

business deductions.

What is not a business?You are not in business if you carry on a hobby, even if such activity isdone profitably. What defines a hobby is that the prime motivation to

undertake the activity is personal enjoyment.However, if the hobby becomes your main form of income or main

activity, the ATO will probably consider this a business. To determine

this, consider:

w How much time do you spend on your hobby?

w Do you still have a day job?

w Do you have systematic accounting records?

w Is it a regular activity?

w How large a sum is gained in relation to the time you spend?

w What is the main reason for you undertaking this hobby: personalrecreation or financial gain?

If you are engaging in your hobby with the primary intention of

making a profit and are dedicating significant time to the task, it willmost likely be seen as a business and any income must be disclosed in

your taxation return.


9/66


10/66


11/66

B l a k e s G O G U I D E S

B l a k e s G O G U I D E S10

w If these profits had been paid to you as salary or dividends, theinterest earned would form part of your personal income.

One-off transactionsIncome earned from one-off transactions in the course of carrying on abusiness, even if done in an unexpected way, may form part of the business

income. If the business is paid a lump sum compensation amount for lossof profit, or as consideration for an income stream, the unexpected lump

sum might still be classed as assessable income.

So, all trading profits related to the business must be included asbusiness income. One-off profits might need to be. Capital gains will beultimately included in the income tax return of the business. How much

gain is taxed depends on the specific application of the CGT provisions(see pages 43-46).

Lease incentivesA cash incentive paid to you to encourage you to enter into a lease isclassed as assessable income. This is seen as a payment that you have

received in the course of your business. The same approach applies to

lease surrender payments.If you receive a non-cash incentive that could be converted to cash,

such as a car, the value of the car will be brought to account as assessable

income. Even where the item is not convertible to cash, an estimate of its

value will be made and brought to account as income.

However, some lease arrangements will be tax effective, including rent-

free periods, interest-free loans for business purposes, free fit-out paid by

the landlord or a free holiday.


12/66


S M A L L B U S I N E S S a n d TA X 11

B U S I N E S S D E D U C T I O N S

What is a business deduction?A business deduction is a loss or amount that you spend in the course of

carrying on your business.

w Costs incurred to start up a business (such as plant and equipment, shopfittings, franchise fees, initial building costs and costs of trademarks or

patents) arenot income tax deductible. These are capital costs.

w Costs incurred to wind up a business might not be tax deductible.

From 1 July 2005 blackhole expenditure, which is business-related

expenditure that is not tax deductible or claimable in the CGT cost base,

can be written off on a prime cost basis (see page 37) over five years.This does not mean, however, that you cannot claim tax deductions in

later financial years for liabilities incurred while you operated a business,if they have come to account much later.

Home office expensesIf you operate your business from home, you can claim the cost

of your home office (see Blakes Go Guide: Tax and You). However,if you sell your home, you will lose your capital gains tax mainresidence exemption for that proportion of your home (see page 44).This means that you will have to pay some capital gains tax if you sellyour home, when usually you would not.

Whether you can claim home office expenses depends on what kind ofwork you do and whether you have an office to do it in. To claim the full costsof a home study (such as a proportion of your rent or mortgage, lighting,

electricity, heating and stationery costs), you must be able to show that yourhome study is a place of business, not just used for convenience. To establishthis, it is best to have the study separate to the house, with separate telephone

line and electricity meter. If you do not have separate meters, the ATO advises

that you should claim home office expenses at 26 cents per hour, not as a

proportionate area of your home. It is more difficult to claim a home study if

you have another office to go to. Here the ATO could claim that you worked at

home for convenience and therefore could not claim the deduction.

If you do undertake paid work or business activity in the home study, you canclaim the running costs of the study: the separate telephone bill, electricityand depreciation on your equipment (such as computer, books, desk, carpet andcurtains in the study). This is often a better option than claiming a proportion of

your home mortgage as a home study: if you do this, you will lose the equivalent

proportion of capital gains tax exemption for your main residence.


13/66



Other costsYou can also claim all the costs related to the running of your business, suchas bank account charges, stationery, telephone expenses, car running expenses

used for business purposes, employee wages (subject to the personal services

income regime discussed on page 27), superannuation, long service leave and

annual leave entitlements. All claims should be documented and accounted for.

InsurancePremiums paid for certain forms of insurance are deductible, such as workerscompensation premiums paid by an employer. As an employer, you are alsogenerally entitled to claim the cost to insure against the death or disablement

of your employees. An employee or self-employed person can also take out

disability insurance and claim the premiums as a tax deduction. You cando this if the insurance is to replace the workers income should he or she

be disabled. However, you cannot claim the cost of premiums if the benefit

is a lump sum, say for the loss of a limb. Premiums for trauma policies,

where a lump sum payment is made for specified illnesses, are also unlikely

to be deductible. The reason for this is that lump sum payments are viewed

as capital. Deductions can only be claimed for insurance to protect yourincome stream. Key-person life policies are considered non-deductible

unless the payment is used to ensure continuing revenue.Costs of other general insurances taken out in the course of your business,

such as for fire, burglary, public liability, loss of profits and motor vehicle

insurance, are generally deductible. Premiums for professional liabilityinsurance to cover acts occurring in the course of carrying on the business

are also deductible. Similarly, if loss of money by theft or embezzlement is

not covered by insurance, it can be claimed as a tax deduction.

Tax-related expensesYou can claim costs that you incur in dealing with your taxation affairs,for example, costs associated with:

w having your tax return prepared

w fees for professional tax advice

w lodging your tax return electronically

w attending an ATO audit

w objecting to the Commissioners assessment

w appealing an assessment through the AAT or the Federal Court.

You can only claim the cost of professional tax advice from a recognised

adviser such as a tax agent/solicitor. For Simplified Tax System (STS)taxpayers, this cost is deducted when the expense is actually paid.


14/66



T Y P E S O F B U S I N E S S E N T I T I E S

Are you a small business?A new

Simplified Tax System(STS)

was introduced from 1 July 2001

for small businesses. Special rules apply to small business in relation to

accounting arrangements, depreciation and trading stock rules.

To be a small business your business and related businesses must havea turnover of less than $1 million net of GST credits ($2 m from 1 July

2007) and have less than $3 million in depreciating assets at the end of

the tax year (not applicable from 1 July 2007).

If you satisfy the small business criteria and wish to use the STS, you

must notify the Commissioner on the approved form. You can then chooseto opt out of the system, but in this event you cannot re-enter the system

for five (5) years. If you fail to meet the eligibility criteria, you will also

leave the system.

STS taxpayers will use the cash accounting method. Under this method,income comes to account as soon as it is received, and you can claim

deductions when they are actually paid. This does not extend to specific

provisions such as the capital gains tax regime.

Structuring a small businessA small business can be structured in a number of ways. You could be

a sole trader, a partnership, a trust or a company.The table below briefly summarises some of the considerations

when deciding which entity to use. Be careful that you do notdivert personal services income in a manner that is considered to be taxavoidance (see page 27).

EntityIncomesplit?

Fringebenefits tax?

Deductwage totrader?

Pass on losses?

