SMALL BUSINESS by Susan Young B.Com LLB Grad Dip Law
Topics we are covering The tax benefits available Immediate deductibility of start-up expenses Treatment of prepayments Small business restructure rollover relief The reduced corporate tax rate Companies receiving passive income The changes in the imputation rules as a result of the cut to the corporate tax rate Proposed changes to Division 7A
Introduction An entity is a small business entity if it: carries on a business; and satisfies the $10m aggregated turnover test
Turnover Turnover is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business, but not other income, such as salary or wages Do not include GST
Aggregated turnover An entity s turnover will be aggregated with that of another entity where: - the entities are affiliates of each other; or - they are connected It does not include income from dealings with each other
Tax benefits available Immediate deduction for acquisitions of depreciating assets < $20,000 Small business pool Simplified trading stock rules 2 year amendment of assessments Choice to account for GST on a cash basis
Tax benefits available Choice to pay GST and PAYG by instalments FBT car parking exemption FBT - multiple work-related portable electronic devices ATO Small Business Superannuation Clearing House Immediate deductibility for certain small business start-up expenses
Tax benefits available Reduction in the corporate tax rate Immediate deduction for certain prepaid business expenses Roll-over for restructures of small businesses
Tax benefits available CGT small business concessions: CGT 15-year asset exemption - a full exemption from CGT on the disposal of an active asset which has been held continuously for 15 years CGT 50% active asset reduction - 50% exemption on the disposal of active assets CGT $500,000 exemption - exemption of up to $500,000 on the disposal of active assets CGT roll-over - deferral of making of capital gains Small business income tax offset
Accounting for income and deductions Small business entities can calculate their taxable income using the most appropriate method for their circumstances ie. cash or accruals
Focus of this session Immediate deductibility for small business start-up expenses The prepayment rules and small business The small business restructure rollover relief The reduction in the corporate tax rate The current position with companies receiving passive income The changes in the imputation rules as a result of the cut to the corporate tax rate The changes to Division 7A proposed to take effect next year
Immediate deductibility of start up costs Small business entities can immediately deduct certain costs incurred when starting up a business that were previously only deductible over 5 years under s 40-880 of the ITAA 1997 (the black hole expenditure provision)
Immediate deductibility of start up costs Immediate deductibility is limited to 2 categories of expenditure: expenditure on advice or services relating to the structure or the operation of the proposed business; and the payment to an Australian government agency of fees, taxes or charges relating to establishing the business or its operating structure
Prepayments For small business entities, there is a 12 month rule which allows immediate deductions for prepayments where: - the eligible service period for the expenditure incurred is no longer than 12 months; and - the period of service ends no later than the last day of the income year following that in which the payment was incurred
Prepayments Example: Prepaid expense where requirements met T Pty Ltd is small business entity. On 31 May 2017, it paid $15,000 for business advertising to cover the period 1 June 2017 to 30 May 2018. The eligible service period is not more than 12 months. The period of service ends before the last day of the income year following that in which the payment was incurred (30 June 2018). The prepayment satisfies the 12-month rule and T Pty Ltd can claim an immediate deduction for the prepayment
Prepayments Excluded expenditure Amounts of less than $1,000 Amounts required to be incurred by a court order or law of the Commonwealth, state or territory Payments under a contract of service eg. salary and wages Amounts that are capital, private or domestic in nature
Small Business Restructure Roll-Over Subdivision 328-G ITAA provides Australian resident small business entities (aggregated turnover < $10 m) with a rollover for gains and losses arising from the transfer of CGT assets, trading stock, revenue assets and depreciating assets as part of a restructure of a small business. It does not cover GST or Stamp Duty
Small Business Restructure Roll-Over The roll-over is available where Australian resident SBEs: transfer an active asset of their business to another small business entity as part of a "genuine restructure of an ongoing business ; and where the ultimate economic ownership (UEO) of the asset (directly or indirectly) does not change
