A little federal budget tax planning may be in order

The federal budget is coming next week – we know that tax changes are afoot. Knowing your options now can be a great help. By TERRY HAYES of Thomson Legal & Regulatory.

By Terry Hayes

The 2007-08 federal budget is only a few days away. Tax changes are a certainty – it’s just exactly what those changes will be that we don’t know yet.

Why don’t we look at a few “what ifs”?

What if the Government provides more tax cuts? Likely, if you listen to some, not likely if you listen to others. But definitely a possibility.

If the personal tax rate scales, for example, are reduced – maybe the 40% rate will be reduced (which applies to income between $75,000 and $150,000), or the 45% rate reduced (to incomes above $150,000) – SMEs operating as sole traders or as partnerships need to heed some basic rules.

Conventional wisdom says that when tax rates are reduced, income should be deferred until after the rate reduces, so as to ensure it is taxed at the new lower rate.

And expenses should be brought forward, so they are tax deductible at the existing higher rate (in other words, they are worth more before the tax rate reduces). But bear in mind that there are tax rules that govern such deferrals or bringing forward.

If the taxpayer reports on a cash (or receipts) basis, amounts are assessable when they are received. If the accruals (or earnings) basis is used, amounts receivable are recognised as income – income may not be assessable in a financial year if the legal obligation to receive it occurs in the next financial year.

In Tax Ruling TR 98/1, the tax commissioner states that the cash basis is likely to be appropriate for business income “derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services”, for example a sole practitioner.

But the situation may be different in some circumstances, for example:

• The taxpayer’s income-producing activities involve the sale of trading stock.
• The outgoings incurred by the taxpayer, in the day-to-day conduct of the business, have a direct relationship to income derived.
• The taxpayer relies on circulating capital or consumables to produce income.
• The taxpayer relies on staff or equipment to produce income.

The commissioner considers that if any of the above factors is present “to a significant degree”, the accruals method may be the most appropriate basis of reporting income.

Prepayment of expenses by an SME can provide an immediate tax deduction, thereby maximising the deduction if tax rates are to be lowered.

Generally, prepayments of deductible expenses less than $1000 each can be claimed as tax deductions in the year the prepayment is made. However, beware that the tax office will look closely where two or more such prepayments are made and may apply anti-avoidance rules.

Where the prepaid expenditure is for a period of more than 12 months, the deduction will need to be apportioned (for example, a prepayment of interest on a loan will be deductible over the period to which the interest relates).

If tax rates are cut from July 1, 2007, reducing assessable income for the year ending June 30, 2007, will mean less income taxed at the higher rates. In that case, a perennial year-end tax planning point that would become even more important concerns the valuation of trading stock.

If the value of closing trading stock on hand at the end of the year exceeds opening stock, the excess amount will be included in the assessable income of the business.

Therefore, a reduction of closing stock on hand will reduce assessable income. There are several methods for valuing trading stock and SMEs should discuss with their accountant the method that best suits their circumstances.

These are just a few of the issues that come into play if the federal budget produces tax cuts. SMEs should have these issues in mind once the budget’s details are known.

If any changes are to apply from July 1, 2007, there won’t be much time to act, so getting on the front foot will be important. A quick call to your accountant or adviser after the budget might produce some very useful tax savings.

Of course, tax planning should not solely be a year-end activity, and it is always prudent to be continually thinking about ways to keep the tax expense at a legal minimum. And of course, tax planning of any nature should not ignore the possibility of the application of the anti-avoidance rules.

Terry Hayes is the senior tax writer at Thomson Legal & Regulatory, a leading Australian provider of tax, accounting and legal information solutions; www.thomson.com.au

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