Dr Mark Pizzacalla, Partner, BDO
The tax year-end is an important time to ensure your business and personal tax affairs are in order. Here’s some key things to remember.
One of the most important aspects of tax planning is to ensure all appropriate elections and choices have been made and the correct documentation is in place for transactions that have or are to be finalised before 30 June 2021.
This is even more essential this year given the massive disruption businesses have experienced through the pandemic.
Note: This article is focused on the usual year-end tax planning challenges, rather than any changes that have occurred in the Federal Budget. This article is not meant to be exhaustive and your individual and business circumstances must be considered.
Timing of income derivation
Consider whether the amount is income or capital because income and capital gains have different tax timing rules.
- What is the appropriate method of income recognition for each type of income: cash or accruals?
- Cash (generally) for income from personal services, rent, interest, dividends and other income from non- business investments.
- Accruals (generally) for trading income or other business income that relies on circulating capital or staff or equipment to produce income.
- Consider specific rules to determine when income is derived and, if appropriate, whether income can be deferred until after 30 June 2021.
- Alternatively, if your client is in a tax loss position, consider whether they can accelerate income prior to 30 June to recoup such losses.
Income received in advance
- Income received in advance may not be derived (and taxed) until the services are provided. Income received in advance should be credited to an unearned income account.
- This rule will generally not apply if payment is not refundable if services are not provided.
- Income received in advance must be released to profit when services are provided, or if services are not provided, when it is determined the services will not be provided and no refund is claimed by customer.
Timing of expenses
- Expenses are generally deductible if incurred by 30 June 2021. This requires a presently existing liability.
- Provisions are generally not deductible. Some accruals are not deductible.
- There are specific rules that determine when some expenses are deductible (in particular, see the following prepayment rules).
Ensure repairs are incurred on or before 30 June 2021 to obtain the deduction in the 2021 income year, but they must not be:
- initial repairs
- substantial replacement of an asset or
- improving an asset.
- Donate to deductible charities before 30 June 2021 (assuming you are in a profit position).
- Ensure the payment is to an endorsed deductible gift recipient (DGR).
- Donations are not deductible if a benefit is received by the donor, unless the contribution was made at eligible fundraising event for a DGR and contribution is more than $150:
- Deduction will be reduced by value of any benefits received at the event.
- GST inclusive value of benefits received must not exceed lesser of 20% of contribution and $150.
- Review bad debts before 30 June 2021.
- Remember the rules for deducting bad debts. Write-off (and record in board minutes) bad debts before year end to get a deduction in that year (provision for doubtful debts not deductible).
- Bad debts may not be deductible if there has been a change in ownership or control of a company or trust (unless company passes the same business test).
- Consider an appropriate valuation method – you can choose cost, market selling value or replacement price.
- Identify any obsolete stock – special valuation rule. Scrap unwanted stock by 30 June 2021.
- If taxpayer is a small business entity, stock valuation is not required if the difference between opening and estimated closing value of trading stock for the year is $5,000 or less.
- If expenses are not subject to the prepayment rules, prepay deductible expenditure by 30 June 2021.
- The prepayment rules spread a pro-rated deduction over more than one year, where the expenditure provides benefits after end of the current income year.
- The prepayment rules do not apply to excluded expenditure, which includes:
- amounts required to be paid by law or a court and
- expenditure under $1,000.
- Small business entity taxpayers and non-business individuals are allowed prepayments in the year incurred if the benefit does not extend beyond 12 months.
Audit accruals are not deductible unless the audit contract creates a presently existing liability before 30 June 2021 (subject to the prepayment rules discussed above).
Taxable payments reporting system
Businesses in building and construction are required to record payments to contractors and report these payments to the ATO. From 1 July 2018, businesses engaged in the courier or cleaning industries were also required to make these reports. From 1 July 2019, the rules will extend to businesses engaged in IT, road (freight) transport, and security industries. The annual report is due to be lodged by 21 July 2021.
Some of the following super fund issues require advice from a qualified financial adviser:
- Employee superannuation guarantee quarterly contributions are required by 28 July 2021.
- Ensure at least the minimum pension payments have been made for those in pension phase.
- Before making any contributions prior to year-end, ensure you are aware of your contribution caps.
- Make sure you take into account contributions already made and ensure contributions made for the year do not exceed the concessional and non-concessional contribution limits.
- Ensure that contributions made near the end of the year are actually received by the fund by 30 June to ensure deductibility.
- Review salary sacrifice arrangements, especially if you have more than one employer, to ensure you do not breach your concessional cap in total.
Super guarantee and contractors
Employers need to ensure they make super contributions for all eligible employees, including certain independent contractors for superannuation guarantee charge (SGC) purposes. Under SGC, “employee” includes individuals who are employees in the ordinary sense (PAYG) and independent contractors engaged under a contract primarily for the provision of labour. Where you engage contractors, you should review the contracts to determine whether the individuals are treated as employees for SGC purposes.
Director and employee entitlements
- Conduct shareholders’ meetings before 30 June 2021 to approve directors’ fees and bonuses to receive deductions for the 2020-2021 year.
- Ensure arrangements for employee bonuses based on 2021 results are in place before 30 June 2021, and confirm bonus amounts via Board minutes to receive the deduction for the 2021 year.
- Ensure employee salary packages that include fringe benefits and/or additional employer super contributions are reviewed and in place before the sacrificed salary is earned by the employee.
