Aside from company tax cuts, one of the major pro-business policies that the Government took to the 2016 Federal Election was to increase the Small Business Entity (SBE) turnover eligibility threshold from $2 million to $10 million effective 1 July 2016 (and therefore proposed to apply in the current financial year). Treasury estimates that this increase to the threshold would result in an additional 90,000 to 100,000 businesses being eligible for the SBE concessions. Promisingly for business, the Australian Greens party and the Nick Xenophon Team party have announced that they support this change. This greatly increases the prospects that it will pass through the Senate and into law once the Federal Parliament reconvenes. If legislated, this reform will pave the way for access to the following array of SBE concessions for businesses with a turnover of under $10 million (which businesses with a turnover of $2 million already enjoy):
- The 27.5% company tax rate as at 1 July 2016
- The simplified depreciation rules, including immediate tax deductibility for asset purchases costing less than $20,000 until 30 June 2017
- The simplified trading stock rules, which give businesses the option to avoid a financial year-end stocktake if the value of their stock has changed by less than $5,000 during the year
- A simplified method of paying PAYG instalments which will be calculated by the ATO
- The option to account for GST on a cash basis and pay GST instalments as calculated by the ATO
- Immediate deductibility for various start-up costs (e.g. professional fees and government charges)
- A 12-month prepayment rule; and
- The more generous FBT extemption for work-related portable electronic devices.
The increased turnover threshold will not however apply for the purposes of accessing the CGT Small Business Concessions. The current access rules will continue to apply whereby your business’s aggregated turnover must be less than $2 million or alternatively, the net value of your assets must be less than $6 million just before the relevant CGT event (e.g. sale). Furthermore, it is not yet clear whether the increased turnover threshold of $10 million will apply to the new income tax and CGT exemption for genuine SBE restructures.
WHAT IS AN SBE?
SBEs can include companies, partnerships, trusts or sole traders. To qualify as an SBE the following two criteria must be met:
1. CARRYING ON A BUSINESS
To be an SBE you must in the first place be carrying on a business. The long-standing ATO tax ruling in this area is Taxation Ruling TR 97/11 which contains the following series of factors that may indicate that a business activity is indeed being carried on:
- There is a significant commercial purpose or character
- There is more than a mere intention to engage in business
- There is an intention to make a profit and a realistic prospect that a profit will be made
- There is a repetition and regularity to your activities – and some genuine time spent on the activity
- The business is carried on in a similar way to others within the same industry
- There is organisation to your activity
- There is size and scale to the activity
- It is not a hobby or a form of recreation.
Leaving aside the tax concession on offer, carrying on a business (as distinct from a hobby) brings with it a range of tax obligations. If you are in any doubt as to whether you are indeed carrying on a business you should consult your Accountant.
2. TURNOVER LESS THAN $2 MILLION
If you are carrying on a business, you will be an SBE if your aggregated annual business turnover (i.e. gross profit) is less than $2 million. This includes the turnover of:
- Connected entities – an entity is connected with another entity if:
- Either entity controls the other, or
- Both entities are controlled by the same third entity.
- Affiliates – an affiliate is any individual or company that, in relation to business affairs, acts or could reasonably be expected to act:
- According to your directions or wishes, or
- In concert with you.
The aggregation rules ensnare quite a number of related businesses – requiring them to add their annual turnover together and as a result potentially take them over the $2 million threshold. If you are in any doubt as to the application of these rules, talk to your Accountant.
The aggregation rules ensnare quite a number of related businesses – requiring them to add their annual turnover together and a result potentially take them over the $2 million threshold. If you are in any doubt as to the application of these rules, talk to your Accountant.
The $2 million turnover threshold is absolute. If it is exceeded by even $1, your business will be ineligible for the many SBE concessions on offer (detailed later). If your business’ turnover is around $2 million, it’s worth keeping a close eye on it at financial year-end. While we do not suggest that you avoid growing your business just to stay under the threshold, if your turnover is nearing the threshold at financial year-end, it certainly pays to stay under that threshold from a tax perspective – perhaps by deferring year-end invoicing where practical to the following financial year (post 30 June).
We now examine the SBE concessions listed earlier:
COMPANY TAX CUT
SBE companies pay a lower rate of company tax.
Currently, the SBE company tax rate is 28.5% (as opposed to 30% for non-SBE companies). The Government is proposing to reduce the SBE company tax rate by a full percentage point to 27.5% from 1 July 2016 to apply to the new definition of SBE (all companies with a turnover of less than $10 million will therefore be eligible).
Company X has a turnover of just under $10 million and taxable income of $9 million.
In 2015/2016 the tax payable would be $2.7 million.
Assuming the Government passes its changes into law (as stated it has preliminary support of other parties in the Senate), Company X would be paying $2.475 million in tax if the turnover was the same in 2016/2017 (a saving of $225,000).
Practically speaking however, a large number of small business owners (especially those with a turnover of less than the current SBE threshold of $2 million) do not retain the profits in the company as per the above example. Rather, many of these owners will strip the profits out of their company as franked dividends in order to live. Where this is the case, under the proposed new law the reduced company tax payable will be negated by the reduced franking credit that the shareholder will receive.
For example, if Company X paid out the remaining post-tax earnings to its Directors as franked dividends, then the Directors would only receive a reduced 27.5% franking credit. Assuming they were in the top marginal tax rate of 49%, they would in effect pay “top-up tax” of 21.5% (49 – 27.5) when they lodge their personal income tax return (instead of top-up tax of 19% (49-30) under the current rules. Therefore, in real terms they would personally be no better off. We will need to await the Explanatory Memorandum to the new law to confirm that the franking credit will equal the amount of tax paid by the company, but this appeared to be the case in the Budget Papers released back in May 2016.