What your accountant doesn’t tell you: Here’s why business owners have the edge in tax savings

Small business owners get the best tax deals in Australia. Here's how we optimise our tax structure at SBO – and how you can do the same.

Owning a small business is the best tax deal in Australia.

Whether you run a side hustle or a $20M business, earning business income opens up great opportunities for tax savings and wealth creation.

As an accountant, I’m going to share some structuring and tax tips we use at the Arbor Group (my group of businesses). 

This blueprint is available to every Australian small business. 

It’s not for everyone, but if you’re in the business of empire building like we are, you’re in the right place.

First, a quick disclaimer: This is not tax advice, and is specific to my personal circumstances. Speak to a registered tax agent before making any decisions relating to the below. If you’d like a consultation on how you can also utilise these tips, book a meeting with our friendly team at SBO Tax.

In this article:

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          The Fringe Benefits Tax exemption for electric vehicles

          My wife and I picked up our first ever brand-new car last weekend. 

          We needed a second car as my business travel – trips to the office and offsite – was becoming more frequent.  

          We bought it in the company name to claim the GST. That takes 10% off the price.

          But here’s the real kicker….

          Ordinarily, I’d have to pay Fringe Benefits Tax (FBT) because it’s not wholly used for business purposes.

          But, with the recent FBT exemption for electric vehicles, it effectively becomes tax-free for us personally.

          Once you factor the tax write-off my company gets, the cost of a Tesla Model 3 goes from $66,100 to $45,500.

          This effectively means a $20k cash saving.

          There are a couple of considerations you need to take into account with this:

              • It only applies for certain EVs or hybrid vehicles purchased and used on or after 1 July 2022 (there is a price cap).

              • The benefit provided still counts from a reportable fringe benefits amount (RFBA) perspective, even though there’s zero FBT payable. This matters if you have a HELP loan, pay child support, don’t have private health insurance, or are on the cusp of the arbitrary $250k tax threshold for Div293 (tax on excess super contributions). 

            Deferring tax with holding companies

            If you’re in the business of long-term empire building, it’s vital to have strong foundations.

            From a tax and capital compounding perspective, nothing beats structuring your portfolio of businesses via a holding company.

            It works like this.

            A company holds the shares of your portfolio of operating businesses. It’s important to note that this entity doesn’t trade – it simply holds the shares/investments in your group.

            Cash dividends, via profits of your businesses, are paid up to your holding company. This is where cash accumulates.

            Your family trust is the shareholder of your holding company. You can decide to pay those dividends to your family trust, which you can distribute to you/family members – or don’t. You can stockpile that cash in the holding company and use it to seed/acquire a new business to add to your portfolio of business investments.

            The important thing here is that a holding company:

                • Helps with asset protection in your operating businesses, because excess cash is paid up to the holding company.

                • Gives you optionality to pay dividends, unlike trusts, which force you to distribute profits every year – usually at marginal tax rates higher than 25%. This alone means deferring up to 25c in the dollar of ‘top-up’ tax by retaining profits in a company, as opposed to paying profits out to individuals.

              The taxes of taking money from your business

              Business owners pay a ‘tax’ on every dollar that’s withdrawn from their company bank account. 

              The tax paid is:

                  • Income tax – The amount the federal government takes from your dividends / wage

                  • Opportunity cost tax – A ‘tax’ on the lost opportunity of reinvesting that same dollar into growing your business and generating returns.

                Most folks understand the income tax cost, but few truly understand the opportunity cost – because it isn’t a tax, per se. But it is a real expense that needs to be considered.

                Let’s take the example of an entrepreneur who owns and operates a business doing $150,000 per annum of EBITDA (earnings before interest, taxes, depreciation and amortisation). On an annual basis, the entrepreneur has two choices:

                    • Pay an annual dividend to himself (in addition to his market salary); or

                    • Re-invest the $150k into the business and continue to compound it at, say, 15% per year by growing it.

                  Calculating the future value of a fixed return of 15% in the business over a 20 year period reveals that, by not withdrawing the $150,000 per year, the entrepreneur will forgo $17.82 million in favour of $3 million.

