The government, as part of its federal Budget measures, is signalling its intent to cut the company tax rate for small business from 30 per cent to 28.5 per cent. Normally this would be welcome news, but with the current tax system, this tax cut could actually end up disadvantaging the majority of small businesses.
Cuts in the company tax rate benefit those businesses that are operated by companies. The reality is that many businesses, of which the majority are micro and small businesses, aren’t operated by companies. These businesses tend to be sole traders, partnerships or trusts and their profits are taxed at personal tax rates, not the company tax rate.
For example, there are around 2.7 million businesses with turnover of less than $2 million, but only 675,000 of these businesses are conducted by companies.
Laws that try to extend a similar tax cut to non-company operated businesses will add further complexity to the tax system and create more opportunities for aggressive tax planning. In the end, what the proposed tax cut will do is create a financial and competitive advantage for some small businesses over others, based solely on their legal structure. That is not a good outcome.
A second issue is identifying exactly what a small business is. Currently there are numerous, often inconsistent, definitions of a small business in the tax law. What is small for income tax is different to capital gains tax and what will qualify as small under the FBT laws would not be small under the GST laws. ASIC, the ABS and other government regulators also have other definitions.
Unless you understand clearly what a ‘small business’ is you can’t efficiently target initiatives like proposed tax cuts. Good initiatives will encourage small businesses to grow. But this means that if the definition is too restrictive, say based on a turnover threshold which is too low, it will actually create a disincentive for businesses to grow.
A $2 million turnover is one of the more common thresholds for small business. If a lower tax rate applied for businesses below this threshold, then why would a business want to grow to, say, $2.1 million turnover and get a higher tax bill?
It makes sense to set the thresholds higher, perhaps around $10 million in turnover, and index them regularly. This move will capture the vast majority of small business and will present less of a disincentive for growth.
The small business sector is a vital sector for economic activity and employment, but in terms of tax collections, they contribute only a small percentage of the overall tax intake. This presents the government with a real opportunity to support a key section of the economy but at a limited economic cost.
The issue of a tax rate cut for small business highlights some of the fundamental flaws existing in our current tax system.
There are solutions the government could implement to help small businesses. Many issues with their current proposal could be overcome by having a special purpose ‘small business entity’ for tax purposes.
Rather than cut the company tax rate, a tax cut could be directed at this type of entity. It would provide a more effective way for the government to target incentives and be less open to abuse when compared to the current system.
Tax cuts are always welcome by business; however, they need to be structured to ensure they actually benefit the business as intended.
Greg’s tax expertise and 20 plus years’ experience as a Chartered Accountant enables him to work with clients to deliver practical, commercially focused outcomes, whether it’s a technical tax matter or a broader business issue. Recognised as one of Australia’s leading tax advisors, Greg has assisted countless businesses, individuals and families to deal with complex and significant tax issues. He is a published author and regular conference presenter.
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