Special Professional Income Averaging
Australian individuals in certain creative fields, known as Special Professionals, often earn fluctuating levels of income from year to year. To avoid paying too much tax in a year when income is in a higher tax bracket, some can take advantage of income averaging.
Generally speaking, it works by reducing the amount of tax owed in a high income year by comparing it to the previous four years’ SP income and applying a tax concession on the “above average” amount. It can be especially advantageous in the first few years of your career or start-up business in a special professional category, when the prior year average income is low or zero.
Primary producers (farmers), being subject to droughts and other conditions which delay their income, use a similar system of income averaging so they too pay a fair amount of tax in higher profit tax years.
Special professionals categories are:
- Authors of literary, dramatic, musical and artistic works. This can include graphic designers and computer programmers.
- Performing artists (e.g., music, theatre, dance, TV and radio appearances)
- Production associates who provide artistic support. (e.g. all kinds of film and TV professionals.)
Income which is earned from your special professional activities is potentially subject to income averaging. The definitions and methodologies in the legislation are very complicated, so a creative industries specialist (such as Electra Frost) is more likely to identify your eligibility.
The calculation of tax benefit is also affected by identifying the first year of eligible income and by changes in tax residency. It’s very important to properly analyse your eligibility within the legislation, and be sure that the correct income has been reported in the right sections of your tax returns, as the ATO can question the basis of your claims.
The above is not intended as advice, and it’s too complex to explain at length here. If you’d like to know whether you may benefit from income averaging, please contact us for a consultation. You will need to show us copies of your last four to six tax returns for us to work out your potential overall tax saving, and we may need to amend some of your prior year tax returns.
Per Diems – Travel Allowances and Expenses
The first thing to understand is that ‘per diems’, for tax purposes, means income ‘per day’. Per diems are not something that you claim as a deduction. However, if you are an employee receiving a bona-fide travel allowance then you may be exempted from keeping written evidence of travel expenses claimed as a deduction against the ‘per diem income’ of up to a certain amount.
For tax purposes, per diems are called travel allowances. The allowance is paid to an employee to cover costs whilst travelling away from home, overnight, for work-related purposes. The allowance is intended to cover accommodation or meals and incidental expenses, or both.
Be aware that contractors and companies (those who are not employees) cannot use this exemption and must keep written evidence of the travel expenses they claim against their ‘per diems’.
It’s important to understand that you can’t automatically claim the maximum amount as a deduction, as the upper limits for each location and salary range are for the ‘substantiation exemption’.
You may still be called upon by the ATO to explain how, in your individual situation, you would have reasonably incurred the amount you claimed as a deduction. Be honest. Don’t go claiming $109.35 a day for meals if you had breakfast provided on-site and bought microwave dinners.
You should also maintain a travel diary so we can work out your claim and defend it to the ATO on your behalf if they call us to – see this ATO-compliant Excel travel diary on our website.
Starting A New Business
Start-up businesses: Which is the right structure for you?
Start up businesses need to make one important decision from the outset – what type of business set-up will suit your enterprise best? And which structure will be best for the future?
You’ve got a choice of four basic business structures – sole trader, partnership, company or trust. Of course, there are also more sophisticated structures out there, but most possible structures are essentially hybrids of two or more of these basic four.
Which structure is best will depend on a few considerations. Do you want to stay small and work from home? Will you need to employ staff? How long will you stay in business? Will you have a partner or partners? What is your market? Will you need to chase start-up capital or obtain funding from a bank or other source?
Of course you can always change business structure as your enterprise changes and grows, but it is helpful if you understand the costs involved in making this change and some of the impediments that may arise.
For many businesses, the growth plan may well include changing to a different structure at a key point in the future – for example, if you plan to expand overseas. Ultimately, the business should be in the structure that is most appropriate in each stage of its life cycle.
Luckily, eligible small businesses can now restructure without any tax consequences under some new CGT laws recently introduced by the government.
Difficulties can arise moving to the next level of business. Business owners are often not aware that they are passing different threshold tests for tax obligations, such as GST, PAYG withholding and payroll tax. Growing a business is satisfying, but more so when the tax and regulatory consequences have been taken into account.
