Over the past two months while talking with clients, there have been a number of tax-related issues that have come to the surface. These are relatively common issues that people get wrong, so we have broken them down below so you don't get caught out.
Common Tax Issues Small Businesses Need to Know About
Three common tax issues that you need know about are:
- Differentiating between a business and a hobby
- Non commercial losses
- Self-managed superannuation funds (SMSFs) and property investment
1. Differentiating between a business and a hobby
If you run a business then the income is taxable and expenses are generally deductible while when you just have a hobby the income is not taxable nor are your expenses deductible. So is your activity a business or hobby? This is solely determined by the facts. Some of the characteristics of a business include:-
- Are your activities carried on in a commercially viable way?
- Do you have the purpose of making a profit as well as the prospect of making a profit, even if you make a loss in the short term?
- Are the activities repetitive and have regularity?
- Is your business similar to other businesses in your industry?
- Is your activity planned, organised and carried out businesslike?
- Do you maintain a separate business bank account?
- Do you maintain appropriate licenses and qualifications?
- Do you maintain business records and account books?
If you can positively respond to these questions then you are likely to be running a business. Further information can be obtained from the Australian Taxation Office Website.
2. Non-commercial losses
Ok you are running a business either as a sole trader or in a partnership and in the first couple of years, you have generated losses. Can they be used immediately? In short, no. They will need to be deferred, i.e. they will not be available to offset against income from other sources unless you can satisfy one of the following tests.
Tests for non-commercial losses
a. Your income from other sources is less than $250K and you can meet one of the following four tests:
- Assessable Income from the business is greater than $20K; or
- It has generated a profit in 3 of the last 5 years including the current year; or
- The business uses real property valued at least $500K continuously; or
- The business uses other assets valued at least $100k continuously.
b. If you are an Artist or Primary producer and your other assessable income is less than $40K.
3. Self-managed superannuation funds (SMSFs) and property investment
It seems you can’t pick up a paper or read an investment news website lately without seeing something about SMSF’s and their ability to invest in property, be it a cautionary tale or a positive promotion.
This is because of changes to the Superannuation Industry (Supervision) Act 1993 (SIS) in 2007 now allow limited non-recourse borrowing by SMSF’s.
Non-recourse borrowing is where the lender can only use the property being purchased as the security and cannot use other assets of the SMSF.
On the cautionary side, be warned that there are quite a number of requirements that need to be followed strictly to ensure any investment and associated borrowing is compliant.
Requirements for SMSFs and property investment
Failure to follow these requirements can render your SMSF non-compliant and liable for severe penalties. For example:
- The property must be purchased in the name of the security trustee.
- The trustee of the security trustee must be different to the trustee of the SMSF
- The full deposit must be paid by the superannuation fund out of its own funds. It is essential that any deposit is paid from the funds of the SMSF or from the borrowing by the SMSF and from no other source.
- The trust documents reflect the arrangement under which the security trustee purchases the property in its name with the funds being provided by the SMSF.
- The loan documentation must be non-recourse, that is, the lender can only seek recourse from the property in the event of a default.
- When the property is purchased as above in the name of the security trustee with the funds provided by the SMSF and with the assistance of a loan from the lender the property stands in the name of the security trustee although it is beneficially owned by the SMSF.
- The SMSF makes repayments to the lender under the mortgage.
The additional cost of establishing a compliant borrowing arrangement can be expensive. For example:
- Establishing a Corporate Trustee: $700 - $1000
- Establishing a Custodian Trust: $1000 - $2000
- Lenders Legal Fees: $1500- $3500
- Lenders loan application Fee $500 - $1500
On the positive side, providing an investment property meets your fund's investment strategy criteria it can assist in balancing your portfolio and removing the daily shocks of share market movements.
Also, if maintained in the fund until the fund reaches the pension phase and the beneficiaries are over 60 then any gain on sale of the property is likely to be free of capital gains, This is provided the strategy is deemed not to have been an anti-avoidance measure,
Should you require any assistance on this or other accounting and tax-related matters please do not hesitate to contact us.
- All of the above information is general in nature and each person’s personal circumstances need to be considered before embarking on any strategy. Please discuss with your accountants and or legal advisors.
- The writer has an SMSF which has recently acquired an investment property using limited recourse borrowing.
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