Small Business Restructure Roll-Over In Law Companion Guideline LCG 2016/3, the ATO states a 'genuine restructure of an ongoing business' is one that could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business going forward. The SBRR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests
Small Business Restructure Roll-Over Safe harbour rule There is a "safe harbour" rule which provides a transaction will be taken to be part of a genuine restructure if, in the 3-year period after the transaction takes effect: there is no change in the UEO of the significant assets of the business (other than trading stock) that were transferred; those significant assets continue to be active assets; and there is no significant or material use of those assets for private purposes
Small Business Restructure Roll-Over Where an individual operates as a sole trader, they hold the UEO. Where the entity is a company, the provisions will look at the ultimate shareholders to determine the UEO. If there is more than one individual who is an ultimate economic owner of an asset, each of those individuals shares of that ultimate economic ownership must be materially unchanged, maintaining the same proportionate ownership in the asset
Small Business Restructure Roll-Over Example Amy, Anna and Adrian run a business as equal partners and want to transfer their interests in the assets of the partnership to a company. Amy, Anna and Adrian establish a company, whereby 300 identical shares are issued. 100 shares are issued to Amy, 150 shares are issued to Anna, and 50 shares are issued to Adrian. While this doesn t change the individuals who have the ultimate economic ownership of the asset, there is a change in the proportionate share of that ultimate economic ownership. Accordingly, Amy, Anna and Adrian cannot use the small business restructure roll-over
Small Business Restructure Roll-Over Special rule for discretionary trusts A special rule provides a transaction does not have the effect of changing the UEO if the transferor or transferee has made a family trust election and every individual who, just before or just after the transfer took effect had the UEO of the asset(s), was a member of the family group
Small Business Restructure Roll-Over Example from LCG 2016/3 Steven operates a business through a company. Steven, his wife, Vicki, his son Daniel, and his daughter Courtney, are the shareholders. The company transfers the business' active assets to a trust where he and his family members are beneficiaries. A family trust election is made and Steven is the primary individual specified in the election. Steven, Vicki, Daniel and Courtney are all members of Steven's family group. The company can use the SBRR to transfer its assets to the trust
Small Business Restructure Roll-Over The acquirer of the asset is effectively taken to acquire the asset for its roll-over cost (irrespective of the amount paid for the asset). The roll-over cost is an amount that (if received) would not give rise to a profit/gain or loss. For example if the cost base of an asset is $100 and the market value of the asset is $200, the roll-over cost is equal to $100
Small Business Restructure Roll-Over Membership interests (shares and units) Where membership interests are issued in consideration for the transfer of assets, the cost base of those new membership interests will be: the roll-over cost of assets transferred that are not pre- CGT or depreciating assets; plus the adjustable values of the transferred depreciating assets; less any liabilities the new entity has undertaken to discharge associated with those assets divided by the number of membership interests
Small Business Restructure Roll-Over Example from EM Membership interests E Pty Ltd transfers three assets that it owns to the S Trust in circumstances that qualify for rollover: a CGT asset having a cost base of $100,000; a second CGT asset having a cost base of $1 million; and a depreciating asset having an adjustable value of $400,000. The S Trust issues 10 units to E Pty Ltd in exchange for the transfer. The cost base of each unit is $100,000 + $1 million + $400,000)/10 = $150,000
Small Business Restructure Roll-Over Pre-CGT assets retain their pre-cgt status following a restructure Other assets transferred as a part of the restructure will have a refreshed acquisition date being the date of the restructure
Small Business Restructure Roll-Over Example from LCG 2016/2 Transfer of assets A company transfers its assets to a discretionary trust on 1 Jan 2017. The company and the trustee choose to apply the SBRR. As at 1 Jan 2017, the active assets of the company are: a small consulting room, which was acquired by Vitamin Pty Ltd for $200,000 in 2010. The market value is $230,000 goodwill, which is self-generated a pill press, with an adjustable value of $14,000, and trading stock - 50 bottles of homeopathic pills - cost $250