Although the choice is yours, it may help to know how each structure will affect the way your income is taxed, your operating costs, how you will be able to protect your assets, and how clients and other businesses will deal with you. Another thing to keep in mind is how easily a structure may make a future restructure.
To be a sole trader is the simplest business structure, and as the name implies you will be operating the business in your own name, and will control and manage all aspects of your business. For tax purposes, your personal financial affairs and your business’s affairs are one and the same – there is no separation.
The sole trader structure is inexpensive to set up and there are few legal formalities, but you will need an ABN (Australian Business Number). You receive the full benefit of any profits, and keep all after-tax gains when you sell-up (see below for more). However you also personally bear the full brunt of any operating losses.
Access to finances is limited to your own resources, and you are legally responsible for everything the business does. You also put private assets at risk, such as your house or car, if the business goes into serious debt and these private assets are targeted in any debt collection efforts.
As a sole trader:
- you use your individual tax file number when lodging your tax return
- the income of the business is treated as your own income
- your business income is taxed at your personal income tax rates along with your income from other sources (which can be as high as 49%)
- depending on your turnover, the ATO may need you to pay PAYG instalments over the year towards the amount of tax that can be expected at the end of the financial year
- you may also have to register for goods and services tax (GST)
- you will also need to take care of superannuation arrangements, but may still be able to claim for personal contributions, and
- if you decide to take on an employee, you’ll need to pay 9.5% of their ordinary time earnings into their super fund as well as PAYG withholding.
Also note that amounts of money you take from your sole trader business are not “wages” for tax purposes, even though you may consider this the case, so you can’t claim a deduction for money you “draw” from the business.
This arrangement sees you carrying on business with one or more other people, and receiving income jointly. There are more shoulders to bear the burden, but also more people to share profits, losses and responsibilities. A greater chance of legal dispute between the business partners themselves also exists (when compared to a sole trader).
Partnerships are still inexpensive to set up, and there will likely be greater financial resources than if you operated on your own as a sole trader. On the flip side however, you and your partners are responsible for any debts the partnership owes, even if you personally did not directly cause the debt.
This means that where one partner refuses to pay a debt of the business, the other partner is still liable for the whole amount of that debt. Each partner’s private assets may still be fair game to settle serious partnership debt. This is known as “joint and several liability” – the partners are jointly liable for each other’s debts entered into in the name of the business, but if any partners default on their share, then each individual partner may be severally held liable for the whole debt as well.
A written partnership agreement may not be legally required in every state and territory, but these agreements are usually inexpensive and will clearly set out the terms of the partnership (which reduces the risk of a future dispute).
As a partnership:
- the business itself doesn’t pay income tax. Instead, you and your partners will each need to pay tax on your own share of the partnership income (after deductions and allowable costs)
- the business still needs to lodge a tax return to show total income earned and deductions claimed by the business. This will show each partner’s share of net partnership income, on which each is personally liable for tax
- if the business makes a loss for the year, the partners can offset their share of the partnership loss against their other income
- a partnership does not account for capital gains and losses at all on the disposal of CGT assets (such a real estate); if the partnership sells a CGT asset, then each partner calculates their own capital gain or loss on their share of that asset
- the partnership business is not liable to pay PAYG instalments, but each partner may be, depending on the levels of their share of relevant income
- as a partner you will need to take care of your super arrangements, as you are not an employee of the business
- personal contributions may still be deductible, and any eligible employees of the business will still need to be covered for the compulsory super guarantee.
Again, money drawn from the business is not “wages” for tax purposes. As with any business, the partnership will need an ABN and will need to register for GST if the business’s annual turnover is more than $75,000 (before GST).
Operating your business as an incorporated company will transform your enterprise into a separate legal entity. This more complex business structure is usually more costly to set up and administer, and will also come under the regulations of the Australian Securities and Investments Commission (ASIC).
A company will have far greater access to capital as shares can be issued to potential shareholders in exchange for funding. Shareholders and directors are not generally liable for the debts of the business beyond the amount of capital they have contributed, therefore asset protection is one advantage of this structure because creditors cannot, in most cases, go after a shareholder’s or director’s personal assets, only the company’s assets.