Sole trader No No No Qualified yes

Partnership Possibly Not for partners No Qualified yes

Trust Possibly Not forbeneficiaries

Yes No

Company Possibly Yes foremployees

Yes Not toshareholders


15/66

14 B l a k e s G O G U I D E S

Entity

Dividendimputationcredits onprofits?

GST?Capital

gains taxdiscount?

Limitedpersonalliability?

Sole trader No Yes, ifturnover

over$50 000

Yes No

Partnership No Yes, asabove

Yes No

Trust Possibly Yes, asabove

Yes Yes, forbeneficiaries

Company Yes Yes, as

above

No Yes, for

shareholders

The type of entity you use affects the manner in which tax is collected andimportant issues such as protection of assets. You should speak to yourfinancial adviser to decide which structure is best for you.

Superannuation contributionsThere are particular provisions for superannuation contributions for small

business. Eligible persons (those who are self-employed or without employer-sponsored superannuation for the whole of the year) are also entitled to taxdeductions for personal superannuation contributions if they contribute to a

complying superannuation fund. Substantially self-employed people are thosewho receive less than 10% of their total adjusted income from employment on

which employer-sponsored superannuation contributions has been paid.

There are limits on how much you can deduct for superannuationcontributions. From 1 July 2002 you can claim the first $5000, plus 75%

of the excess amount contributed over $5000, subject to a maximum levelof deductions based on age. For example, the greatest amount eligible

persons could claim as a tax deduction for personal superannuationcontributions in the 2006/2007 tax year are:

Age Limit of deduct ion

Under 35 years

3549 years

50 years and over

$15 260

$42 385

$105 113

These deduction thresholds alter each tax year. There are also specificregulations for the spouse of the taxpayer. From 1 July 2007 you canclaim 100% of your superannuation contributions, up to a limit of $50 000

p.a. or $100 000 if you are over 50 years of age (until 2012).


16/66


Limits on losses fromnon-commercial business activities

Special measures have been introduced to prevent losses from non-

commercial business activities from being deductible against the incomeof an individual taxpayer (whether alone or in partnership). The businessloss can only be deducted against other income if it satisfies one of thefollowing four tests:

1 The assessable income from the activity is at least $20 000.2 The value of the real property used in the activity is $500 000 or

more.

3 The total value ofother assets (other than motor vehicles) used on a

continuing basis is at least $100 000.4 The particular activity resulted in a taxable income (profit) for at least

three out of the last five income years.

The Commissioner may also choose to allow the deduction, even if noneof the tests is satisfied.

The limit does not apply if:

w the individual is carrying on primary production or is a professional

artist whose income from other sources does not exceed $40 000; or

w the activities (such as negative gearing of a property or shares) do notconstitute a business.

This means that if you earn $2000 income from an olive farm but have

$15 000 worth of costs, either on your own or in partnership, you cannot

deduct those costs from other income you have earned (Test 1, above)

unless the real property costs more than $500 000 (Test 2).

In effect, these limits mean that any hobby will have to earn inexcess of $20 000a yearto entitle you to claim any costs associated withearning it. Again, this is subject to the other tests relating to the value of

the real estate or active assets that are used for income production.

However, if you own shares in acompany that carries on the businessof olive farming, or have units in a unit trust, the business entity can stillclaim the losses against the entitys other earned income. A company or a

trust cannot pass on losses to its individual shareholders or beneficiaries

(see below). You can, however, negatively gearan investment in capitalassets (such as real property or shares). If you borrow to buy the shares,and the company cannot make a distribution of profits, the interest youpay to hold the shares will be tax deductible against your other income.


17/66


S O L E T R A D E R S A N D P A R T N E R S H I P S

Sole tradersIf you are a sole trader, this means that you carry on business on your own.

You might employ other staff, but do not have any partners.You might be working from home, and in this case, you should

consider claiming home office expense deductions (see Blakes GoGuide: Tax and You).

You will probably also use a carfor work purposes. As it is legallyimpossible to employ yourself, fringe benefits tax is not an issue.

However, to claim the work-related expenses relating to the car you must

keep appropriate records, including a log book. In other words, you needto substantiate all your business expenses.

If you have tools of trade, you can depreciate these items. The costof employees wages is claimed as a tax deduction against the income that

you earn.

If you are a sole trader, you cannot split your earnings with yourpartner or spouse. To do this, you must be in partnership.

W h a t e l s e s h o u l d a s o l e t r a d e r c o n s i d e r ?Even though fringe benefits tax will not apply to benefits provided tothe individual sole trader, similar allowances, compensations or benefitscould still be included in the sole traders assessable income if they relate

directly to the services rendered, such as a client giving you a watch to

thank you for good service.

If you are a small business that earns less than $20 000 per year, it

might be argued that the non-commercial losses provisions apply to you(see page 15). If this is the case, you will not be entitled to deduct costs

incurred in carrying on your enterprise.

If you are a consultant, you should carefully consider the personalservices income regime to determine whether this applies to you (seepage 27).

PartnershipsThe main tax advantage in having a partnership structure is the capacity

to split the incomeearned between partners. There are, however, anumber of considerations for this. A partnership can be structured so

that one controlling partnerhas the ability to control the disposal ofthe partnerships income. If this is the case, the income is classed as

uncontrolled partnership income and an extra tax is payable on it.Essentially, this means that the top tax rate is applied to this income.


18/66


19/66



tools. This $2500 is classed as partnership income in the hands ofthe partner.

w If, however, the partner had genuinely lent the partnership $50 000,the interest on the loan would be the separate income of the partner,

and the interest paid by the partnership would be deductible from thenet income of the partnership.

w Any payment made to a relative or related entity must be a reasonableamount for the services rendered or otherwise the Commissioner ofTaxation may disallow a deduction for the cost.

At the partner level, the partner will declare any share of the net incomeof the partnership in his/her tax return. If the partnership has made a loss,

the partner can claim the loss against any other earned income (subjectto the non-commercial losses rules on page 15). If his/her income in theyear is insufficient to absorb the loss, it can be carried forward to thenext year.

C h a n g i n g t h e p a r t n e r s h i pApartner can assign or transfer his/her interest in the partnership toanother person. The right to a partnership interest is an asset that canbe sold and transferred. To do this successfully,

all rightsrelated to the

partnership interest must be transferred. To be effective, the assignment

must occur before the declaration of the net income of the partnership

(usually as at 30 June). If this is done, it is effective for all the income

earned in that tax year. If the partnership is dissolved, or a partner isadded or resigns, the partnership accounts must be struck. Partners areliable for the profits or losses determined at this point as well as at the

end of the tax year.

Additionally, a partnership may be required to notify its partners ofits instalment income under the Pay As You Go provisions, so that apartner can make an instalment payment (see page 54). This is only aninstalment of tax, which is an estimate of the tax payable. At the end ofthe tax year, when the net income of the partnership is finally determined,

the balance of tax payable or a refund will be calculated.

Structuring your business as a partnership can be tax effective as

you can share the income so that each person can access lowertax rates and direct more income to the lower income earner.However, where the partnership involves life partners, the ATOis concerned to check that it is in fact a business arrangement.


