Getting in front, both personally and in a good business sense, is not done by chance. It requires some canny planning. MICHAEL LAURENCE has a few top tips.
By Michael Laurence
Astute business owners will look beyond end-of-year tax and super strategies and look for ways to improve their positions over the next 12 months and beyond. And some new exciting opportunities are opening up.
“I have never been a strong believer in rushed, last-minute attempts to cut tax in the final weeks of a financial year,” says Sydney tax and superannuation lawyer Robert Richards. “Proper planning should be done at least a year in advance.”
Here are four smart strategies to put you and your business in front, and to protect yourself for the years ahead.
Encourage business angels with the prospect of big, tax-free profits
New tax and super laws have created highly favourable conditions to entice investors to take a minority stake in your business. These investors have an opportunity to save a fortune in tax while boosting their super savings. And you get badly needed money to allow your business to grow.
Deloitte tax director Les Szekely says minority stakeholders can potentially make multi-million-dollar, CGT-free profits from the eventual sale of their stakes. And then they can contribute a large amount of the money into super to take advantage of a tax-free retirement under the Government’s Simpler Super initiative, being introduced next month.
The imminent arrival of tax-free super benefits for those aged over 60 provides a real sweetener for minority shareholders who decide to direct CGT-free profits into super, says Szekely.
From 2006-07, individuals with a minimum 20% stake in a small business – known in tax law as “significant individuals” – have been given access to the full range of small-business CGT concessions. This makes the concessions available to more stakeholders, replacing the previous limit of two “controlling individuals”.
These 20% or so stakeholders can one day sell their share in your business entirely, largely tax-free, by combining the standard 50% CGT discount (available to all individuals and trust beneficiaries or unit-holders if assets are held for at least 12 months) and various small-business CGT concessions.
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Consider the example of a $2-million capital gain by a one-fifth shareholder who is eligible for the small-business CGT concessions:
- First, the standard 50% CGT discount available to everyone would reduce the taxable gain to $1 million.
- Then the small-business CGT reduction of 50% would cut the taxable gain to $500,000.
- Finally, the taxable capital gain would be reduced to nil by another small-business CGT concession – known as the retirement exemption – that allows a CGT exemption to a lifetime maximum of $500,000. (This money must be rolled into super if the vendor is aged under 55.)
In addition to making super contributions up to the standard annual limits applying to most fund members, each eligible 20% or so stakeholder in a small business is entitled to contribute up to an indexed lifetime limit of $1 million from the sale of their stakes.
(Proceeds from the sale of a share in a small business that can be contributed to super up to this $1-million lifetime limit are those that qualify for certain small-business CGT exemptions – these are assets that attract the 15-year ownership CGT exemption and gains that qualify for $500,000 retirement exemption, discussed earlier.)
In order to be eligible for the CGT small-business concessions, the net market value of each stakeholder’s business assets, personal shares, personal investment properties as well as those of their associates must not exceed $6 million (the new cap from July 1).
Lawyer Robert Richards says shareholders who are concerned about exceeding the $6-million asset cap should consider such strategies as increasing their super contributions or making gifts to family members – gifts and super are among assets not included in the cap for the small-business CGT concessions.
Get your company constitution in shape
Richards points out that shareholders with dividend-only shares do not have access to the small-business CGT concessions. “Given the great tax-savings opportunities with the CGT concessions, it would be a smart idea to ensure that all of your shareholders, if appropriate in your circumstances, have access to the concessions if they own at least 20% of your company.”
In order to be eligible for the small-business CGT concessions, a shareholder must be entitled to at least 20% of a business’s income and capital.
Think twice about incorporating a new business or division
The personal tax cuts in 2007-08 and 2008-onwards mean that by July next year, more than 80% of taxpayers will have marginal rates below the 30% corporate tax rate. This will remove another key incentive for many small-business owners to incorporate.
Richards says companies will no longer provide a means to defer taxes if the shareholders pay tax at less than 30%. And, significantly, companies do not have access to the standard 50% CGT discount, discussed earlier.
The standard CGT discount is limited to individuals, partnerships and beneficiaries of unit and discretionary trusts.
Richards says unit trusts can provide their unit-holders with the same level of protection from liability as company shareholders provided there is a corporate trustee. “My message is simple: don’t rush to set up a new company without giving the tax consequences a lot of thought.”
Watch out for a crackdown on untaxed distributions
Tax commissioner Michael D’Ascenzo issued a warning this month of a crackdown on private companies that are entering complex schemes to allegedly avoid tax on private company dividends.
Although D’Ascenzo is referring to a particular type of scheme – see taxpayer alerts – tax specialists say that his warning should act as a sharp reminder to private company owners who are tempted to avoid tax by claiming that dividends are loans to shareholders.
All large shareholders of private companies should understand that the commissioner has the power under division 7A of the tax act to deem so-called loans to shareholders as dividends, resulting in the money being taxed at the shareholders’ marginal rate rates – without the benefit of franking credits.
During 2006-07, the tax office targeted private company dividends that were disguising dividends as loans to shareholders, and its attention to this form of tax-avoidance will continue into 2007-08. Of course, many people inadvertently fall foul of the division 7A provisions and never had intended to avoid tax.
“Although division 7A has been around a long time, it is repeatedly trapping SME owners – particularly those who are relatively new to business and whose businesses are rapidly expanding,” says tax consultant Gordon Cooper, principal of Cooper & Co in Sydney.
To avoid breaching division 7A, private companies are required to use properly documented loan agreements that provide for repayment within seven years and for the payment of interest at the minimum legal benchmark rate.
Cooper points out that an amendment to division 7A is now before Parliament to give the tax commissioner discretion about whether he declares a deemed dividend if a company has not meet these requirements. Under current law, he has no choice but to exercise is power if the law is breached.
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