The company will pay its own tax on its own profits at a company tax rate (see below). But tax reporting requirements are more onerous than those for an sole trader or partnership, and minority shareholders have little say in the running of the business unless they hold a directorship or are in senior management.
For a company:
- it will need its own bank account, and its own tax file number
- it needs to lodge an annual income tax return, as money earned by the business belongs to the company
- the tax return will need to show the company’s income, deductions and tax it is liable for
- PAYG instalments will need to be paid, which are credited against the end-of-year income tax
- it will pay tax on its assessable income (profits) at the company tax rate (currently 27.5% for a small business, otherwise 30%), and there is no tax-free threshold
- GST will need to be registered for and paid if annual turnover is more than $75,000
- compulsory superannuation payments have to be made where required by law in respect of the company’s employees (including yourself, if you are a director paid as an employee of the company) as well as PAYG withholding
- if you receive wages, director’s fees or dividends, these need to be shown on your individual income tax return.
If you are a shareholder in the company then you are entitled to receive dividends on which you will pay tax. Just be aware that if the company makes loans or payments to you, or if you take company assets for yourself, the law may treat these transactions as unfranked dividends, and they’ll be taxable to you as such, unless they are formally converted into interest-bearing loans.
As outlined above, ordinarily a director is not liable for the debts of a company. However a number of tax debts, like superannuation owed to an employee, bypass this rule. This means that where the company doesn’t pay these debts, the ATO will make directors of the company personally liable for them.
The way a trust operates can be described as an obligation or a promise, where a person or a company agrees to hold income-earning assets or property for the benefit of others. A trust formalises this obligation. The one who legally holds the assets is the trustee. Those who benefit from the income are the beneficiaries.
One basic outcome of a trust is to separate legal ownership and control (which the trustee has) from beneficial ownership (which the beneficiaries hold). A natural result from this is increased asset protection, as the beneficiaries’ personal finances are not put at risk by the business, since the business assets are legally owned by the trustee and not by the beneficiaries.
Be mindful that this is a legal relationship, meaning that, unlike a company, the creation of a trust does not create an entity that can generally be sued in its own right. The exception to this general rule is taxation — for tax purposes a trust is seen as a separate entity.
The most common variety of trust is a discretionary trust – such trusts give the trustee flexibility as to who distributions of income and capital can be made to.
Setting up a trust can be more expensive, and administrative paperwork potentially more complicated. But there can be tax advantages, because:
- tax is usually paid by the beneficiaries at their personal tax rates, which may be well below the top marginal rate
- as trustee of a discretionary trust, you can use your discretion each year to decide which beneficiaries receive income, and how much – as long as the outcomes are within the rules contained in the trust deed, which is the document governing how the trust operates
- the trust’s beneficiaries, via their individual returns, pay tax on their share of the trust’s net income “distributed”
- if all income is distributed, the trust itself would generally not be liable for any tax except in limited circumstances, when the trustee would pay tax on behalf of certain beneficiaries (mainly children under the age of 18 and people with certain disabilities)
- a trust will need its own tax file number, and ABN and GST obligations may apply
- a trust is not liable for PAYG instalments but beneficiaries may be, depending upon the amount and type of income distributed to them
- the same superannuation obligations also apply
- PAYG withholding and other obligations also apply if the trust hires employees for its business.
If the trust holds on to income, you as trustee will be assessed on that income at the highest individual marginal rate. If the trust carries on a business, all income earned and claims for expense deductions must be shown on a trust tax return, which will also show the amount of income distributed to beneficiaries.
Comparison – Speak to us for assistance
No one structure will suit all business types. Each individual business will have different requirements and growth plans. However, a consideration of what structure a business takes at the outset can minimise costs and risks to the business in the future.
The key determinates that will drive these decisions are:
- the need to remain flexible for possible restructuring of the business, and
- balancing the need to streamline the tax affairs of the business with the protection of the business and personal assets of the individuals involved.