20/66



T R U S T S

Types of trustsThere are a variety of different trusts. Each trust must have a trustee whois the legal owner of the all the assets of the trust, and one or more

beneficiaries who are entitled to the benefit of what the trusts owns.Originally, trusts were set up to protect those unable to deal with their

own affairs, such as children or the mentally ill. The trustee would manage

the trust estate for their benefit.

Trusts fall into two main categories fixed trusts or discretionarytrusts.

F i x e d t r u s t s

Fixed trusts, such as unit trusts, provide for a fixed proportion of interestto each nominated beneficiary. For instance, if there are 100 units in the unit

trust, a person who holds ten units will be entitled to 10% of the income of

the trust. However, it is possible to have different rights to income from the

trust. So it could be that only holders ofA class units share in the capital orassets of the trust, plus income flowing from the trusts investments, while

holders ofB class units share in income only.

D i s c r e t i o n a r y t r u s t sA discretionary trust works on the basis that a nominated person, usually

the trustee, can decide who will gain the benefit from the trust (usuallyby way of resolution at the end of the tax year). The persons who can benefit

are within the class of beneficiaries listed in the trust deed. For family

trusts, this often is all the relatives of a certain person. A discretionary

trust has the flexibility to have the income of the trust distributed to the

lower-earning members of the family who pay less tax. (There are special

taxation provisions for minors, discussed on page 21.)Importantly, unlike partnerships, trusts cannot pass on losses to individual

beneficiaries. The very purpose of a trust is to protect its beneficiaries,and only benefits can be passed on to the beneficiaries. This means thatbeneficiaries cannot offset trust trading losses against their other income inthe same way as a partner in a partnership can. However, the trust can carry

forward the losses to be applied against earnings in future years.

Trustees and settlorsWhen establishing a trust, it is very important to choose the trusteecarefully. Generally, a company is appointed as a trustee, which allowsfor continuity of the trust and allows for all members of the family to be

beneficiaries. If you do not establish a trustee company, the person you


21/66



nominate as trustee must be someone of strong integrity in whom youcan place absolute trust. This is because the trustee has legal ownership of

the assets of the trust, and can buy and sell them.

The other person you need to establish a trust is a settlor. The settlor

is the person who sets up the trust with a cash payment, which could beas low as $10. It is very important that the settlor is nota parent of minor

(under-18) beneficiaries of the trust. Where this happens, the Commissioner

can claim that the trust is a revocable trust. A revocable trust is one inwhich the terms of the trust deed can be altered to give the settlor a

beneficial interest in the trust income or property. If it is deemed to be a

revocable trust, the tax payable is equal to the marginal rate of the settlor.

Paying taxFinding out who is responsible for paying tax on the earnings of the trustdepends on a number of interlinking factors.

Step 1 : The first step is to determine the net income of the trust asif the trust were a resident taxpayer. This is a calculation of the income

earned, less the allowable tax deductions.

Step 2 : Next, determine how much is payable to which beneficiaries. This

will depend on whether it is a fixed trust or a discretionary trust. The trusteewill have to pass a resolution as to how the income is to be distributed.

Step 3 : The next step is to determine who are the beneficiaries. Whopays the tax and the tax rate depend on the qualities of the beneficiaries.

There are three issues to consider:

w Are they residents?

w Are they presently entitled to the money, that is, can they demand

immediate payment?w Are they under a legal disability, such as being under 18 years of age?

A r e t h e y r e s i d e n t s ?Any resident beneficiary who is able to deal with his or her own affairs(and is not under a legal disability) is responsible for the tax payable on

his or her trust distributions.

In the case of beneficiaries who are considered unable to deal with

their own affairs (such as children, the mentally ill or non-Australian

residents at the end of the tax year), the trustee is liable to pay the tax on

the trust on their behalf. The trustee is also responsible for the tax payable

where a person has a right to income from the trust, but cannot claim

it immediately (for instance, where a trust is established so that a child

cannot claim the income until he or she is 25 years of age).


22/66


23/66



C O M P A N I E S

Company structureOne of the primary benefits of a corporate (company) structure is that ifthe business is not successful, family assets are protected (subject tocertain exceptions), because only company assets are sold to pay back

the businesss debts. A company structure also allows for a degree of

income-splitting. However, note should be taken of the personal servicescompany provisions discussed on page 27.

Generally, a company will have two directors (public companies willhave up to five) and a number of shareholders who purchase shares inthe company. A company must also have a Public Officerwho deals withtaxation matters.

SharesDifferent categories ofshares can have different rights. Some shares mightonly give rights to income earned by the company, while others mightgive rights to the capital or the property of the company. However,the proportion in which the rights to income or capital are allocated is

determined according to the number of shares each shareholder owns.This does not allow for the flexibility of the discretionary trust structure.

As in a trust, a company cannot pass on its losses to its shareholders.Shareholders cannot then offset any business losses against their own

income (although they may have a capital loss if they sell their sharesand the value of the company has fallen). A company can employits directors and claim deductions for the directors salaries andsuperannuation contributions. However, as directors are employees,

any benefits may be subject to fringe benefits tax (see pages 29-36).

DividendsThe shareholders of the company will receive the profits of the company

in the form ofdividends. Individual shareholders can then benefit fromdividend imputation credits if they receive franked dividends (seeBlakes Go Guide: Tax and You). If the credits exceed the tax paid by the

shareholder, the shareholder can claim a refund for the excess.

However, there are two situations in which dividend imputationcredits cannot be claimed:

w The first is where a private company (a company that is not listed onthe stock exchange) makes a loan to a shareholderor an associate


24/66


25/66


26/66


If the company does not do so, it may be liable for over-frankingtax or a franking debit. The company must notify the Commissioner ofTaxation if its benchmark franking percentage differs significantly from the

benchmark franking percentage for the last franking period.

Paying taxCompanies have a different system oflodgement and payment of tax toother entities. A company lodges its tax return according to its lodgement

category and the tax return will reflect the income for the previousfinancial year. For example, the 2002/2003 lodgement season would return

the income for the 2001/2002 tax year. The lodgement dates depend on

the size of the businesss turnover. The lower the turnover, the earlier the

tax return needs to be completed.

Companies should pay their tax in instalments over the financial year.Generally, quarterly instalments must be paid. If the companys income

year ends on 30 June, and it pays GST on a quarterly basis, the instalmentdates would be:

Quarter ending Instalment due

30 September

31 December

31 March

30 June

28 October

28 February

28 April

28 July

There are different instalment dates for companies that lodge GST on

a monthly basis. PAYG instalments must be paid electronically if thetaxpayer is required to lodge its GST return electronically. The company

rate of tax from 1 July 2001 is 30%.

Passing on lossesA company can carry forward any losses it makes indefinitely. This issubject to the company either being owned by the same persons or

carrying on the same business in the loss year as in the year the

loss will be absorbed against other assessable income. If either of

these two tests are not satisfied, the loss cannot be carried forward

to be offset against future income gains.

