The 3 Biggest Mistakes Business Owners Make with Tax Minimisation

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Let’s face it – sometimes you just don’t know what you don’t know. You would think that employing staff would be a simple thing, but often times no.

In my work as an accountant who also does bookkeeping and payroll for my full-service clients, I often find that my new clients are not paying their staff correctly. This is generally because they don’t know what they are supposed to be paying and/or have not had the correct advice from their previous bookkeeper/accountant. So, here’s a few things you should be doing:

  • Prepare a contract for all your employees which includes a job description. The contract includes their start date, their hours of work, their rate of pay and when it will be paid, among other things. Let me know if you need a template for an employment contract
  • Pay your staff at the award There are many jobs in industries that are covered by an Award, including Hair & Beauty Industry, Hospitality, Retail, Clerical and many others
  • If there is no Award for your industry then the industry standard or your industry professional organisation can help you with the appropriate pay rate for them
  • Apply the minimum standards to your employees. In Australia, The National Employment Standards (NES) are minimum standards even without an Award relating to your industry. One of the minimum standards is that the maximum weekly hours for any employee is 38 hours per week. Consequently, depending on the industry or agreement with the employee, any hours over that are overtime hours to be paid at the overtime rate. Go here for a copy of The National Employment Standards
  • Follow the award provisions regarding paying overtime including TOIL, entitlements to leave and breaks
  • Pay overtime hours at the correct rate. This is not covered in the NES but should be covered in your industry award. If your employees are not covered by an award, the standard rate is 1.5 times the ordinary hourly rate for that employee for the first three hours of overtime worked for that day. Did you know that Time in Lieu (TOIL) is also accrued and paid at the overtime rate when taken
  • Keep overtime/TOIL accrued to a strict minimum. Unnecessary overtime will make your wages bill blow out and you may not see enough increase in sales/revenue because of it. You or your manager must be on the game and send your staff home when their daily hours are up if possible.
  • There is a 3.3% increase to minimum wages due to the annual wages review announced on 6th This applies from 1 July 2017. You need to review your employees’ current award on 1st July and update their pay rates accordingly.

The concept of a “going concern” exemption for the purposes of the goods and services tax (GST) can still cause confusion when businesses are sold.

The sale of a business may be GST exempt if the enterprise is deemed to be a “going concern” — which refers to an enterprise’s ability to continue trading. The ATO (and the GST legislation itself) says a supply of a going concern occurs when:

  • “a business is sold, and that sale includes all of the things that are necessary for the business to continue operating”, and
  • the business is carried on, “up until the day of sale”.

The GST exemption has its advantages — a buyer of a business does not have to find extra funds to cover GST that is added to the purchase price. And while the buyer is entitled to get the tax back via the input tax credit system, this cannot happen until some time after the completion of the transaction. It also must be remembered that while the GST is eventually refunded, any stamp duty payable on the sale of a business will include the amount for GST.

What are the requirements for the exemption?

Business owners may be aware of the existence of a GST exemption but not completely understand the way it operates. The GST legislation says that the sale of a going concern will be GST-free if:

  • the sale is “for consideration”
  • the purchaser “is registered, or required to be registered” for GST, and
  • “the supplier and the recipient have agreed, in writing, that the supply is of a going concern”.

The sale of business contract will usually specify that the business (that is, the “supply”) is a going concern when the contracts are exchanged. This is critical, because it shows that all parties to the sale acknowledge that the business is a going concern.

A vendor is required to supply “all of the things that are necessary” for the continued operation of the enterprise. This does not mean everything that is owned by the business. It does however mean those things without which the enterprise could not function. Generally, this includes the necessary assets such as premises, plant and equipment and customer contracts. It can also include arrangements such as ongoing advertising.

The legislation requires the vendor to carry on the business “up until the day of sale”, with it deemed to be transferred on the date on which “effective control and possession” of the business is handed over to the buyer. While this date generally refers to the settlement date, “the day of sale” may occur before or after the settlement date. Importantly, there is no requirement for the purchaser to actually continue carrying on the business.