This overview of basic structures is however general in nature, and you should consult this office if you are considering a new business venture or changing an existing one. This will ensure that the right structure for your business is put in place.
Record Keeping For Small Business
What are my record keeping obligations?
Maintaining reliable and accurate records will help you manage your cash flow and track your business performance. Aside from that, if you are self-employed or a director of a company you actually have a legal obligation to maintain proper records.
As the burden of proof falls upon the taxpayer in the event of any dispute it is imperative that adequate, well-organised records are kept for the statutory periods as set out in the ‘Tax Act’. Generally, for 5 years. There are penalties for not keeping records and it will reduce the risk of tax audit and adjustments if the records are kept and maintained for the required statutory period.
This Ruling TR 96/7 sets out the statutory requirements that people (including companies) carrying on a business must keep adequate records that support and explain all transactions.
In particular this would include:-
- All documents supporting amounts of income and expenditure
- All documents showing any estimates, elections, calculations or determinations relevant to the Act and showing basis for and methods used to arrive at an estimate, determination or calculation.
- All records must be in plain English (or convertible to English) and be easily accessible and should be kept for 5 years. This would include records that are kept in paper or electronic form.
Do I need to pay for accounting software?
If you have a company or if you’re GST registered, with more than 20 transactions a month, we usually recommend using online accounting software with double-entry accounting and we can help you choose and implement an appropriate solution for your business.
If you decide to go with a free or very cheap cloud accounting product, expect to get what you pay for. Some do not meet Australian standards and it can end up costing you more for an accountant to reconstruct your data at BAS and tax time. At least make sure that you can export full transactional records to Excel to prepare ATO-compliant cash book templates, before investing your valuable time in a bargain product.
For sole traders, a record of all your income and expense transactions in an Excel spread sheet can be enough for your tax accountant or BAS preparer to work with. For example:
Income – Cash Receipts Book entries
|Invoice Number||Invoice Date||Date Paid||Payer||Description||Total Sale||Comments|
|00092||01/08/17||07/08/17||Jon Smith||Artwork: XXX #5||2200.00||Private sale|
|Sold 18/8||01/09/17||Rob Jones, Sun Gallery||Artwork: YYY #2||1650.00||See gallery commission invoice – 40%+GST|
|00093||10/09/17||17/09/17||Jenny Jean||Design work||400.00||Paid in cash|
|00094||10/10/17||Not paid||X.Interiors||Mural painting||1100.00||Bad debt written off|
|RCTI||01/12/17||15/12/17||Joy Galleries||Artwork: XXX #7||990.00||Consignment sale|
|00095||03/04/18||05/04/18||Ada in Jakarta||Artwork: ZZZ||800.00|
|15/05/18||Aus Council||Grant “describe”||11,000||Not spent. Project commences in Sep 2018, ends Sep 2019.|
Recording the invoice numbers shows you’ve not left any out. Recording the payment dates and other information helps your accountant put the right amounts of income in the right places in your tax return.
Expenses – Cash Payments Book entries
|Date Paid||Supplier||Description||Total Cost||Business %||Comments|
|14/07/17||Harvey Norman||IMac Computer||1,119.00||Computer for design work|
|14/07/17||Harvey Norman||Home/office Fan||110.00||50%|
|01/09/17||Sun Gallery||Commission||660.00||Sale of Artwork: YYY #2|
|17/11/17||Ikea||Desk for office||327.00|
|02/03/17||Qantas||Conference flight||626.00||50%||Jakarta trip – see travel diary|
|04/04/17||Bob Johns||Contractor, install||250.00||ABN checked – valid|
|Annual||3 Mobile||Mobile phone bill||716.50||70%||Total paid in 2017-18|
|Annual||M&J RE Agent||Home studio rent||15000.00||18%||See floor plan and agent payments ledger|
The cashbook format is very simple to manage. It allows your transactions to be easily categorised and checked for completeness. You can record the raw data from which any cash-basis financial, tax, BAS or budgeting report can be built as required. Using this format and not leaving out necessary information can help to keep your accounting fees down.
Here are SOME examples of what NOT to do:
- If you just give your accountant a page of “totals” it might not be enough.
