When it comes to tax mistakes a business owner can make, there are many. But three stand out as the most repeated and the easiest to avoid: hiding cash, lack of cash- flow management and borrowing tax ineffectively when there is not enough cash.
The biggest mistake owners make, where their businesses take large amounts of cash, is to hide money by diving into the black economy. The problem with black money is that it must be spent on non-essential things such as entertaining and holidays. Even when cash is spent on the so-called ‘untraceable discretionary items’, the ATO can still detect tax evasion. This often occurs in a business where cash is being skimmed and does not match the results of businesses in the same industry. When this occurs the tax office can easily prove that cash has been taken by checking critical items of expenditure.
An example of this was when the ATO targeted strawberry growers. Suspecting large amounts of cash were not being declared, the ATO reviewed certain items being claimed. By multiplying the number of punnets purchased by the average sales value of a punnet of strawberries, the ATO was able to determine how much income should have been declared. This resulted in tax assessments being issued.
One of the biggest problems caused by not declaring cash is the effect that this has on the value of the business. The true worth of a business is the amount of profit it makes. Where large amounts of cash are not declared, the profitability of the businesses decreases. Unless a business owner can find someone willing to accept a nod and a wink, they will find it difficult to sell their business for what it is truly worth.
Lack of cash-flow management can lead to the next biggest mistake made by business owners: ignoring ATO deadlines. This often takes the form of not lodging tax returns and GST statements on time, or failing to pay tax, GST or superannuation by the due date. When a business starts to delay paying PAYG Withholding amounts from employees, GST collected, and the 9 per cent superannuation contribution for employees, it is digging a financial hole that it often can’t climb out of. Just because the Tax Office is not constantly demanding payment doesn’t mean it can be ignored.
The ATO is showing that it is prepared to take an increasingly harder line with people and business that owe money. It is now using the services of professional debt collection agencies and is only too willing to wind up businesses and put people into bankruptcy for non-payment of tax. In some circumstances the ATO can get behind the corporate veil and chase directors where PAYG Withholding amounts are owed.
When cash is in short supply, borrowing incorrectly can lead to increased tax being paid. Interest charged on business or investment loans is tax deductible, but for private loans it is not. The way in which borrowed money is spent, rather than the type of security used, determines its deductibility. For example, where a loan is taken out to extend a home, with a factory being the security, no deduction will be allowed for the interest. Conversely, the interest on a loan taken out to purchase a shop, with a home being used as security, will be tax deductible. When it comes to borrowing, the golden rule is borrow for business and investment purposes, and pay cash for private items.
For example, let’s say Bob the plumber has $20,000 in his bank account and a tax debt of $15,000, and he needs to purchase a new one tonne ute costing $35,000. Bob is best to spend $15,000 cash to pay off his tax debt, finance the ute using a tax deductible mortgage, and keep $5,000 in cash for other private purposes. Had Bob spent the $20,000 as a deposit on the ute, and taken out a loan to pay the tax, he would have had no cash left, a non-deductible loan of $15,000, and a tax-deductible loan of only $15,000.
It is also always good practice to keep business and private loans separate, rather than combining them into one loan. When business and private loans are combined, repayments of the loan are applied in proportion, but where separate loans are taken, out interest can only be paid on the business loan, while the private loan is paid off as quickly as possible.