- Check to ensure companies and trusts seeking to claim a deduction for current year or prior year losses satisfy the company loss and trust loss rules by 30 June.
- Where a debt owed by the taxpayer is released prior to 30 June, ensure there are no adverse consequences from the application of the commercial debt forgiveness rules.
- These rules operate where a debt is released and interest on the debt is deductible, or if the debt is interest free, interest would have been deductible if interest was charged.
Sale of investments – CGT issues
- Where CGT assets will be realised for a gain, consider delaying making the contract for sale until after 30 June unless you have losses that may be lost because of the loss integrity measures.
- Caution is required if you crystallise capital losses to offset against capital gains just before 30 June 2021 as this may result in the loss being denied if the taxpayer does not lose effective control of the loss assets, or they are replaced with substantially identical assets (wash sales).
- Timing of disposal under a contract for CGT purposes is generally the date of making the contract.
- If assets are held for less than 12 months by individuals, trusts or super funds that are eligible for the CGT discount, consider delaying sale until 12 months has passed.
- Take care if using options to defer the date of sale of an asset to pass the 12-month rule for CGT discount or to delay CGT event until the next year, as certain options may not be effective for these purposes.
- Recoup capital losses against indexed capital gains before discounted gains.
CGT Small Business Concessions
- Consider the application of the following concessions:
- 15-year exemption
- active asset reduction
- retirement exemption and
- small business rollover.
- To qualify for the basic concessions, the taxpayer must either pass the $6 million net asset value test, or be a small business entity with an aggregate turnover of less than $2 million; and the assets must satisfy the active asset test used in the relevant business.
- Scrap all obsolete items by 30 June 2021 to claim undepreciated cost.
- Consider reassessing the effective life if the asset has excessive use.
- Balancing adjustment on disposal – excess assessable or deficit deductible – rollover is available.
- Consider delaying disposal of items for a profit until after 30 June and bringing forward disposal of items for a loss to before 1 July.
Depreciation for small businesses
- Small businesses can claim an immediate deduction for assets they start to use or install ready for use, subject to the new asset costs thresholds.
- A small number of assets are not eligible for the immediate write-off, including horticultural plants and in-house software allocated to a software development pool. In most cases, specific depreciation rules apply to these assets.
- Assets valued in excess of the asset write off thresholds may be placed in the small business depreciation pool and depreciated at 15% in the first year and 30% in subsequent years.
- The pool can be immediately deducted if the balance falls below the relevant thresholds over the period (including existing pools).
- These rules are also subject to the concessional rules for SME and larger businesses as part of the Government’s investment incentives
Personal services income (PSI)
- If you, or an entity you work for (personal services entity), receive income for the reward for personal efforts or skills (eg, consultants), the PSI rules may limit the deductions that you or the personal services entity (PSE) may be entitled to claim, and you may be taxed on the PSI received by the PSE.
Project costs/business related costs
- Project costs can be pooled and deducted over the life of project using the diminishing value method.
- Other costs that are not otherwise deductible, not included in the CGT cost base of an asset, nor included in the depreciable cost of an asset, may be deductible over five years – they must be directly related to a business that is, was or proposed to be carried on for taxable purposes (blackhole expenditure).
- Review all shares, loans and other financial instruments used to raise finance to determine whether they are debt or equity.
- Year-end actions to
consider for debt/equity rules:
- Consider whether payments on instruments are deductible debt deductions (interest) or non-deductible dividends.
- A non-share capital account needs to be established if instruments other than membership interests (shares) are issued by the company, which are treated as equity.
- At call loans made on or after 1 July 2005 to a company from a connected entity may be equity. Companies with a turnover of less than $20 million are exempted from this rule.
- Consider whether
thin capitalisation rules apply to reduce deductions for interest and debt
deductions if the taxpayer:
- has a foreign investment
- has a foreign owner or
- is a non-resident investor.
- Thin capitalisation applies to all debt deductions, not just related foreign party debt deductions (includes unrelated Australian or foreign debt). If the entity’s debt exceeds maximum allowable debt, a proportionate amount of entity’s debt deductions may be disallowed.
- Consider whether the de minimis rules apply.
- Companies paying less than 100% franked dividends, benchmark franking percentage rules apply.
- The franking percentage chosen for the first frankable dividend paid in a franking period establishes the benchmark percentage.
- The franking period is usually the income year for private companies and six months for public companies.
- All frankable dividends paid during the franking period must be franked in accordance with the benchmark percentage.
- Companies should determine whether a franking account is in deficit and whether they are liable for Franking Deficit Tax, payable by 31 July 2021 for year ended 30 June 2021.
- Where the franking deficit exceeds 10% of the franking credits for the company in the year, the company’s entitlement to a tax offset for FDT is reduced by 30%.
- The changes to the small business company income tax rate affect the imputation rules.
- For example, the maximum franking amount (amount of franking credits that can be attached to a fully franked dividend) will be either 30% or the reduced base rate entity rates.
- Companies will need to consider their turnover levels prior to 30 June to determine whether they will suffer a lower franking rate in future tax years.
- Companies that are impacted by a changing rate may seek to pay higher fully franked dividends prior to 30 June to free up excess franking credits.
- If the taxpayer is a company with 100% owned subsidiary companies, partnerships or trusts, consider making a consolidation election before lodging the head company’s first consolidated tax return. Consider whether the advantages outweigh any disadvantages.
Acknowledgement: Dr Mark Pizzacalla would like to acknowledge Alex Bessell (Accountant, BDO) for his assistance with this article.