                  The opportunity cost of withdrawing the $150,000 per year is $14.82 million in future value.

                  And this doesn’t even take into account the taxes that the entrepreneur will pay on the dividends on the way out – in reality, the $150,000 dividend is more likely to be around $100,000 cash after income tax.

                  When you frame it like this, you can start to understand the power of capital compounding in your business, and why it matters. A lot.

                  It’s this kind of thinking that makes my business partner and I hesitant to draw excessive amounts of capital from our business, because opportunity cost is significant.

                  How you can actually get paid from your holding company

                  At this point, you’re probably thinking, ‘OK, great, I kind of get it – but how do I actually access the cash personally from my company?’ 

                  If you’re a business owner trading from a company structure, there’s no doubt your tax accountant has at one point attempted to explain a thing to you called Division 7A (Div7A for short).

                  Typical tax accountants like to rag on Div7A. Behind closed doors, you’ll hear them in the tea room bickering about a client’s use of their company cash as a personal slush fund.

                  Whilst this may be the case in some circumstances, Div7A is a  perfectly legal and effective way to defer tax – as long as it’s managed and governed well. 

                  Tax planning is crucial.

                  Div7A in a nutshell

                  Here’s my attempt to explain Div7A in layman’s terms.

                  Division 7A is a section in the Australian tax law that deals with loans made by private companies to their shareholders or associates. Essentially, if a private company lends money to one of its shareholders or associates, there are tax consequences that need to be considered.

                  The first principle to understand is that the money in your company’s bank account is not your money. It’s the company’s money, used for the company’s benefit. 

                  Companies pay a tax rate of 25%. The only way to get this money paid to you as a shareholder is by paying a dividend. When a company pays you a dividend, this needs to be declared in your personal tax return. You pay personal income tax on this dividend at marginal tax rates, which can be up to 45%. Because the company has already paid 25% of income tax on the dividend, you pay tax on the difference, or a ‘top-up’ tax.

                  Practically speaking, many small business owners don’t actually ‘pay dividends’ when they decide to transfer money out of the company bank account into their own bank account. They take it as a ‘loan’.

                  The problem the ATO has with loans to shareholders is that they are not reported as income. This means the shareholders are using company money without paying tax on it. So that’s why the ATO created Div7A – to ensure that shareholders are paying tax on the money they’ve taken from the company. 

                  Managing Div7A

                  There are two ways to deal with loans to shareholders.

                      1. Pay a dividend for the full loan amount. This means the shareholders pay tax on the entire amount in the financial year.
                      2. Set up a loan agreement over seven years (or 25 years if taking security of an asset), and pay it back over seven years at an interest rate (FY23: 4.77%). 

                    1.  

                    Most folks choose the second option. But instead of paying the cash back from your personal bank account back to the company bank account to meet the first year loan repayment, you declare a dividend for the same amount instead.

                    As a shareholder, it effectively allows you to spread your reportable income tax over a seven-year period, whilst still getting access to the cash today. 

                    The first year loan repayment is not due until the following tax year, meaning you get an interest-free loan for a year.

                    The added kicker is the flexibility to distribute these dividends to multiple beneficiaries via your family trust (+subject to Section 100A), effectively reducing the average tax even lower. 

                    This alone can create some significant tax savings over time.

                    Start making your small business work for you 

                    If you’ve made it to the end of this article, congrats! You’ve uncovered some of the best-kept tax secrets for small businesses in Australia. By being smart with how you structure your taxes, you can enjoy some sweet savings and wealth creation opportunities that can really make a difference.

                    Whether you’re interested in taking advantage of the FBT exemption for electric vehicles, deferring tax with holding companies, or considering the taxes of taking money from your business, there’s a wealth of information available to help you apply these strategies to your business.

                    So, are you ready to start optimising your taxes and growing your wealth? Get in touch with SBO Tax today for a complimentary chat with one of our expert tax advisors. You’ll be on your way to maximising your tax benefits and achieving your financial goals in no time

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