Small Business Restructure Roll-Over The roll-over applies to gains and losses arising from the transfer of active assets. An active asset is an asset, owned by the taxpayer (tangible or intangible) used or held ready for use in the course of carrying on a business eg. the business premises owned by the operating entity; or used or held ready for use in the course of carrying on a business by the taxpayer s affiliate; or another entity connected with the taxpayer Rental properties generally excluded Shares and units generally excluded
Reduction in corporate tax rate The corporate tax rate was reduced from 28.5% to 27.5% for the 2016 17 income year for small business entity companies. In 2017 18 the aggregated turnover threshold for the lower corporate tax rate has increased from $10 million to $25 million and in 2018 19 it increases to $50 million. From 2017 18, corporate entities eligible for the lower tax rate are called base rate entities. The small business entity definition remains at $10 million while the base rate entity threshold continues to rise
Passive investment companies On 4 July 2017, the Minister for Revenue and Financial Services issued a media release that stated the policy decision made by the Government to cut the tax rate for small companies was not meant to apply to passive investment companies Following the Minister s Press Release, the ATO issued a fact sheet in which it outlined its view as to when a company will carry on a business
Passive investment companies On 18 October 2017, the Government introduced Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017 into Parliament It applies from 1 July 2017 and proposes that corporate tax entities with predominantly passive income (such as rent, dividends, interest and capital gains) cannot access the lower corporate tax rate of 27.5% and will pay tax at 30%
Passive investment companies The Bill provides a corporate tax entity will qualify for the lower corporate tax rate only if: no more than 80 per cent of the corporate tax entity s assessable income for that income year is passive income; and the aggregated turnover of the corporate tax entity for the income year is less than: for the 2017-18 income year $25 million for the 2018-19 income year $50 million
Passive investment companies Base rate entity passive income distributions (eg dividends) other than non-portfolio dividends franking credits attached to such distributions a non-share dividend interest income royalties and rent a gain on a qualifying security a net capital gain; and an amount that is included in the assessable income of a partner in a partnership or a beneficiary of a trust estate to the extent that it is referable (directly or indirectly through one or more interposed partnerships or trust estates) to another amount that is base rate entity passive income
Passive investment companies Prior to 1 July 2017, pay tax at lower rate if carrying on a business and below the threshold Draft Taxation Ruling TR 2017/D7 Where a company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it is likely to be carrying on a business. This is so even if the company's activities are relatively limited, and its activities primarily consist of passively receiving rent or returns on its investments and distributing them to its shareholders
Corporate tax rate for imputation purposes 2015-16 income year When the company tax rate for small business entities reduced to 28.5% with effect 1 July 2015, the maximum franking credit rate for a distribution remained unchanged at 30% for all companies for the year ended 30 June 2016
Corporate tax rate for imputation purposes 2016-17 income year From the 2016-17 income year, the operation of the imputation system is based on the company s corporate tax rate for a particular income year, worked out having regard to the entity s aggregated turnover for the previous income year. This is referred to as the corporate tax rate for imputation purposes. For the 2016-17 income tax year the corporate tax rate for imputation purposes will be: 30% if the company's aggregated turnover for the 2015-16 income tax year was equal to or exceeded $10 million; or 27.5% if the company's aggregated turnover for the 2015-16 income tax year was less than $10 million
Corporate tax rate for imputation purposes 2017-18 income tax year From 1 July 2017, an additional passive income test must be satisfied to qualify for the lower tax rate For the 2017-18 income tax year the corporate tax rate for imputation purposes will be: 30% if the company's aggregated turnover for the 2016-17 income tax year was equal to or exceeded $25 million or the 80% passive income test was not met in 2016-17; or 27.5% if the company s aggregated turnover for the 2016-17 income tax year was less than $25 million and passive income was less than 80% in 2016-17
