One of the main contributing factors to the $11.1 billion small business tax gap has been identified as taxpayers failing to understand their tax obligations, particularly when “unnecessarily complex” business structures are in place.
The ATO acknowledges that most small businesses are not structurally complex, with around 80 per cent owned and operated by one or two people, using a base structure of company, trust, partnership or sole trader.
However, it has advised small businesses to review their business structures after finding a number of examples of business owners not understanding their obligations.
These include company owners using company assets for private purposes, or private assets for company purposes, causing incorrectly claimed business expenses, undeclared profits and dividends, and misapplication of loan accounts.
The ATO also sees sole traders transitioning to a company or trust structure, without understanding that business assets are now owned by a separate entity and that personal use of these assets can result in a fringe benefits tax obligation.
The Tax Institute’s senior tax counsel, Professor Robert Deutsch, told Accountants Daily that business owners often don’t understand what their chosen business structure means for them.
“What I find often, and this is both anecdotal and hard evidence, is people with companies and trusts mixing up whose income it is and mixing whose expenses it is and it easier for that to happen than one might think,” Professor Deutsch said.
“For example, if you’ve got an individual who operates their own activities, which could be entirely private or partially business, but at the same time they have a company of which they are the sole shareholder, it is very easy, and it happens all too often, to either inadvertently or deliberately mix the two up.
“So, you end up with income in the company because you are getting a lower tax rate than in the hands of the individual who might be on a higher tax rate, or vice versa.”
Professor Deutsch believes tax practitioners can play a key role in educating their clients to help them keep up with their obligations.
“If they are going to set people up in company structures or trust structures, they need to explain very carefully to the taxpayer exactly what that means and how careful the taxpayer has to be in identifying invoices and expenses and where they are really meant to be going,” Professor Deutsch said.
“It has got to be horses for courses. If you’ve got a very sophisticated taxpayer, I think it is OK to put them into something that’s a bit complex with maybe a couple of companies and a couple of trusts, but if you’ve got a very simple taxpayer who just wants to run a small business efficiently, you’ve got to be very careful when you start advising on complex structures.
“The problem I find is that taxpayers understand what it means at the beginning, but a year later, they are so busy trying to make ends meet that they’ve forgotten all about that and they can’t even remember what the structure is trying to do and they can’t remember what they are meant to do in terms of their invoicing.”