C o n t i n u i t y o f o w n e r s h i p t e s tThefirst test is the continuity of ownership test. This will be satisfiedif more than 50% of voting powerof the company, 50% of the rightsto dividends, and 50% of the rights to capital of the company


27/66


are beneficially owned by the same persons. This means that if the

60% of the shares of the company are sold, the company cannot

carry forward its losses. When this test is not satisfied, the company

might still be able to carry forward its losses if it passes the same

business test.

S a m e b u s i n e s s t e s tThesame business test is satisfied if the company carries on the samebusiness in the claim year as was carried on immediately beforethe change of ownership. The same business means in the nature of

the same business it does not have to be identical. For instance, a

business of distributing and installing swimming pools is not the same

as the manufacturing, selling and installing of pools. Where there isa change in the way business is done, such as different clients and

different employees at a different place with a different name, the test

might not be satisfied.

The same business test also requires that the company does not deriveincome from a business that it did not carry on before or enter into atransaction of a kind that it has not entered into previously. For instance,

you cant buy the shares in a company that operates clothing stores (and

has carry forward losses) and continue to operate the clothing stores butalso launch into property development and claim the benefit of the carried

forward losses.

Transferring losses within a company groupIf the company is a member of the same-wholly owned group, the company

can transferits losses to other companies in the group. This means thatthere must be 100% common beneficial ownership of the two companies.

Both companies must be resident companies and the transferee company

must have income against which to offset the transferred loss. The loss

can be transferred in whole or in part to one or more companies in the

group. These measures have been enhanced with the introduction of

consolidation for companies.

Claiming losses for bad debts

An entity cannot claim a lossfor a bad debt unless the income for thedebt had previously been brought to account as income for tax purposesand the loss has been officially written off. Additionally, a company cannot

claim a deduction for a bad debt unless it satisfies either the continuity of

ownership test or the same business test (discussed above).


28/66


P E R S O N A L S E R V I C E S I N C O M E R E G I M E

What is PSI?Personal services income (PSI) is income earned through salary or wages,or as a consultant by exercising effort or skill, when the work has

been done for a partnership, trust or company (a personal servicesentity). It does not include income generated through investmentin property or the carrying on of a business.

The Personal Services Income regime came into effect in the2000/2001 income year (but its enforcement was deferred to the

2002/2003 income year for people who operated under the old Prescribed

Payments System). Its effect is to include personal services income in

the assessable income of the person whose work earned the income,regardless of the entity into which the income was channelled.

For an entity to fall within the PSI regime, more than half the incomereceived by the entity must be personal services income. The entity must

also consider whether one individual has contributed to more than half

of its income, or whether the efforts of other employees or the use of

intellectual property also contributed to the earnings.

DeductionsThe deductions claimable are limited to those able to be claimed by anemployee, rather than a business subject to a number of exemptions.

A personal services entitycan stillclaim deductions for:

w entity maintenance deductions, for example bank accounts for a trust

w car expenses, for a car that has no private use, or car expenses andrelated fringe benefits tax, limited to one car per person

w superannuation contributions but if a person contributes less than20% of the personal services income, the entity can only claim the

superannuation guarantee scheme contribution (see page 52)

w salary or wages paid to the person who earns the personal services income.

Personal services business (PSB)A personal services business (PSB)is not caught by the regime. To beclassed as a PSB, you need to satisfy the

results testorthe

80% rule.

To satisfy the results test at least 75% of the PSI must be income for

producing a result (such as producing computer software, rather thanworking as a programmer) where:

w the individual supplies his/her own tools of trade


29/66



w the individual is liable for the cost of rectifying any defect in the workproduced.

In other words, the PSI earner is an independent contractorand not

an employee.Alternatively, you can satisfy the 80% rule, where no more than80% of the personal services income is earned from one single client,

plus one of the three other tests for qualifying as a PSB.These are the:

w unrelated clients test: the service provider must gain income from twoor more entities as a result of public offers (for example, advertising)or

w employment test: at least 20% of the principals work must beperformed by employed persons or

w business premises test: the business must be conducted from premiseswhich are used exclusively for business and which are physicallyseparate from the home or an associates premises.

If it is unclear whether you satisfy the above tests, you are best advised to

apply to the Commissioner for a Personal Services Business Determination

to state that you are a personal services business.

Give careful consideration to choosing the right businessstructure for you. Tax matters are only one issue to considerwhen making your final decision.

When you take over a business, negotiate the most tax effective

way of buying the business. If you want to take advantage ofcompany losses, think carefully about making major changesto the way the company does business before the losses havebeen claimed.

Be careful to separate your deductions between your businessand your personal affairs. The PSI regime only applies to yourbusiness deductions. You might fail the tests in a new business

because it is operated from home though this does not meanthat you cannot claim other tax deductions such as the interestcover on negatively geared shares.


30/66



F R I N G E B E N E F I T S T A X

What is a fringe benefit?If your business employs staff, it may be liable to pay fringe benefits tax

(FBT). A fringe benefit arises where a past, present or future employee orhis/her associate receives a benefit from you as their employer, or froman associate of yours.

The amount of the FBT will depend on the type of benefit you are

providing. There are 12 categoriesof fringe benefits and the method todetermine their taxable value is different in each. Fringe benefits listed inthe Fringe Benefits Tax Assessment Act1986 are:

1 Car benefits 7 Living-away-from-home allowance benefit 2 Car parking benefits 8 Property benefits 3 Debt waiver benefits 9 Residual benefits 4 Loan benefits 10 Entertainment benefits 5 Expense payment benefits 11 Airline transport benefits 6 Housing benefits 12 Board benefits.

As an employer, the business will pay the fringe benefits tax on the

grossed-up taxable value of the fringe benefit at the top marginalrate of tax.

Calculating FBTThe formula for calculating FBT depends on whether the employer is entitled to

an input tax credit in relation to the fringe benefit. If this is the case, it will be aType 1 benefit. If not, it is a Type 2 benefit. As a simple example of how fringebenefits are calculated, take debt waiver fringe benefits (a Type 2 benefit).

Lets say a business lent an employee $10 000 to buy a car, and the businessforgave that debt so the employee did not have to repay it. The taxable value of

the benefit is $10 000. There are two steps to calculating the FBT payable.Step 1 is to work out the grossed-up taxable value of the Type 2

benefit, where the FBT rate is 46.5%:

Value of the benefi t 1___________

(1 FBT rate)

Using the example of the $10 000 debt waiver, the calculation will be:1

= $10 000 __________1 0.465

= $10 000 1.8692

= $18 692


31/66


32/66



Other exemptions are provided for professional membership fees andsubscriptions, newspapers used for business, relocation expenses, worksitemedical facilities and emergency assistance. The costs of these items arestill tax-deductible and are important ways to assist your employees in a

tax-effective manner.Some benefits are expressly excluded from the FBT regime, namely

salary or wages, most superannuation contributions, benefits under an

employee share scheme, payments on termination of employment and

capital payments for personal injury.

Note that if the benefit could be claimed as a tax deduction in thehand of the employee, generally no fringe benefits tax will arise.

Ta x r e t u r n s a n d F B TIf your employee receives over $1000 grossed-up value in fringe benefits

in a year, an amount ofreportable fringe benefitsmust appear on his/her payment summary. Employees do not pay tax on reportable fringebenefits. However, this amount is added to their assessable incomefor threshold purposes, such as the Medicare levy surcharge and the

superannuation surcharge.

