Tax Planning in Australia: How to Make Tax a Form of Investment For Your Business

LAST UPDATED ON: October 19, 2021

“Tax can be an investment."

This may sound odd for anyone who views tax as nothing more than a necessary evil to be paid in order to operate their business. But in reality, there are many ways that businesses can make tax work for them… by turning their annual tax bill into 'a form of investment'.

This article reveals some practical tips you can use to better manage your tax and increase your wealth. Some of these strategies are available to any small or medium-sized Australian company. Others are particularly suitable for sole traders or working partners in small business partnerships because they involve the use of salary-sacrifice arrangements to reduce personal tax. And a few require that you have some very specific attributes, such as:

- You must be aged under 65 years; or

- You and your spouse (or de facto) must each earn less than $50,000 per year; or

- Your business has an aggregated turnover of less than $2 million.

All these strategies are designed with one thing in mind: how to get the lowest possible taxable income? By doing this, you'll benefit from lower PAYG withholding taxes (Australian resident companies pay 32.5% on their annual taxable income). Also, any franking credits generated by franked dividends paid out by these companies will be entitled to a company tax rate of 30%. And you'll reduce your annual PAYG installments, which will free up more of your working capital for other investments. It's just like giving yourself a pay rise – but without having to lift a finger!

1. Convert personal services income into business income

In Australia, business Income is taxed at 28% compared with personal services income, which is taxed at 45%. It's better to create a company and convert your personal services income into business income because it will save money on taxes and fees. Of course, this decision could only make sense if you'll be able to generate enough profit by doing this.

Personal services income is the money you earn from doing work as an employee (or as a self-employed person). There may be ways for you to convert this income into ordinary business income instead. For example, if you sell some private assets and reinvest the sale proceeds in your own business, the income you receive on that private asset sale may be classified as business income rather than personal services income

2. Use salary-sacrifice arrangements to reduce your PAYG withholding taxes

This is where both you and your employer agree to part with some of your pre-tax dollars through a salary-sacrifice arrangement. Salary sacrifice reduces the employee's cash wage but increases their take-home pay because no PAYG withholding tax has been deducted from these additional earnings. So the net result is more take-home pay than before. For example, if your current total taxable income was $100,000 and you salary-sacrificed $20,000 into a superannuation (i.e., deferred compensation), then $20,000 would be added to your business's taxable income. But because you'd receive lower taxation on the deferred compensation (and therefore your business would also benefit), it may well be worth doing this.

3. Lower your taxable income by using franked dividends

Franking credits are dollar-for-dollar tax credits that reduce or eliminate corporate tax payable on franked dividends paid out by companies subject to Australian company tax rates (currently 30%). For example, if a company has $100 of after-tax profits and pays these profits out as franks-eligible franked dividends, then the company will have $70 left in its kitty after paying all its other expenses, such as interest charges. And to top it off, it'll only pay $30 of company tax on this $100 profit, which means it'll have franking credits worth $30. But because the company has already paid 30% tax on its profits, these franking credits are worth an extra 30 cents in the dollar to you as a shareholder receiving franked dividends from that company.

So if you receive franked dividends from companies subject to Australian company tax rates then you should be aware that your tax payable will be zero (because your other income is below the threshold for the higher personal tax-free threshold). And any excess franking credits can give rise to a non-refundable tax offset at a rate of 38.143c per dollar of franking credit received.

There's another opportunity to dramatically increase your after-tax returns on Australian shares. This involves investing at least some of your money in shares/units which are franked, rather than being fully "grossed up". For example, if you made a capital gain on an investment where all income was taxed at 30% (such as with most managed funds) then the after-tax value of that capital gain would be 70 cents in the dollar. However, if you invest some or all of it into franked investments subject to company tax rates (currently 30%) then only 30% is taken out by way of tax at the corporate level, meaning that your grossed-up capital gains will be worth considerably more.

So how can you make sure the profits are taxed at 30%? Well, this may not always be feasible. But if the company has already paid tax on its taxable income in previous years then it can carry back a portion of its franking credits to offset past corporate tax. In this instance, when you sell your units in that company just quote the ATO reference number for that prior year's assessment and include all relevant documents when lodging.

4. Capital gains from the sale of real estate subject to CGT concessions

Capital gains from the sale of real estate are normally taxed at a flat rate of 50%, which can seem a bit unfair given personal marginal tax rates up to 45%. But there are some ways you can lower or even eliminate this unwelcome capital gain tax bite:

· If you're over 65, then all your capital gains made in the last 3 years are tax-free.

· If you make less than $37,000/year (filing singly or jointly) then your capital gains will be tax-free up to $500,000.

· If your income is between $37,001 and $80,000 then 50% of it is excluded from taxation. So if you have a taxable income of

$60k then half of that ($30k) is non-taxable when it comes to paying CGT on the sale of real estate. Plus any unclaimed amount can give rise to a non-refundable tax offset at a rate of 25.5c per dollar of taxable income which is excluded from your personal tax return.

· If you're a farmer then your CGT concessions will be much more generous, with 50% of all capital gains in the last 3 years being non-taxable and any unclaimed amount able to give rise to an offset equal to 12.5% of your taxable income excluding your primary production business or agricultural activity earnings (reducing by $1 for every $2 you earn over $100k).

5. Capital gains on trading stock

Capital gains on trading stock are normally taxed at a flat rate of 50%, which can seem rather unfair given that personal marginal tax rates are up to 45%. However, if you've held onto shares for more than 12 months, then 50% of the gain arising from those shares is tax-free. Any unclaimed amount can give rise to a non-refundable tax offset at a rate of 25.5c per dollar of taxable income which is excluded from your personal tax return.

But what about if you make less than $37,000/year (filing singly or jointly)? Then all trading stocks are automatically deemed to be "long term", allowing any capital gains on sale after 1 year to become non-taxable up to that same threshold of $500,000 per couple or $250,000 per person.

However, there's another opportunity for additional discounts if you're an active day Trader. If you hold onto your shares for at least 30 days prior to trading then 50% of all trading stock gains are tax-free after 12 months. And if you trade for less than 31 days then only 25% of the gain is counted as taxable.

Further guidance on capital gains taxation in Australia can be found at https://www.ato.gov.au/Individuals/Capital-gains-tax/

It would be best to consult a qualified accountant familiar with capital gains tax, particularly if you have any questions about long-term vs short-term investments or how to make sure you pay no more tax than necessary on any one investment or income stream. Bear in mind that this article was intended to provide an overview of some common tax planning issues in Australia rather than a comprehensive guide for any specialized area. Remember that the above tips are not intended to be relied upon as personal advice, only some general guidance, which may not be suitable for your circumstances.

As you can see there are many opportunities to reduce taxes when it comes to investment in Australia. Not only do these strategies increase your investments' returns but they also give you greater options in managing your money so that you can reach your financial goals more quickly.