It will take more time to deconstruct your totals in order to do the job properly, which can increase your accounting fees.
Don’t use a monthly cash flow format – example:
This looks flashy, but it is hard to see exactly what has been included. Computer might mean a new iPad or a peripheral item – or multiple purchases. Many types of expenses are categorised and treated differently for tax purposes. Your accountant can classify your purchases if you describe the actual item or service you purchased.
You don’t do your BAS or tax return on a monthly basis, either. The above format is more appropriate for monthly budgeting and cash flow forecasts, which are built by using the raw transactional data from your cash books.
- Have a dedicated bank account for business income and expenses
For sole traders, in our experience, this is the single most helpful way to maintain accurate records and keep costs down.
Without a separate account, one of the biggest challenges for you and your accountant is to untangle your business life from your private life. This can mean hours trying to remember what each bank transaction is.
You can also more easily prove the completeness and accuracy of your record keeping system (with a bank balance reconciliation).
You’re also more likely to be able to prove that the meal or hotel or concert was for business, not leisure, if you can say that your business policy is to always pay for business expenses with your business card!
Also, in the unfortunate event of an ATO “records keeping systems integrity audit”, you don’t want the ATO officer trawling through your personal financial life and thinking of extra fines to charge you for any negligence they discover in the time consuming process!!
Can we stress this any more? I don’t think so. You just have to get a business bank account, or at least a normal bank account that’s only used for business. (Please do it)
Tip: Save yourself hours of data entry by downloading your business bank transactions from online banking in Excel.
- Keep up to date
Try to set aside an hour or so each week to record and file the income and expenses for that week. Put it in your diary and commit. It’s so much easier to do when everything is fresh in your mind.
“All that said, I recommend Money Day to my clients. Money Day is exactly what is says on the tin – a whole day, once a month, devoted to financial bookkeeping. If you concentrate on the books even just once a month, you’ll get into good habits, and after a while you’ll be happy to learn it doesn’t have take a whole day. And the most important thing about Money Day at our office? The champagne we drink when it’s all over!”
Private Companies (Example Pty Ltd) and other business structures
The reporting and record keeping requirements for companies, partnerships and trusts are stricter than those for sole traders.
These business structures should ideally maintain double entry accounting systems that can produce Financial Statements (Profit & Loss, Balance Sheet), bank reconciliation reports, and both accruals based and cash based reports.
Seek professional advice to choose the right accounting software for your business. We can help.
- Record keeping for small business – Australian Tax Office
- Electronic record keeping – Australian Tax Office
- Record keeping evaluation tool – Australian Tax Office
- Managing risks to your records – Australian Tax Office
- What records should my company keep for ASIC?
Records for Capital Gains Tax
Similar to the Income Tax Section 262A, the section 121-20 of the Income Tax Assessment Act 1997 (ITAA 1997) requires that taxpayers must keep records of all acts, transactions or events which could reasonably be expected to give rise to a Capital Gain or Loss through a Capital Gains Tax Event (refer Capital Gains Tax section). These events may have already happened or could be future events. These records must again show details of how the acts, transactions, events or circumstances are relevant in calculating whether a capital gain or loss has been made. These records must be held for 5 years after it is certain that no CGT event can or will happen.
Electronic versus Paper Records
Particularly relevant for the CGT record keeping-original records that can be transferred into an asset register. This can be kept in paper format or electronically, however, it must be secure and software should provide an audit trail (of additions and deletions) so that entries cannot be easily altered. Your record must contain all the relevant information and can be maintained by either the taxpayer or by a registered tax agent).
Where paper records have been converted to electronic records they satisfy requirements if they are not altered once stored, are kept for five years and can be retrieved and read at any time by Tax Office staff.
Contractor Or Employer?
Content coming soon.
Employing Family Members
Content coming soon.
Working Or Moving Overseas
Content coming soon.
Should I Register For GST?
Content coming soon.
Donating Your Artwork – Gift Deductions
Content coming soon.
Artist Grants and Advances
Content coming soon.
Investing In Property
Content coming soon.