Importantly, not only is the cost of the benefit deductible to you if it

is incurred to make your business more efficient, the FBT is also claimableas a tax deduction.

The FBT tax year differs to the financial year and runs from 1 April to31 March each year. The employers FBT liability is due and payable on21 May. If the FBT liability for the previous year was $3000 or more, theemployer must pay the tax in quarterly instalments. FBT instalments arereported on your Business Activity Statement (BAS). These instalment dateswill match the GST instalments also notified on the BAS. For monthly payers,

it is the 21st day of the following month. For quarterly payers (deferred BASpayers) it is the 28th day of the month following the end of the quarter. Final

payment is due with the lodgement of the annual FBT return.

Motor vehicle fringe benefitsA popular work-related fringe benefit is the provision of a motor vehicle.An employee is deemed to use the motor vehicle for private use if it isgaraged at his/her home, even if it is only driven to and from workand for work purposes. However, there is an exception for utilitytrucks if the employees only private use is to drive the truck toand from work, then the car is not subject to FBT.

From 1 July 2002, the effective life for motor vehicles has been

changed to eight years. This will affect residual values for motor vehicles.


33/66



There are two methods for working out the value of a car fringe benefit:

the statutory formula method and the operating cost method. Unless thecar is used for a significant amount of business use (around 70% or more),

generally the statutory formula method results in less FBT being payable.

For the 2004/2005 financial year, the limit for depreciation for cars is$57 009.

S t a t u t o r y f o r m u l a m e t h o d

ABC E____

DWhere:A = the base value of the carB = the statutory fractionC = the number of days during the year on which a car fringe benefi t

was providedD = number of days in the tax yearE = the amount of any recipients payment

A : The base value of the caris the cost of the car (including sales tax)other than registration costs and any tax on registration or transfer. If the

car is leased, it is the original leased value of the car.B : The statutory fraction is determined by the number of kilometrestravelled each year according to the following table:

Distance travelled in the year Statutory fraction

Less than 15 000 kms .26

15 000 to 24 999 kms .20

25 000 to 40 000 kms .11More than 40 000 kms .07

C, D : These will generally be 365 (366 in leap years) if you have a car forthe whole of a FBT year (1 April to 31 March) or the number of days youhad the car.

E : A recipients payment is any payment made by the employee to theemployer for the use of the car during the year. It also includes any payment

for costs related to running the car which the employer does not reimburse,such as oil, petrol, repairs, registration or insurance. The employee needs to

keep documentary evidence of these expenses (other than oil and petrol).

For instance, if you give your employee the use of a car from 1 April to

31 March, and the car is worth $20 000 and 19 000 km is driven in the car

that year, the calculation would be:


34/66



20 000 .20 365= $4000__________________

365

The $4000 is the taxable value of the fringe benefit, which is then grossed

up, and FBT is charged on that amount. If, however, your employee hadbought $50 worth of petrol every week for the year, this would reduce the

taxable value by $2600 to make it $1400.

O p e r a t i n g c o s t m e t h o dThis method requires your employee to keep a logbook for a continuousperiod oftwelve weeks which records each business journey, the date, theodometer reading at the start and finish and the purpose of the travel. The

costs related to the car should also be recorded. The amount of businessuse and private use is then calculated. The value of the car fringe benefit

is determined according to the operating cost formula:

[C (100% BP)] RWhere:C = the operating cost of the car during the holding periodBP = the business percentage of use for the holding period

R = the amount of any recipients payment

C : The operating cost will be the lease costs or, where the car is owned bythe employer, it will include the depreciation and imputed interest cost. The

interest rate is the same as the standard variable owner-occupied housing

loan rate. (For the year ended 31 March 2007 this rate was 7.3%).

BP : The business percentage is the proportion of the kilometres whichwere used for business purposes in the period.

R:

See E on the previous page.Say you used the same $20 000 car for business purposes for 14 000 km

and for 5000 km of private use. The calculation would be:

The cost of the car = $20 000 18.75% for depreciation = $3750$20 000 7.3% for interest = $1460registration and insurance = $1500petrol = $2600

service and repairs = $2000Total cost = $11 310

Business percentage = 14 000 (number of business km)_____________________________19 000 (total number of km)

= 74%


35/66


Taxable value of the car fringe benefi t is then:$11 260 (100% 74%) = $2927.60

As discussed earlier, a recipients payment is any payment made to the

employer for the use of the car during the year. It also includes any

payment for costs related to running the carwhich the employer doesnot reimburse, such as oil, petrol, repairs, registration, or insurance.

You need to keep documentary evidence of these expenses (other thanoil and petrol).

The figure above could be reduced by paying for the petrol, which

makes the cost of the car $10 000 26% = $2600. This payment for petrol

of $2600 is classed as a recipients payment, leaving no FBT liability.

Car parking fringe benefitsIf the employer provides on-site car parking for its employees, it may beliable for FBT on the car parking fringe benefits. This will occur where:

1 There is a commercial parking station within one kilometre of thebusiness premises.

2 The parking station charges the public more than the car parking

threshold of $6.62 (for the year commencing 1 April 2006) for the day.3 The car is parked for more than four hours between 7am and 7pm.4 The car is owned by the employee (or his/her associate) or is a car

provided by the employer.

5 The car is parked within the vicinity of the employees primaryplace of employment.

6 The car is used to travel between the employees home and his/herprimary place of employment.

Car parking for disabled employees is exempted.A small business employer is also exempted from paying FBT on the car

parking benefit if its income for the previous FBT year is less than $10 million.

There are five possible methods for determining the FBT liability.These are:

1 The commercial parking station method, being the lowest public car parkfee for six hours by any commercial carparking station within one kilometre.

2 The market value method, being the amount the employee could havebeen expected to pay.

3 The average cost method, being the average of the lowest fees chargedby any commercial car parking station within one kilometre of the

business premises.


36/66


4 The 12-week register method, where a log book is kept of the parkingin that period which is representative of the year.

5 The statutory formula method,which provides the following calculation:

Daily rate number of days in availability period 288 employees________________________________366

The daily rate is determined using points 13 above. So, for instance, ifthe daily rate was $10 and there were 20 employees (on average) over the

year, the taxable value would be:

$10 366

288 20 = $57 600____

366

The employer can choose whichever method it wants of calculating carparking FBT for the FBT year (1 April to 31 March).

Loan fringe benefitsThe taxable value of a loan fringe benefit depends on three key factors:

1 the interest rate of the loan2 the benchmark interest for the period3 whether the loan is used for income-producing purposes.

If the loan is used by the employee for an income-producing purpose, thetaxable value of the loan is reduced. For instance, if you lent an employee

$400 000 and the employee used $250 000 of the loan to pay off his/her

home loan mortgage, and used $150 000 to buy a rental property, loan

fringe benefits tax would only apply to the amount used to pay off his/her

home loan. The reason for this is that the employee could have claimed theinterest on the loan to acquire the rental property as a tax deduction.

