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Beware the Double Tax Trap for Growing and Start-Up Businesses

Paul Sweeney
Paul Sweeney

Every business owner wants to grow a profitable business that continues to grow and remain profitable in the long term. Rapid growth in both revenue and profits are seen by many to be the keys to achieving this.

There is one consequence of rapid profit growth that can destroy your profitable business. That consequence is taxation, or more specifically double taxation.

Without careful planning the strong growth in profit for your business could also be the reason your business will struggle to survive in the next twelve months.

Profitable businesses are taxed at the time the income tax return is lodged. Where there is a rapid growth in profit, the tax credits previously paid will not be enough to cover the tax debt for the return lodged. This is a major blow to your cash flow.

Under the PAYG Instalment system, businesses are required to make quarterly instalments of income tax in advance for the following year. The amount of PAYG Tax instalment required is based on your most recent tax return lodged. The Australian taxation Office (ATO) assumes you will make the same level of profit as declared on your most recent tax return. PAYG instalments are paid by quarterly instalments due 28 October, February, April and July each year.

After you lodge your return there will be a "catch up" instalment.

Let's look at an example of how this works. Fred started his tiling business in 2017 and broke even. In 2018 he has made a very nice profit of $200,000. His company Bedrock Slate and Tile Pty Ltd (BST) qualifies for the 27.5% company tax rate.

Year 1 2018
Revenue $1,000,000
Taxable Profit $200,000
Tax @ 27.5% $55,000

If Fred lodges BST's tax return in March 2019, BST will have an income tax debt due

on lodgement of its return of $55,000. Now that BST has lodged its first tax return with tax payable the ATO will update the PAYG Instalment details.

For the June 2019 Activity Statement, BST will be required to make a PAYG instalment for the 2019 of $55,000 (ignoring indexation). For the September 2019 quarterly activity statement BST will be required to pay one quarter of the estimated PAYG being $13,750 in October 2019.

April 2019 $55,000 2018 Tax Total
July 2019 $55,000 2019 Instalment
Sept 2019 $13,750 2020 Instalment
Total $123,750  

In 7 months BST will pay 2 ¼ years of tax.This is a huge sting and will make a massive dent in your cashflow. Unless Fred had planned for this and set aside funds to make these payments Fred will have a major issue with cashflow and making these payments

If Bedrock Slate and Tiling continues to grow without controlling the cash flow issues, the taxation impact on cash from the second year of growth will increase.

In our example if Bedrock Slate and Tiling achieves these figures:

Revenue $2,000,000
Taxable Profit $500,000
Tax @ 27.5% $137,500
Credit for 2019 Tax Instalments PAID $55,000
Balance of 2019 Tax Payable $96,250

Then it will have tax payments due of:

April 2020 $96,500 2019 Tax Balance
July 2020 $96,500 2020 Instalment
Sept 2020 $13,750 2021 Instalment
Total $206,750  

Again, in 7 months BST will be paying 2 ¼ years of taxation.

Not paying your tax debts on time may impact your ability to raise funds by borrowing in the future. A business with a clean tax portal report showing commitments are paid on time will have much more success getting funding than a business with a poor tax payment position. Where a business has entered into a payment plan with the ATO to manage cash flow, lenders such as traditional banks may see this as the business being unable to meet its key obligations.

Every business owner must have an action plan for how you will grow and survive.

  • You need to plan well in advance for how you will fund the growth
  • Set aside reserves for making your taxation payments on time
  • Organise the funds for how your growing business will pay this double taxation hit
  • If you need to organise funding, start the process well in advance of when you will need to make tax payments

Get your business finance fit and avoid cash flow issues like this.

Published on by BiziNet

Pretium Solutions Pty Ltd

Pretium Solutions Pty Ltd

Tel: 02 9135 8450
Street Address: Suite 113, Nexus Norwest, 4 Columbia Court, Baulkham Hills NSW 2153

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