Effective tax planning is an important consideration for new businesses in the start-up phase, growth phase and beyond. Stephen Nicholas, Deloitte Private Partner, outlines the steps to minimising the impact of tax on your new business. With careful planning and forecasting and by being aware of key dates as well as seeking advice when you need it, you’ll be well on your way to managing your company tax without a hitch! Read on to find out more.
Effective Tax Planning For New Businesses
After her first year of business (the year ended 31 March 2014), Sarah completed her tax return in July 2014. She finds she has $100,000 of profit with tax to pay of $28,000. This triggers a 2015 Provisional tax assessment of $29,400. Based on $100,000 of profit Sarah is faced with tax to pay of $57,400. Sarah’s cash is tight due to her growing business so she estimates her provisional tax at $21,000 thinking if she has no cash, then she cannot be making much profit. The next year Sarah completes her tax return in July 2015 and discovers her profit is $150,000, resulting in tax of $42,000. Sarah has short paid her income tax by $21,000. She has IRD use of money interest payable at a rate of 8.40% of $997 and under estimation shortfall penalties of $4,200. To make matters worse, Sarah’s 2016 Provisional tax assessment is $44,100. Sarah has $70,297 of tax and interest to pay. Sarah is in trouble!
Where did Sarah go wrong?
- She didn’t correctly estimate her future tax liability
- Sarah didn’t understand the costs of getting it wrong
- Sarah didn’t save money for tax
Minimising the impact of tax is dependent on careful tax planning, cash flow forecasting and understanding the impact of penalties and interest. Outlined below are the steps to effective tax planning.
- Always pay the minimum.
You need to know what your prior year tax liability is and what your provisional tax liability is. As an absolute minimum you should always pay this. This will remove any under estimation/payment penalties.
- Forecast your net profit before tax.
Calculate total income and expenses, make sure you prepare this on an accruals basis (what you have invoiced and the invoices you have received) rather than on a cash basis. Consider items like depreciation, interest on loans and non deductible costs such as entertainment costs. The more accurate you are with this forecast the better your tax estimate will be.
- Calculate the tax.
Which tax payer is going to pay the tax and what tax rates are they on? If the profit is retained in a company then a flat tax rate at 28% is payable. If you are a sole trader or pay some or all of the profits out to the shareholders use the individual tax rates of 10.5% up to $14,000, then 17.5% up to $48,000, then 30% up to $70,000 and 33% on income over $70,000. An individual has the advantage of the safe harbour from interest on under paid provisional tax if the total tax is less than $50,000 and the minimum amount of provisional tax has been paid. This rule does not apply to companies who will have interest payable at 8.40% on any underpaid provisional tax.
- When is the tax due?
Consider the different due dates for payment of tax and build a monthly cashflow to calculate how much you need to save per month. Most entities have their financial year end as 31 March, so for the year ended 31 March 2016 provisional tax payment dates are 28 August 2015, 15 January 2016 and 7 May 2016.
- Update the forecast.
Revise your calculations before each provisional tax date. Have you paid the right amount of tax? Will you need to increase future payments?
- Never increase your estimate of provisional tax.
You can always pay additional tax at each instalment date if you have forecast an increased liability, but do not estimate it up.
- Always file your tax returns on time.
If you have a tax agent then you get an extension of time to file. But aim to get your tax returns completed quickly so you know what your minimum provisional tax amount will be and if you are due to pay terminal tax so you can start saving.
- Forecast two tax years ahead.
If you are forecasting your 2015 provisional tax requirements, then you can use the 105% uplift basis and start considering your 2016 provisional tax requirements also.
- Consider using a Tax Pooling Agent.
These businesses provide a method of trading tax payments. So if you have underpaid your tax and do face interest and penalties then tax pooling is a great way to reduce those costs.
The key is to be proactive and think forward. It is better to know what your tax requirements are so you can plan for them and do something about it. If you ignore it you may end up paying penalties and interest, just like Sarah.
Stephen Nicholas is a Deloitte Private Partner based in Wellington. He enjoys helping his clients realise their vision for their enterprise and ultimately ensure their dreams become reality. He’s run his own small business, so has an intimate understanding of what people need to do to achieve the optimum from their business. Along the way, he can also provide support to navigate the many compliance issues that crop up. The advice Stephen provides is pragmatic and focused on achievable results.