The tax liability risk (in case the ATO does not view the sale as a supply of a “going concern”) ultimately lies with the seller, as it is the “supplier” in any transaction that is required to remit GST to the ATO.

Some vendors seek to avoid this tax liability risk related to the business by including a clause in the sale contract requiring the buyer to indemnify the vendor for any GST that may be payable in the event that the ATO does not view the transaction as one of a going concern.

Disclaimer: All information provided in this newsletter is of a general nature only and is not personal financial or investment advice. Also, changes in legislation may occur frequently. We recommend that our formal advice be obtained before acting on the basis of this information

Given the state of the property market in Australia these days, a not-uncommon situation can arise where a residential property owner seeks to demolish and subdivide the block containing the family home and build residential units.

If you have the available land of course, the above is a solid strategy. However it can cause headaches from a tax perspective — and in some cases the ability to access the main residence exemption and even the CGT discount can be compromised.

Divvying up the backyard

A question that arises every now and then concerns the effects on the CGT main residence exemption where the owner decides to subdivide the land containing their principal place of residence, in some cases demolishing the existing home, and build residential units.

The scenarios that are typically raised involve one of the following choices:

  1. demolish the main residence, subdivide the land, build two home units, sell one and live in the other
  2. subdivide the land, build a home unit on the newly created previously vacant portion, and sell the unit (with the original residence staying intact)
  3. subdivide the land and sell the non-main residence block (with original dwelling staying intact).

When dealing with these situations, the following pertinent tax questions may need consideration:

  • Would demolition of the original main residence would trigger a capital gain or loss (if any)?
  • What are the CGT implications of subdividing the property?
  • Is the sale of the home unit or vacant land the “mere realisation” of an asset or is there is a profit-making activity conducted?
  • How would the original dwelling/unit, retained and lived in by the taxpayer, be treated for CGT purposes?

Note that there may be some GST implications that are not dealt with in detail here. Suffice to say that any venture undertaken by home owners in building units for the purposes of sale may, from the ATO’s viewpoint, constitute an “enterprise” and may necessitate an ABN and registration for GST. Speak to us if you consider that this may be the case.

Scenario 1: Demolish dwelling, subdivide land, build two units, sell one and retain other as main residence

Consider the following scenario:

  • Jim acquired a dwelling in May 2012 and resided in the dwelling as his main residence.
  • The land is less than two hectares.
  • Due to the poor state of the dwelling, it was demolished in June 2016. No consideration was received as a result of the demolition.
  • The land was subdivided into two blocks and Jim then commenced to build a unit on each block. Jim continued to be the owner of both blocks.
  • Upon completion in January 2017, Jim moved into one of the units as his main residence (as soon as practicable after completion).
  • The unoccupied unit was sold in February 2017.
  • Jim lived in rental accommodation from June 2016until January 2017.

The subdivision of land results in each new block registering a separate title. The subdivision itself has no CGT consequences, provided Jim continues to be the owner. However it does create two new separate CGT assets. A further consequence of subdividing the land into two blocks is that the cost base of the land is required to be apportioned to each new block in a “reasonable way” (such as using the land area or a market valuation).

In disposing of the non-main residence unit, a question arises as to whether the building of the unit and its subsequent sale is a “mere realisation” of a capital asset or a profit derived from an isolated transaction. This is not always clear, and requires consideration of all the necessary factors. We can provide guidance should this be a source of confusion.

Unlike the non-main residence unit, the main residence unit continues to qualify for the CGT main residence exemption.

Note also that notwithstanding that the original dwelling has been demolished, Jim can still extend the main residence exemption to the newly built unit provided that certain conditions are met.

Specifically, he can choose to treat the vacant land as his “main residence” for a maximum period of four years from the time that he ceases to occupy the demolished dwelling until the replacement unit becomes his main residence (“the four year rule”).

