The end of the tax year is rapidly approaching. What a year it has been. It started strong, businesses doing well and some decent tax reform on the way. Then Covid-19 hit….you know the rest!
As year end approaches it is more important than ever to be ready. Small businesses need cash right now and an easy win is unlocking any tax refunds that they may be entitled to.
To get you off to a great started I’ve summarised the top ten tax deduction issues that I’ve dealt with over the last twelve months, either with my clients or in discussions with other accountants. It is by no means an exhaustive list but if you are ticking all the relevant boxes below you are off to a great start.
No receipts for expenses
It is a very commonly held myth that you can substantiate deductions with bank statements alone. This myth is in part due to the messaging from the modern cloud based accounting systems which push the idea that you can easily maintain all your records from automatic bank feeds.
There is no requirement to attached copies of the receipts to the data in your accounting system but you need to have them stored somewhere for the duration of the audit period (5 years). If you claim expenses that you cannot support they will be disallowed during an audit.
Unsubstantiated Travel Expenses
Most of us travel for business at some stage, it’s inevitable. Sometimes we’re even lucky enough that the business travel takes us to somewhere we wanted to visit anyway. This is where the deduction problem arises. Business owners attempting to claim 100% of the costs associated with a trip that was, at least in part, personal.
Any business owner who intends to claim the costs of a business trip must ensure they keep detailed records of all expenses (see point 1) as well as a travel diary or itinerary to show what they were doing during each day and how those activities related to their business. If you are going to a conference keep a copy of the program and any other documentation they give you with your other trip records.
The most important part of the whole process is to apportion the costs between business and personal. If you travel to Queenstown for a week long conference and you stay an extra week to go skiing you have to split all the costs. Yes, that includes the flights. The argument of “I had to fly over for the conference anyway whether I had the holiday after it or not” does not work..trust me, I’ve tried it during a live audit!
Motor Vehicle Costs – Logbooks
To use the logbook method for claiming motor vehicle costs you must keep records of all costs and have a valid logbook in place. The logbook must run for twelve uninterrupted weeks. Once completed, the logbook will last for 5 years assuming your business use of the vehicle does not change substantially.
The ATO have clarified their position on the form a logbook must take. It’s not generally acceptable to run an excel spreadsheet. You can use a spreadsheet for your calculations but the trip information must be supported by one of the following:
- Data export from a tracking app;
- Calendar or appointment books detailing the trips you took;
- A physical logbook purchased from a newsagent or other document provider. If you are using a logbook check the publication date. If the date on the book is after the first date shown for the logbook period you might get a few questions from the auditor.
Note: just because you are driving a Ute for work does not exempt you from the requirement to keep a logbook. The ATO has been known to frequent popular four wheel drive locations (like Fraser Island) documenting all of the vehicles covered in business logos and other sign writing being loaded on the barges. This data is then checked against the business’s tax return to see if a private use portion of motor vehicle costs has been reported.
Motor Vehicle Costs – cents per KM method
This is a big one. So many business owners use the cents per kilometre travelled approach to claim some cost of operating their personal vehicle as a business expense.
You cannot just make the number up.
While you do not need to keep a full logbook you are expected to show the ATO some support for your estimate. usually this would be a calendar or diary to support the trips/dates and some sort of evidence to show the distance travelled for that trip. I usually use google maps to support the distance for my trips.
Home Office Costs
Business owners often claim some part of their home/personal costs against their business income when they undertake business related activities from home. With all of the Covid-19 shutdown requires this year those costs are likely to rise considerably.
The nature of the expense you wish to claim will determine the approach to use. However, there is one part of the process that is often overlooked. To work out how much of the various costs you can claim as a deduction you must be able to provide some sort of evidence that you worked from home in the first place and for how long.
The easiest option is to keep some sort of work diary, even if it’s just a digital calendar. If you’re claiming that you worked from home for 8 hours a day, 5 days a week for 50 weeks in the year you should have a diary or calendar, prepared at the time the work was performed, to prove your claim.
You cannot claim a deduction for the cost of clothing purchased for business unless the items purchased fall into one of three categories:
- The item has your business logo permanently attached;
- The item is consider occupation specific clothing – e.g. a Chef’s hat; or
- The item is protective equipment – e.g. Steel capped boots.
Clothing that is essentially the same as anyone else could wear on any given day is not deductible, even if you purchased it to wear while working.
There are some small exceptions to the above rule. For example, undercover police offices can claim the costs associated with purchasing plain clothes for work even though the items would normally be excluded. This exemption does invalidate the general rule. It’s a specific exemption granted for the police force. Just because you have to wear particular clothes for work (e.g a lawyer wearing a suit) does not make it deductible.
To claim a deduction for the costs associated with cleaning your work clothing you first need to satisfy the previous point. No deduction is available for cleaning clothes unless you can establish that they are eligible work related clothing in the first place.
You can then determine the amount to claim as a deduction for laundry and cleaning costs. You will need a diary or other written evidence (receipts) if you wish to claim more than $150 for laundry costs in a given year.
Where the amount claimed is less than $150 you can make a reasonable estimate of your costs using the following rates:
- $1 per load if the load is made up only of work-related clothing
- 50c per load if you include other laundry items
You may be asked to demonstrate how often you wore your eligible clothing (eg. evidence that you worked four days a week for 48 weeks in the year).
A really common mistake that I see all the time is failing to establish an adequate link between what your business does to generate income and education that the business owner undertakes. You need to carefully consider whether or not the course is directly related to the business’s services.
For example: Assume you run an IT business installing computer systems in office locations for small businesses. It is not reasonable to claim the costs associated with the owner undertaking a degree in computer programming, even though at first glance they both appear to be related to computers. The business does not build custom software applications for its clients, it installs hardware. The business may provide software development services in the future but right now it does not and the costs associated with the field of study are not an allowable deduction.
However, courses that improve your ability to run your business effectively are fine even if they do not necessarily relate the services your business provides to the world. For example, you can claim the costs of a social media marketing course against your business income even if the business does not sell Digital marketing services. The skills derived from the course will still be actively used in the running of the business.
Your staff are doing a great job? You want to reward them with a little extra money as a once off bonus? Great! Just make sure you process it through your payroll system like any other component of their salary and wages. Payments made to staff in the form of salary and wages, which have not been treated as such in the accounting records are not deductible. You cannot transfer the money to their bank account and record a bonus expense (or similar) in your records. It has to go on the employee’s payment summary.
Staff Parties (Christmas, End of year etc)
This is another staff benefit that goes wrong more often than you would think. If your business pays the cost of staff entertainment this can be a Fringe Benefit. You can qualify for an exemption here but only if you satisfy both of the following points:
- The cost per person is less than $300, and
- The benefit is infrequent (it’s not something you provide regularly).
Business owners commonly stumble at point 2. If you have Friday afternoon drinks with the team every week we can all see that the benefit is not infrequent and, therefore, does not qualify for the exemption. However, the same rule applies where the event is something you do every year, like a Christmas Party. If you hold an event about the same time each year it is no longer infrequent even though it only happens once a year.
Make sure any costs that could fall into this trap are easy for your account to find in your accounting records. Do not hide them in some general or other expense account. Make sure they are coded to an entertainment account.
What should you do next?
- Review the list above and determine which items apply to your situation; and
• Start getting the information together ready for year end. It is only a few weeks away.