Planning to make your business more efficient - a tax planning case study

The goal of tax planning is to have an overall look at how your business has been tracking for the year and to put in place some strategies that will help reduce the tax liability likely to arise come year end. Most importantly, it is also to plan your cash-flow so you are aware and can budget for any upcoming liability. If left until year end, there is little that can be done to mitigate exposure to tax.

It is also a great time of year to consider in general how your business is going and look at different procedures or policies to make your business more efficient, productive and profitable.

If you can estimate your bottom line profit for year end, concerted efforts can be made to generate a desired result, which will in turn reduce the tax liability at year end. Common ways of managing your tax by decreasing profits include, but are not limited to:

prepaying expenses;
paying additional superannuation – the business will get a deduction for this but only if the superannuation was physically paid by year end; and
paying additional wages or a director’s fee – this may be done also if there are loans from a company to the owner/shareholder of the business, and thereby negate any issues that may have arisen over Division 7A loans.

In addition to finding ways to reduce the taxable profits of the business, clients can plan how to reduce their overall ‘group’ tax. The questions that arise are: How do we distribute the profits? Should or can a dividend be paid and, if so, can it be franked? Who can we distribute to this year? What other income do they have?

For example, a recent case looked at how a business, which was run through a trust, distributes the profits for the year, in the most tax effective way possible. We had to take into account the following:

who the available beneficiaries were;
the ages of the beneficiaries;
the importance of putting money into superannuation for each of the beneficiaries;
the cash-flow effect overall; and
the tax implications.

Without tax planning the client would have had a tax liability of approximately $65,000 and a cash inflow of approximately $175,000. After considering the needs of the client and the above parameters, we determined four possible scenarios, with each scenario then breaking down further into the difference between contributing to superannuation or not. Each scenario looked at the tax saving to the client group and also the effect the planning would have on the cash-flow of the group.

The different options looked at various ways of paying money out through a trust; from paying wages, making additional superannuation contributions or simply making a distribution at year end. We considered whether we had opportunity to distribute to ‘minor’ beneficiaries and also in what order and how much to distribute to each beneficiary. In deciding this, it was necessary to take into account any outside income that any of the beneficiaries may have had.

The benefits to the clients were varied but, under the best scenario, it was determined that the client could reduce their expected tax liability by $11,500 (if no additional contributions to superannuation were made) - $14,500 (with additional contributions to superannuation) and increase in their overall cash by $14,000 (with additional contributions to superannuation) - $30,000 (if no additional contributions to superannuation were made). As can be seen, the additional consideration of whether or not to contribute more money into super for the beneficiaries, produced quite different results, when all other variables remained the same. Had this tax planning not been carried out before the financial year end, the majority of the opportunities presented to the client would not have been available.

It must be remembered when undertaking a tax planning exercise that, whilst the dominant reason is to look at different ways to minimise tax, other conditions or obligations, important to the client, must be considered. Other things, such as the effect on cash-flows and whether all legal obligations will be met in carrying out recommendations, must be considered. Therefore, sometimes, the scenario with the best tax outcome is not the best option for the client. It is a balancing act between achieving minimal tax and meeting other goals of the client. Perhaps the tax will be minimised but the cash-flow needs of the client are not met. Perhaps the client is happy to pay the tax now instead of deferring it to later years. It is important to take a holistic approach to tax planning and factor in these other considerations so that the client can make a fully informed decision.

It is clear that tax planning is one of the most important exercises that should be done by most people. It does not just apply to businesses but can be applied to anyone who may be part of a ‘family group’. Forward planning in life and understanding one’s future direction is important. Tax planning is no different. It gives clients options and scenarios based on their particular circumstances so that they can put in place procedures, or take a course of action, that will ensure they are headed in the direction they need to be to meet their individual tax goals, which are congruent with other life goals

For more information relating to your specific circumstances please contact your Baker Affleck accountant on (07) 5538 3088 or click here to send an email request.