Corporate tax rate for imputation purposes Trapped credits issue If dividends are paid from profits taxed at 30%, but franking is done at 27.5%, this can cause surplus franking credits to become trapped in the company and will cause the total tax impost to be higher than the shareholder's marginal tax rate Franking deficit tax issue If dividends are paid from profits taxed at 27.5%, but franking is done at 30%, it may be necessary to frank at something less than a 100% benchmark rate to avoid the imposition of franking deficit tax
Proposed changes to Division 7A In the May 2016 Budget, the Government announced that it is proposing to amend Division 7A with effect 1 July 2018 to include: a self-correction mechanism providing taxpayers whose arrangements have inadvertently triggered Div 7A with the opportunity to voluntarily correct their arrangements without penalty new safe harbour rules such as for use of assets amended rules regarding complying Div 7A loans, including having a single compliant loan duration of 10 years
Proposed changes to Division 7A Self-correction mechanism The Board recommended: qualifying taxpayers self-assess their eligibility for an exception to Division 7A that will operate to reverse the effect of a prior deemed dividend eligibility for the exception be based on satisfying two criteria: it is reasonable to infer, on the basis of objective factors, that the conduct that caused the deemed dividend was unintentional; and appropriate steps have been taken to ensure that affected parties are placed in the position they would have been in had the dividend not arisen
Proposed changes to Division 7A New safe harbour rules The Board recommended supplementing the existing use of company asset rules with the provision of legislative safe harbour rules : for depreciating assets - a rental charge for appreciating assets - a usage charge calculated by multiplying the statutory interest rate by the asset s indexed value, which could be updated with an arm s length valuation every five years
Proposed changes to Division 7A Amended rules proposed re complying Division 7A loans The Board had recommended that: that loans be repayable over 10 years with no choice of 7 or 25 year loans or sub-trust arrangements transitional rules ensure existing 25 year loans are grandfathered and continue to operate over their remaining 25 year terms there be no requirement for a formal written agreement between the parties. However, written or electronic evidence showing that a loan was entered into must exist by lodgement day for the income year in which the loan was made
Proposed changes to Division 7A the statutory interest rate be set at the start of the loan and fixed over the term of the loan the current system of minimum annual repayments be replaced with prescribed maximum balances. Interest could accrue annually but would have to be paid by the end of years three, five, eight and 10. The prescribed maximum loan balances during the term of the loan (including any accumulated interest) would be as follows: 75 per cent of the original loan by the end of year three; 55 per cent of the original loan by the end of year five; 25 per cent of the original loan by the end of year eight; and 0 per cent of the original loan (that is, fully repaid) by the end of year 10
Proposed changes to Division 7A the statutory interest rate be the Reserve Bank of Australia s indicator lending rate for a small business; variable; other; overdraft for the month of May immediately before the start of that income year. This is higher than the current Div 7A rate all pre-existing company loans and unpaid trust entitlements, regardless of when they first arose, transition to these terms. This means that all existing pre-1997 loans and pre and post 2009 UPEs would become new complying 10 year loans starting from the application date of the new provisions. They would have to be repaid, with interest, over 10 years in accordance with the new rules. All existing complying seven-year loans would have their terms extended to the new maximum of 10 years
Proposed changes to Division 7A Think twice about writing off any UPEs: the ATO will deny a bad debt deduction TD 2016/19, and may apply Division 7A where the beneficiary is a private company TD 2015/20 - the release of the UPE represents the "crediting of an amount" which will be a payment for Div 7A purposes to the extent that the release represents a financial benefit to an entity (typically the trustee)
What we have covered The tax benefits available Immediate deductibility of start-up expenses Treatment of prepayments Small business restructure rollover relief The reduced corporate tax rate Companies receiving passive income The changes in the imputation rules as a result of the cut to the corporate tax rate Proposed changes to Division 7A
THE END! Thank You