It is therefore possible for Jim to have an unbroken period of “occupancy” from the time that the demolished dwelling was acquired until such time that the replacement dwelling ceases to be his main residence. During this period, once a choice is made, Jim cannot treat any other dwelling as his main residence.

Scenario 2: Subdivide land, build a home unit on the previously vacant portion, and sell the unit (original residence stays intact)

  • Mary and John acquired a dwelling in April 1996, which was their main residence.
  • The home had a swimming pool on land adjacent to the dwelling.
  • The land is less than two hectares.
  • Their adult children have left home and, requiring cash to fund their retirement, Mary and John have intentions of downsizing their living arrangements.
  • In December 2016, they removed the swimming pool and subdivided the land into two blocks (retaining their existing home).
  • They built a unit on the vacant block, completed in March 2017 and sold in April 2017.

As noted above, the subdivision of land does not trigger a CGT liability provided that Mary and John continue to be the beneficial owners of the subdivided blocks. The cost base of the property would need to be allocated to each block of land on a reasonable basis.

As the unit built on the newly apportioned block was created with an obvious intention of making a profit, and as the owners have continued to use the original dwelling as their home, neither the CGT main residence exemption nor the CGT general discount applies.

The fact that the unit was constructed on land that was originally subject to the main residence exemption (as part of the two hectare area upon which Mary and John’s residence was situated) provides no basis to argue that some part of the gain on disposal should be free of tax pursuant to that exemption.

Unlike the non-main residence unit, the block containing the main residence continues to be subject to the CGT provisions, including the main residence exemption.

The subdivision of Mary and John’s land therefore has no effect in this regard, however the cost base of the block containing Mary and John’s original dwelling would be reduced following allocation of the cost base between the two blocks.

Scenario 3: Subdivision of land with main residence and dispose of vacant block

  • Bob acquired a dwelling in August 1996 for $400,000, which was his main residence.
  • The land is less than two hectares.
  • In September 2012, the property was subdivided into two blocks with one block containing the dwelling (front block) and the other block being vacant (rear block). Bob continued to be the owner of both blocks.
  • The legal costs for the subdivision were $10,000.
  • At the time of subdivision, Bob’s real estate agent advised that the value of front block and rear block should be split 50/50.
  • The rear block was sold in December 2014 for $400,000.

Again, mere subdivision does not trigger a CGT liability provided Bob continues to own both, and the new cost base of each must be calculated on a reasonable basis. As the split, based on the agent’s advice, is 50/50, the cost base for each block is as follows:

Acquisition cost

(50% of $400,000) ………………………..$200,000

Legal fees (50% of $10,000) ……………….$5,000

Cost base per block ………………………..$205,000

For its part, the ATO has indicated in various rulings that situations similar to Bob’s would not necessarily result in an “enterprise” for GST purposes. For income tax purposes, it follows that the ATO would likely consider that Bob has disposed of the land by way of “mere realisation” of his land as opposed to realising a gain from a profit-making undertaking.

Accordingly, the sale of the vacant block would be on capital account and the CGT general discount would be available if the asset is owned for at least 12 months. Therefore the net capital gain to Bob from the sale of the rear block is $97,500 (that is [$400,000 less $205,000] x 50% general discount).

However the net capital gain on the sale of the vacant land would not attract the operation of the main residence exemption. As a general rule, adjacent land would be subject to the exemption if it was primarily used for private and domestic purposes in association with the dwelling. However the exemption only applies if the land and dwelling are sold together. As a result, the net capital gain of $97,500 would remain assessable to Bob.

Please speak to us to clarify any of the above scenarios should they apply to you.

 

Disclaimer: All information provided in this newsletter is of a general nature only and is not personal financial or investment advice. Also, changes in legislation may occur frequently. We recommend that our formal advice be obtained before acting on the basis of this information