Say, for instance, the interest on the loan from the employer was 4%

and the benchmark interest rate was 7%. Because the employee has

only paid 4% interest (ie. $6000), he or she can only claim that cost

as a tax deduction, not the amount ofpossible interest of $10 500.

The next calculation required is to determine the differencebetween the interest paid and the statutory benchmark interestrate. The benchmark interest is published as at 31 March each year(the FBT year). It represents the average of the bank interest rates for the

previous year. In our example, had the loan been given on 1 April 2006 and

been in place until the end of the FBT year, the taxable value of the loanwould be the difference between the interest rate of 4% and the statutory


37/66


benchmark interest rate, which is 7.3%, multiplied by the loan amount,

that is:

$250 000 (7.3% 4%) = $8250

Debt waiver fringe benefitsA taxable fringe benefit arises if an employer forgives a loan to anemployee. So, in our example, if the employer waives the $250 000 owing,

this would result in a debt waiver fringe benefit. The taxable value of the

debt waiver fringe benefit is the amount of the debt forgiven.

Expense payments

If an employer pays or reimburses an employees expenses, an expensepayment fringe benefit arises. If, however, there has been no private benefit

to the employee, and the employee signs a No-Private-Use declaration, FBT

will not apply.

If the employer reimburses accommodation expenses because theemployee is required to live away from home, the employer must declare this on

an approved living-away-from-home declaration form. The form should include

the reason for living away from home, the timespan and the employees usual

place of residence and actual place of residence. This exemption will apply evenif the employees spouse and/or children normally live with the employee.

The employer can reimburse an employee for car expenses where the

employee uses his/her own vehicle for work purposes, without incurring a

FBT liability. The reimbursement is calculated on the cents per kilometre

rate, published each year. The rates for the 2004/2005 tax year were:

Cars with non-rotary engines up to 1600 cc 52.0 cents per km

Cars with non-rotary engines between 16012600 cc 62.0 cents per km

Cars with non-rotary engines exceeding 2600 cc 63.0 cents per km

If you have travelled over 5000 km during the tax year, you can claimone-third of the actual car expenses. To do this you will need written

evidence of the expenses, but not a log book. Alternatively, you can claim

12% of the original value of the car, subject to the car depreciation limit.

If the employee could have claimed a once-only tax deduction for the

expense, the taxable value of the expense is reduced. For instance, if the

employee paid his own conference fees at a cost of $1000, the taxable

fringe benefit is reduced by $1000, leaving no FBT liability. The employee

cannot claim the tax deduction because he or she has not incurred the

expense (it has been paid by the employer).


38/66


C A P I T A L A L L O W A N C E S

Claiming depreciation on your assetsFor any depreciating asset you own which is used to produce assessableincome, you can claim depreciation (also known as decline in value) on itas a tax deduction. The asset must be used or installed ready for use before

you can claim depreciation. You must also be the legal ownerof the asset.There is a limit on the amount of depreciation that can be claimed for cars,regardless of their base cost:

w For cars first acquired in the income years of 2000/2001 or 2001/2002the luxury car depreciation limit is $55 134 and for 2003/2004,

2004/2005 and 2005/2006 the limit is $57 009. This means that even ifthe car cost $80 000, the owner can only claim depreciation on a value

of $55 134. For the 2004/2005 financial year, the limit for depreciation

for cars is $57 009.

w Special rates ofaccelerated depreciation apply to cars or motorcyclesacquired before 21 September 1999 or by a small business taxpayer

before 1 July 2001. After that date, the usual rules of depreciation

according to the effective life of the asset apply.

w You can also claim building depreciationon income-producing buildingsconstructed after 18 July 1985. This has its own depreciation rate.

w You can claim items that cost less than $100 such as stationery as animmediate write off.

Calculating depreciationThere are two methods for calculating depreciation: the prime cost

method and the diminishing value method. If you acquired theplant or equipment before 11.45 am on 21 September 1999, youcan use either method and are also entitled to an accelerated rate ofdepreciation. If the asset was acquired between 21 September 1999 and1 July 2001, only small business taxpayers can use the accelerated rates

of depreciation.

Step 1 : You need to determine the cost of the plant or equipment. Ifyou are a small business taxpayer under the Simplified Tax System you

can claim an immediate deduction for items costing less than $1000. The

cost of the asset includes the price paid and any incidental costs to gain

ownership (such as stamp duty). You can also include the costs of installing

the asset and transporting it to its working location. This would include

any alterations and additions to the plant needed for it to function.


39/66


40/66



is deducted from the diminished base value. So, in this case, for thesecond year it would be 20% of $800 (its written down value), allowing a

deduction to be claimed of $160, and in the third year it would be 20% of

$640, being a deduction of $128, and so on.

To use the prime cost method the depreciation rate is:

Days held

100% asset cost_________ ___________________________

365 effective life of the item in years

So, if the effective life is 10 years, the depreciation rate is 100% divided

by 10 years, giving a depreciation rate of 10%. This means that after

10 years, the entire cost of the item ($1000) will be written off, ie. claimed

as a tax deduction.

When the business ceases to hold the asset (eg. stops using it or disposes

of a depreciated asset), a balancing adjustment must be calculated. If thetermination value (which excludes any GST component) is less than theassets adjustable value (its written-down value), then the business canclaim an additional tax deduction in the year of income in which the asset

was disposed. However, if the assets termination value is higherthan theadjusted value, then the difference must be included as assessable income.

This is because the business has progressively claimed a greater tax loss

than has actually occurred.

Taxpayers and depreciationTaxpayers claiming depreciation must complete depreciation schedules.These schedules are to be included in your tax return and must separate the

assets using the diminishing value method and the prime cost method.

The original cost and the written-down value are also to be shown. Recordsof what assets are pooled must also be kept.From 1 July 2001, small business taxpayers who adopt the

Simplified Tax System (STS) have particular rules for depreciationof assets, but the information above should give you an idea of how

depreciation works in theory. Your financial advisor or accountant

will be able to assist you.

Depreciation for computer softwareFor computer software acquired after 11 May 1998, the effective life is2.5 years, resulting in a depreciation rate of 40% on a prime cost basis.Depreciation can be claimed for each item of software from when the

software is used or installed ready for use.


41/66



Alternatively, from 1 July 2001, the expenditure incurred in developing

or commissioning software can be pooled (all costs added together) and isdeductible at the rate of 40% for the first two years and 20% in the third

year. This pooled deduction is available even if the software is not used.

In the case of commercial website development that only involvescontent being marked up and linked, the ATO considers that no softwarehas been developed. This cost can then be claimed as a general businessdeduction if done in the course of business. If website development occursbefore the commencement of the business, it is a capital cost.

However, website development may result in software where it allows

interaction with users who have been authenticated and the website

underwent a testing and debugging process. The costs ofchanges to such

a website will be classed as software if it alters the functionality of thesite. Ongoing maintenance in the course of business, however, will be a

deductible expense.

Intellectual propertyThere are statutory rates for the effective life of intangible assets, aslisted below:

Asset Ef fect ive li fe

Standard patent 20 years

Innovation patent 8 years

Petty patent 6 years

Registered design 15 years

Copyright The shorter of 25 years or when thecopyright ends

The costs of annual renewal fees such as for patents are deductible as

business expenses.

