It is tax planning season for Australian accountants. This is the period during which you should be meeting with your accountant to estimate your tax liability for this financial year and discuss any possible management strategies.
In the Profit First book Mike touches on his concerns around the advice many accountants give their clients during this process. Given that I completely agree with Mike’s points I thought I’d discuss the topic in more detail.
The core of the issue is the following statement:
I want to pay as little tax as possible.
Shouldn’t I run up expenses and buy assets so that I pay less tax?
This is one of the most widespread, damaging myths in money management. Find the oldest member of your family that has ever run a business and I can guarantee they either believe this to be true or have been advised to do this by accountants or other business owners.
Running up expenses just to reduce taxes is the same as spending ten dollars just to save three. It’s incredibly damaging to your business cashflow and, in most cases, only manages to waste seven dollars!
Your goal is to run the business as profitably as possible. That is your key to achieving financial freedom. You should work closely with your Profit First Professional to reduce your tax liabilities as much as you can without creating cashflow distress in the business.
Current Tax Planning Myths that perpetuate the problem
Myth 1: Buying assets to take advantage of the $30,000 instant asset right-off is good tax planning.
Currently, Australian small business owners can claim an immediate write off for assets with a purchase price of less than $30,000. On the face of it that sounds like an incredible opportunity to claim a very large tax deduction in the current year.
The problem is small business owners rarely plan for large asset purchases. This means that instead of having the cash available to buy the asset the business must take on debt.
So, while the business can claim a $30,000 deduction this year you are stuck paying off the loan, with interest, over the next 3-5 years. Overall the strategy ends up costing you more than any immediate tax you may have saved.
If your business desperately needs the asset and you were planning to buy it soon anyway then the strategy can work. Especially if you have the cash set aside to buy it. However, ideas like “you should update your work vehicle every two years because it’s good for tax” are just ridiculous.
Myth 2: Buying stock before the end of the year will reduce your tax bill.
At the end of each financial year businesses that carry stock need to do a stocktake. The aim of this process is to determine how much stock is being carried by the business. Comparing the stocktake numbers with your inventory system will allow you to see if any stock has been lost or stolen and update your system to accurately reflect the stock in your warehouse.
We insist that business owners do this for two main reasons:
1. To ensure that the financial data is accurate – Even if you don’t do regular stocktakes we can be sure that at least annually the levels are checked;
2. You’re closing stock value needs to be reported on your tax return. It reduces the total Cost of Goods Sold (COGS) figure we report to the tax office.
Why doesn’t buying stock help your tax bill? Because buying more stock just increases your closing stock value. Given that we can’t claim a tax deduction for closing stock all you’ve really done is lock up a lot of working capital (cash) in stock that you may not be able to sell for months.
Myth 3: Prepaying expenses is a great way to bring forward deductions
Many business expenses can be prepaid up to a year in advance. Depending on your situation you may be able to prepay business insurance policies, interest on loans, rent and a number of other expenses. Pre-paying expenses brings the deduction forward to the current year and reduces this year’s tax bill.
Just because you ‘can’ does not mean you ‘should’. The rule of thumb I use with my clients is as follows:
You should consider pre-paying some business expenses if:
1. You have the cash available to make the payment without creating cashflow distress;
2. The vendor offers a significant discount for prepayments; and
3. You expect next year’s business performance to be comparable to or weaker than the current year.
If the client’s answer is no to any of those three points I usually advice against making a prepayment.
Just “one more day”
I found the ‘Just one more day’ message in the Profit First book so useful that I’ve incorporated it into my tax planning discussion, even for clients who don’t use Profit First.
Generally speaking, Mike encourages you to look at all the major purchases you are considering. Before you make the purchase ask yourself “do I need it today or could I wait until tomorrow?”. If you could wait until tomorrow…wait!
You’ll be surprised how often ‘just one more day’ delays the purchase for over a year. If your business keeps going without experiencing any major inefficiency for a year without the item then you really didn’t need it.
The Tax Planning Golden Rule
Smart tax planning is crucial..but wasting money is crazy!
Work with your accountant to plan for large expenses. Accumulate money to pay in cash whenever possible and only buy when something is absolutely necessary. Deductions are great but cash is king!
Read our comprehensive review of Profit First here
Join the Facebook group here