Running a business is hard enough when you think about all the trigger events you need to be in control of. Things like sales pipeline, operational procedures, delivery timelines and quality control, just to name a few. Then add on all the book work and admin you need to be on top of and it’s already getting tough to juggle it all. But then we need to look at the tax side of things and suddenly it goes from a delicate, but manageable juggling act to a frantic attempt to keep everything in the air.
For someone trading out of a company there can be multiple layers of tax liabilities keeping your up at night. These may include:
• GST and PAYG on staff
• Company tax
• Fringe Benefits Tax (FBT)
• Personal income tax.
Unfortunately, there is no silver bullet to setting aside money for these taxes as each business will have different variables which impact how much tax will be payable in each category at different times.
How the timing of income tax payments may impact or new or growing business
Unfortunately, the tax system is reactive. Although your lodge your Business Activity Statements (BAS) quarterly, the ATO doesn’t monitor these in relation to your income tax liability at the end of the financial year.
This means that in the first year of your business (or the first year you make a profit), you will not pay any tax until after you lodge your income tax return. For most businesses, this will often be many months after 30 June.
Once this return is lodged, the ATO get the first snapshot of what profits the business is making and what tax is due based on your previous year. Not only do the ATO want their tax money for the previous year, but now that they know you’re making money they also want you to start paying tax in advance (PAYG instalments).
What does this mean for your business?
In year one you won’t pay any physical tax and your bank account will look nice and healthy. However, in year two you will end up paying two years’ worth of tax in what is typically only a six-month period.
This six-month period is the single biggest cause of business failure in the first two years of business, and if you haven’t been putting tax money aside for this you risk becoming a statistic. This doesn’t mean that those businesses may fail straight away, but they will begin a painful cash flow struggle while the majority of their profits are having to be put towards their legacy tax issues. This can often stretch out for multiple years before a business finally gets in the clear.
Setting up a separate account for tax
In our experience, the one common outcome for businesses’ that have a strategy of putting money aside in a separate bank account for tax are always better placed to pay these liabilities when they are due than those who don’t. If nothing else, we recommend you set up a separate bank account and start putting something aside as soon as possible.
The next step to be ahead of the curve is to build a custom formula for your business which gives you a percentage of sales to set aside each week. This is best done with your tax advisor, so you can make sure all variables in your business are taken into account (e.g. number of staff, your net GST figures and your company / personal average tax rates). This will never be an exact science, but if done right you should always have most of your tax money set aside when things fall due. Making up any shortfall is substantially easier to do than finding the whole amount.
How tax planning can help
Setting up a separate account for tax is just one example of a step that can be put into place to help prepare you for tax time.
When the calendar ticks over to 30 June, it’s actually too late to make big changes to your net tax outcome. But by working with a tax accountant throughout the year you’ll benefit from strategies can reduce your overall tax payable.
Next steps: Start the tax planning conversation
If you’re ready to start your tax planning, or want to find out more, please get in touch!