Tax planning is a vitally important, but often neglected task to complete with your tax accountant towards the end of the financial year for all small business owners in Australia.
In a nutshell, you should estimate your taxable income, determine any dividends or trust distributions (if trading through a company or trust), what should you do to reduce your tax and work out if you have a payable or refund to determine if you should lodge as soon as possible or defer to lodge and pay on the due date.
If you had a profitable year this financial year, but think that next year will not be as profitable, it is worth considering paying for next year’s expenses prior to June 30, 2022.
This is known as prepaying expenses.
The ATO states “a prepaid expense is expenditure you incur under an agreement for something to be done (in whole or in part) in a later income year”.
If you incurred expenditure for something that was to be done in full within this income year — that is, July 1, 2021 to June 30, 2022 — it is not a prepaid expense and the prepayment rules do not apply.
If no exemptions apply, a prepaid expense is deductible over the ‘eligible service period’.
The eligible service period begins on the day the thing under the agreement begins to be done, or on the day the expenditure is incurred, whichever is later.
The ‘eligible service period’ cannot exceed 10 years.
A prepaid expense may be immediately deductible if it is ‘excluded expenditure’ or if ‘the 12-month rule’ applies.
Certain types of business expenditure are excluded from the prepayment rules. These are amounts of less than $1000 (excluding input tax credits), amounts required to be incurred by a court order or law of the Commonwealth, state or territory, payments of salary or wages (under a contract of service), amounts that are capital, private or domestic in nature (except certain research and development amounts) or certain amounts incurred by a general insurance company in connection with the issue of policies or the payment of reinsurance premiums.
If you are a small business entity or would be a small business entity if the aggregated turnover threshold was $50 million, or an individual incurring deductible non-business expenditure you can claim an immediate deduction. You can claim the deduction under the 12-month rule for prepaid expenditure if the payment is incurred for an eligible service period not exceeding 12 months and the eligible service period ends in the next income year.
Examples of expenses you may wish to prepay are rent, insurance, subscriptions, memberships, advertising, software and interest. Pro level tip – if you borrow money to pay for the prepaid expenses, the interest can also be tax deductible, further lowering your taxable income and reducing tax.
So should you prepay expenses every year? The answer to this question involves a lot of variables: such as what entity type you trade through; how does profit this year compare to past and expected future years; if you have a spouse what is their assessable income; do you have tax losses; do you have franking credits if trading through a company; can you distribute income to your spouse; do you have the cashflow to pay for these expenses earlier than usual; are you close to retirement; and are you just over a tax bracket prior to prepaying the expense.
We recommend it is best practice to speak to your experienced tax accountant to get personalised advice for you and your circumstances.
Greg Mawer is the director of Accumulate Accountants + Business Advisors. Greg is a fellow of CPA Australia, as well as an advisory board member, business strategist, angel investor, tax accountant, financial modeller, business founder, speaker and financial literacy advocate.
