Tax discount for unincorporated businesses

Small businesses play a significant role in the Australian economy and it is only recently that they are receiving more of the limelight. The IPA has been constantly advocating that the small-business sector faces a disproportionate level of compliance relative to their size and are deserving of concessional tax treatment for the regulatory burdens and entrepreneurial risk they endure. It is pleasing that our advocacy efforts have been reflected in recent tax policy changes and that the small-business sector is front and centre in the minds of government.

The government has introduced a 1.5 per cent small-business company tax cut from 1 July 2015. As only

30 per cent of small businesses use a corporate structure, the majority would not have benefited from a small business company tax cut. To provide relief more broadly, the government has introduced a small-business income tax offset for unincorporated entities.

Providing a tax discount for unincorporated small businesses is intended to broadly mirror the small-business company tax cut. It will help improve the cash flow of small businesses as it will reduce the amount of tax payable in the financial year, and help to compensate the small-business sector for the regressive compliance costs they face. This is a welcome start to the new financial year especially when combined with the increase in the instant asset write-off threshold of $20,000.

The tax discount will result in unincorporated small-business owners having higher after-tax earnings, which they can reinvest in their businesses, potentially increasing growth and productivity in the small-business sector.

The tax offset is available to individuals who are themselves small-business entities (for example, individuals who operate as a sole trader). The small-business tax offset also applies to individuals who are a partner in a partnership that is a small-business entity, and individuals who are a beneficiary of a trust that is a small-business entity.

The definition of small-business entity remains unchanged: “an entity that carries on a business and has aggregated turnover of less than $2 million”. The term ‘business’ is defined in section 995-1 and includes any “profession, trade, employment, vocation or calling, but does not include occupation as an employee”.

In many cases, small-business entities will receive income from a variety of sources. Income that does not relate to a small-business entity carrying on a business (for example, employment income), will not form part of its net small-business income.

The amount of the tax offset is five per cent of the income tax payable on the portion of an individual’s income that is small-business income. In addition to calculating the offset in this way, the maximum amount of the tax offset available to an individual in an income year is capped at $1,000.

The ‘net small-business income’ of a small-business entity is calculated by working out the assessable income of the entity that relates to it carrying on a business, and subtracting from that assessable income the entity’s deductions, to the extent its deductions are attributable to that income.

Where an individual receives a share of an entity’s net small-business income, the individual’s total net small business income is also reduced by the deductions to which the individual is entitled, to the extent their deductions are attributable to that share.

An individual is able to claim one small-business tax offset for an income year irrespective of the number of sources of small-business income that an individual has. The maximum amount of the offset from all sources of income is $1,000 for an income year.

As the tax offset is available to individuals, it cannot be claimed by trustees who are liable to pay income tax on the income of a small-business entity that is a trust. Even though a trustee may in fact be an individual, the tax law regards them in their capacity as a trustee as a separate entity that is liable for income tax on the income of the trust, as a trustee, and not as an individual.

The small-business tax offset is designed to apply to trusts that actively carry on a business as a small-business entity. Such trusts are unlikely to have beneficiaries under a legal disability that relates to a physical or mental disability.

In the event that a trustee is assessed on the income of a beneficiary under a legal disability, the offset could be obtained by the beneficiary if they lodged a tax return, or a return was lodged on their behalf.

However, where a trust has a beneficiary who is under a legal disability because they are a minor, that minor will not have access to the tax discount unless the following exception applies: a minor will only qualify for the tax discount if the minor derives income from carrying on of business activities that they genuinely carry on either alone or in partnership. In determining the amount of a minor’s business income, regard is had to things like the extent to which the minor had real control over the business and the extent to which the capital of the business consisted of capital contributed by the minor.

Example showing how small business income tax offset works

Adrian is a small-business entity. For the 2015-16 income year, Adrian’s taxable income is $100,000, his basic income tax liability is $25,000, and his total net small-business income is $50,000.

To work out the amount of his small-business income tax offset for the 2015-16 income year, Adrian first divides his total net small-business income by his taxable income ($50,000/$100,000 = 0.5). The result of this calculation shows that half of Adrian’s taxable income relates to his total net small-business income.

Adrian then multiplies the result of the first calculation by his basic income tax liability (0.5 × $25,000 = $12,500). The result of this second calculation shows that $12,500 of Adrian’s basic income tax liability is from his total net small-business income.

Adrian’s small-business tax offset is equal to five per cent of the result of this second calculation (0.05 × $12,500 = $625). The full amount of Adrian’s small-business tax offset is therefore $625.

Adrian can claim the full amount of the small-business tax offset for the 2015-16 income year because it is less than the $1,000 cap.

The recognition that small business faces disproportionate regulatory burden is welcomed. While the quantum of the tax discount delivered via the tax offset is small, it represents a positive step in the right direction. It’s a good news story for tax agents to share with their clients to help lift confidence in the small- business sector.

Tony Greco FIPA is the IPA general manager of technical policy. He can be contacted on (03) 8665 3134 or at tony.greco@publicaccountants.org.au