If you want to claim decline in value (previously known asdepreciation) for second-hand goods, you need to have aprofessional valuation of the asset done. The tax deduction isbased on the value and effective life of the asset. The ATO will

not accept your estimate of the assets depreciated value.

You can claim a direct deduction for small cost items such asstationery that cost less than $100 without using the decline in

value process.


42/66



T R A D I N G S T O C K

What is trading stock?Trading stock is any item that you manufacture for sale or trade for thepurposes of making a profit. There are particular rules relating to the

taxation treatment of trading stock.

The stock must be on hand to be classed as trading stock. This meansthat you must have the power to control the disposal of the stock.

Obviously, the amount for which you sell your goods is brought to

account as income. You are also entitled to a deduction for the costof goods purchased.

Calculating deductionsYou need to determine whether you are entitled to a further deductionor whether you must add back some trading stock value as income. Thisensures that business owners cannot purchase large amounts of stock

simply to claim an early deduction. On the other hand, if you have used

up your stores of stock without replenishing them, you are in fact making

a loss.

This second calculation is simply deducting the cost of goods soldfrom receipts. This is worked out by determining the value of the openingand closing stock on hand at the commencement (1 July) and the end (30

June) of the tax year. The opening stock value must be the same as theclosing stock value of the previous tax year. To determine this, a stocktakemust be undertaken at the close of the tax year.

w If the value of the closing stock exceeds the value of the openingstock, the excess is added to your assessable income.

w If the value of the closing stock is less than the opening stock, you canclaim an additional tax deduction for the difference.

There is no additional deduction for lost or destroyed stock. It will alsonot form part of the closing stock at the end of the year. Spare parts heldfor maintenance and repair are not classed as trading stock.

Valuing trading stockTrading stock can bevalued according to the cost method (full absorptioncost), market selling value or replacement value. (There are special rulesfor obsolete items.) The basis of valuation can be different for each class of

stock or item of stock. The method can also be changed from year to year,

but must remain the same throughout the tax year.


43/66



If you acquire trading stock from an associate (not at arms length)

at a price above market value, you can only claim a deduction for its

market value.

Importantly, if you are an STS taxpayerand the difference between

the value of the trading stock on hand at the commencement of the taxyear and the close of the tax year is less than $5000, you do not have

to account for differences in the trading stock value. You can make a

reasonable estimate that there is less than $5000 difference. Where this is

the case, an STS taxpayer is not required to undertake a stocktake.

The way the trading stock provisions work, there is no advantageto you buying up before the end of the financial year to claim

a large tax deduction as you will be caught by the openingstock/closing stock calculation.

There are special valuation provisions in the event that thetrading stock has become obsolete.

If trading stock is disposed of outside the ordinary course ofyour business (such as giving it away or using it for privateuse) you must include it as assessable income according to itsmarket value.

There are special rules for livestock check with the ATO.

If the trading stock was paid for in foreign currency, theAustralian dollar tax translation is to be brought to accountwhen the trading stock becomes on hand.

The cost method is the full absorption cost of the trading stock,which includes a proportion for costs such as freight, insuranceand delivery.


44/66



C A P I T A L G A I N S T A X

What is capital gains tax?Capital gains tax (CGT) was introduced from 20 September 1985. It appliesto any asset acquired on or after that date. Capital gains are, in general,

profits you make when you sell an asset for more than you paid for it.Certain assets are not subject to capital gains tax, such as:

w Your main residence. You can only have one main residence. Formore information see below, or Blakes Go Guide: Tax and You.

w Decorations (medals) for valour

w Personal use assets acquired for less than $10 000 (such as

furniture)w Wins from gambling, such as lotteries

w Motorcycles and cars designed to carry a load of less than one tonneand less than nine passengers

w Plant and depreciating assets

w Damages for personal injury

w Collectables acquired for less than $500 (such as artwork orjewellery)

w Trading stock.

If you use part of your home for your business or for an income-producing

purpose (such as renting out a room), you lose part of your mainresidence exemption from capital gains. This part is worked out accordingto a proportion of floor space used for the income-producing activity and

the part used as your dwelling. In determining whether it is used for an

income-producing purpose, the main factor is whether the area is set aside

exclusively as a place of business which is clearly identifiable and noteasily adapted to private use. If this is the case, then you will be entitled

to claim a tax deduction against the income earned by the business for a

proportion of the rent or mortgage payable for the area. The exemption is

not lost if you offered music lessons from home in the lounge room.

Calculating capital gains taxHow much capital gains tax you pay depends on when you bought the

asset. If you acquired the asset on or before 19 September 1999, you havea choice beween calculating your CGT liability using the discount methodor the indexation method. You should do both calculations. For propertybought after the early 1990s, the discount method will generally result in

lower taxable capital gains.


45/66


For either method, you need to determine what can be claimed in the

cost base of the asset. This includes:

w the cost of the asset

w any costs ofcapital improvements or enhancements (eg. a new roof)

w any cost incurred to defend your title to your property

w non-capital costs of ownership, which are costs for which you have notclaimed a tax deduction, including rates, interest on loans and repairs

(for assets acquired after 20 August 1991)

w incidental costs in relation to acquiring or disposing of the asset, suchas the fees of an agent, valuer, solicitor or surveyor, costs of transfer,

stamp duty and registration, advertising and valuation costs.

You must keep records of all the cost base items you want to claim.The records must be in English (or convertible to English) and show the

nature of each transaction affecting the asset. The records must be kept

for five years after the last likely CGT event in relation to the asset.

D i s c o u n t m e t h o dUsing this method, individuals are subject to capital gains tax ononly 50% of the total gain effectively, they are gaining a discount.

Trusts are also entitled to a 50% discount on the capital gains made.Superannuation funds are entitled to a one-third discount. Companiesmust pay CGT on the whole capital gain.

For instance, if you signed a contract for a house in Balmain on 7 October

1998 at a cost of $580 000 and sold it on 20 January 2002 for $640 000, you

would be obliged to pay CGT on one-half of the gain. The amount of thegain can, however, be reduced by adding other costs into the cost base ofyour house (ie. its total cost when you bought it):

Stamp duty: $21 590Registration fees: $150Solicitors fees: $5000Real estate agents fees: $15 000________Total costs $41 740

Adding these costs to the original cost of $580 000 means you essentiallypaid $621 740 for the house. So to calculate the taxable capital gain:

($640 000 $621 740) 2 = $9130

This amount of taxable capital gain is then added to your assessableincome for the year, and you are charged the marginal tax rate on the fullamount. So, if your assessable income for the year was $50 000, you would

add the $9130 to this income ($59 130) and pay tax on this full amount.


46/66


I n d e x a t i o n m e t h o dIf the asset was acquired before 19 September 1999, you could elect to use

the indexation method. Indexation ensures that you do not pay capitalgains tax on the inflation factor. It is based on the Consumer Price

Index (CPI) tables. To be entitled to index or claim discount capital gains,you must have held the asset for more than 12 months.

You must work out in which quartereach item in the cost base wasincurred. The quarters in each year are:1 January to 31 March; 1 April to30 June; 1 July to 30 September; 1 October to 31 December.

In the above example, the purchase price, stamp duty, solicitors fees

and registration fees would have been incurred in the quarter ending 31

December 1998. These costs, totalling $606 740, are inflated by comparing

the CPI in the quarter when they were incurred and the CPI in the quarterwhen the property is sold.

Importantly, the indexation factorfor disposals has been frozen at theSeptember 1999 figure of 123.4. In other words, any costs incurred afterthis date cannot be indexed. The CPI figure for the December 1998 quarter

was 121.9. The indexed (inflated) cost base of the asset then becomes:

$606 740 123.4

= $614 206_____

121.9

The real estate agents fees ($15 000) were incurred after September 1999

and thus cannot be indexed. These fees are then added to $614 206 to

give a total indexed cost base of $629 206. Capital gains tax is then paidon the difference between this amount and the sale price of $640 000

($10 794). Where the indexation method is used there is no discount.

Capital lossesIf you sell an asset and make a capital loss, you can claim that loss againstyour other capital gains, but not against your income.If you do not haveany other capital gains, you can carry the loss forward to the next year, or

until you make a gain. However, you cannot index the cost base items towork out your capital loss regardless of when you purchased the asset.

CGT concessions for small business

There are fourCGT concessions for small business which are available fortransactions after 21 September 1999. These concessions are in addition to

the general discount capital gains provisions for individuals. It is important

to apply the exemptions in the correct order to obtain maximum relieffrom potential capital gains tax.

The four conditions to be met to be eligible for these tax concessions are:


47/66


w A CGT event happens in relation to an asset you own.

w The asset must be an active asset of the business (used to operate thebusiness, including goodwill), and have been active for over half the time

that the business has owned it (does not include depreciating assets).

w The event would ordinarily result in a capital gain.

w The total net value of the assets of the business and its related entitiesis less than $6 million.

The four available concessions are:

15-year asset exemption : If you have owned and operated a business

for over 15 years,the business can claim a complete exemption from capitalgains tax on its active assets. However, any active asset must have been

held for over half of the 15 years before sale of the asset. If you are tradingas a sole trader or a partnership, to claim the deduction you must also

be over 55 years of age and retired or permanently incapacitated. If the

business is owned by a company or a trust, any payment to a CGT concessionstakeholder(the controlling individual of an entity who has over 50% of therights to dividends, voting power and capital distributions of a company, or

50% of the rights to income and capital of a trust) within two years of the

sale of the asset is also exempt. However, it is exempt in the proportion to

which the controlling individual held his/her interest in the entity.

50% active asset exemption : This applies to active assets of the

business upon disposal. The individual discount capital gains are alsoavailable and can be applied to the same transaction, so that only 25% ofthe gain will be subject to capital gains tax. This can be reduced further by

the roll-over provisions or the retirement exemption.

Retirement exemption : A full exemption from capital gains tax can be

claimed if the funds received are used formally for retirement. This is animportant decision as there is a lifetime limit of $500 000 for each individual.

A controlling individual of a company or a trust can also claim the benefit of

this exemption if the entity pays an eligible termination payment (ETP)to its CGT concession stakeholders. The entity must state what percentage

of this CGT exempt amount each individual can claim. If this exemption is

claimed, the entity cannot claim a deduction for the ETP.

Roll-over rel ief : Roll-over relief can only can be applied after theapplication of the 50% active asset exemption and allows the business to

defer the capital gains. It means that the business can acquire anotherasset in replacement of the first one (within certain time limits) withoutincurring full capital gains tax liability on the disposal of the original asset.

The replacement asset must also be an active asset.


48/66


G O O D S A N D S E R V I C E S T A X

What is the GST?A goods and services tax (GST) is a consumption tax. In some countriesit is called a Value Added Tax (VAT). In Australia the rate of GST is

currently 10%. This means that consumers will be charged 10% GST

on taxable supplies. For instance, if you have a plumbing business

and the value of the work done is $500, you might charge $50 GST,

making the bill a total of $550. All accounts should be GST-inclusiveand you may be asked for a tax invoice, which a business registered for

GST must supply within 28 days of the request. At the same time, you can

claim input tax credits for the GST you pay other suppliers. You need a taxinvoice from your suppliers to be able to claim these. The tax invoice must

state the suppliers Australian Business Number (ABN), brief descriptionof the goods or services and the GST-inclusive price.

There are three kinds of transactions under the GST scheme: taxablesupplies, GST-free supplies and input taxed supplies.

Taxable supply

To be making a taxable supply, you must:w be an entity (including sole traders, partnerships, companies, trusts

and unincorporated associations)

w be carrying on an enterprise in Australia (which is similar to, but widerthan carrying on a business)

w have a turnover of over $50 000 each tax year (which includes allGST-free supplies and taxable supplies, but not input taxed supplies,

the GST component of taxable supplies or the transfer of capital

assets)

w be registered for GSTor required to be registered

w not be supplying a GST-free product or service.

Most businesses will fall within this definition and will be required to

charge GST and therefore must be registered for GST (see below). To applyfor an Australian Business Number (ABN), which is to appear on your taxinvoices, visit the ATO website at www.ato.gov.au.

Australian Business Number (ABN)On the same day the GST was introduced, new Pay As You Go rules cameinto force. The rules require businesses to register for an AustralianBusiness Number. Obtaining an ABN is part of the process for a businessto register for GST.


49/66


50/66


51/66



Real estateIf you rent residential premises, you will not be required to pay GST on therent. The transaction is input taxed, which means that the landlord cannot

claim input tax credits for any supplies related to the leasing of the premises.

However, if you rent commercial premises such as a shop, and the landlord is

registered or required to be registered, you will be charged GST on the rent.

When you sell residential premises, the transaction will be inputtaxed. The exception to this is that new residential premises, ie. newly built

dwellings or substantially renovated homes, are subject to GST. The sale of

commercial premises or commercial residential premises is also subject to

GST. Commercial residential premises are dwellings such as boarding houses

that are akin to a hotel.When you sell real estate, GST will be imposed on the commissioncharged to you by the real estate agent.

InsuranceGeneral insurance, such as home and contents insurance, is subject toGST. Health insurance, however, is GST-free. The supply of life insurance istreated as a financial supply and input taxed.

AdjustmentsIf an item was acquired by a registered person for a creditable purpose, ie.

for the business, you can claim an input tax credit. If the item is later putto personal use, you are required to make an adjustment to repay part of

the input tax credit claimed.

Where supplies of goods or services are cancelled or goods returnedlater, an adjustment will also need to be made. If the transaction results

in the reduction of your GST liability you must hold an adjustment note.

Adjustments will also be made for bad debts, changes in the intended

business use, and when the business is transferred or closed down.

GST groupsGroups of related entities can apply to be treated as a single taxpayerforGST purposes. To be able to do this, each member of the GST group must be

registered and have the same tax and accounting period for GST. This has anumber of advantages. It will reduce the number of returns that are required

to be lodged. The representative member is respon

blakes go guides small business and tax

Documents