Home-based business expenses

Over the last few years, there has been a significant increase in the number of home-based businesses starting up in Australia.

While working from home can help improve a person’s work and life balance, when it comes to claiming home expenses for these business owners, there are a multitude of factors that need to be considered. There are two types of house expenses home-based business owners can claim:

• Occupancy costs, including council rates, house insurance, rent and mortgage interest

• Running costs, like electricity, phones and gas

For home-based business owners to be able to claim occupancy costs, the house that they run their business in must be clearly identifiable as the place of business, and include an area that is specifically allocated for the business. Business signage, a unique access point for customers or clients and an area of the house devoted to the business can be used as evidence to claim occupancy costs.

Unfortunately, quite a few home-based businesses fail to meet these criteria i.e. tradespeople who carry out the majority of their work onsite. For these kinds of home-based business owners, it is much easier to claim for running costs. This is because all that needs to be proven is that there is an office in the house that is used for business purposes i.e. tradespeople would be eligible to claim running costs for an office they used to prepare invoices, quotes or for research and planning.

Even though claiming occupancy and running costs as a tax deduction can provide home-based business owners with a tax benefit, it can have an expensive flip side. Owners should take note that once their home becomes more than their main residence, there is a high chance that it will end up in the CGT system.

While a general CGT exemption exists for main residences, it can be lost due to the extent that the home is used as a place of business.

What are CGT events?

A CGT event occurs when an individual or company makes a capital gain or capital loss by selling or disposing of an asset they own. Determining the timing of a CGT event is quite important, as it determines which income year an individual will report the capital gain or capital loss, and may affect how their tax liability is calculated.

When a CGT asset is disposed of, the CGT event usually takes place when a contract for disposal is entered into. When there is no contract, the CGT event happens when an individual is no longer the owner of the asset.

When a CGT asset is lost or destroyed, the CGT event happens when the owner of the asset receives compensation for the loss or destruction. If no compensation is received, the CGT event takes place when the loss is discovered or when the destruction happened.

For some CGT events, such as exchanging an asset for a replacement asset, the law permits individuals to defer or roll over any capital gain they make until another CGT event takes place.

If more than one CGT event happens, individuals must apply the rules for the one that is most specific to their situation.

Some CGT events include:

• selling or giving an asset away
• the loss or destruction (voluntary or involuntary) of a CGT asset
• receiving compensation for the loss, destruction or compulsory acquisition of a CGT asset
• the disposal of a depreciating asset used for non-taxable (private) purposes
• capital distributions to company shareholders or unit holders in a unit trust or managed fund
• shares or units being cancelled, surrendered, redeemed or declared worthless
• when you stop being an Australian tax resident

Avoiding tax scams

If a tax refund or promise sounds too good to be true, then it probably is. Tax scams can take many forms, such as false emails and text messages, but phone scams are the number one threat in Australia.

Phone scammers usually impersonate an ATO employee and tell the receiver that they owe a tax debt. The scammers may intimidate or threaten the receiver with severe penalties if they don’t pay.

Some scammers will even try to go beyond stealing your money, and will try to steal your identity instead. These scammers are more interested in accessing personal identification data, such as a person’s tax file number, bank account details, drivers licence, or passport number.

The scammer can then use these private details to lodge fake tax returns and keep the refunds for themselves or claim government benefits while pretending to be that person.

Individuals can protect themselves from such scams by simply being aware of what the tax office does to collect information from taxpayers.

The ATO will never ask for an individual’s confidential details or threaten a person over the phone.  The ATO will also never send text messages and emails asking you to enter personal details online.

However, if a call, email or text message seems genuine, it is best to contact the ATO to check whether the correspondence is valid and true.

Tax implications for overseas workers

Australians who work overseas for an extended period of time should be wary of the tax implications that can arise from taking up such offshore opportunities.

The tax residency status of an Australian who move overseas for employment plays a key role in determining how much tax that person is required to pay in Australia.

Individuals who are “residents” of Australia for Australian tax purposes are taxed on both their Australian sourced and worldwide income. Individuals who are classified as “non-residents” are taxed only on their Australian-sourced income. Non-residential individuals are also ineligible for the $18,200 tax-free threshold, and therefore, all of their assessable income is taxed from the very first dollar.

Foreign employment income is any income that an individual receives from working outside Australia. It includes any salary, wages, commissions, bonuses or allowances. For Australian tax residents, this foreign employment income is taxable in Australia and must be included in an Australian tax return.

However, individuals who pay tax on that employment income overseas can claim the foreign tax as ‘credit’ against their Australian tax obligations. To make this claim, an individual must pay (or be believed to have paid) the foreign income tax, and the foreign income tax must be included in their assessable income for Australian income tax purposes.

Non-residents only need to submit an income tax return if they receive Australian-sourced income. However, there is no need to lodge a return if the only Australian-source income received is interest, dividends or royalties that have had the correct amount of non-resident withholding tax deducted and remitted.

Salary sacrificing

While many employees can sacrifice salary in exchange for most work-related purchases, it is essential that employers are aware of FBT when working out the expense that will replace the income in a salary sacrifice arrangement. Employees should also be wary that if their employer has to pay FBT, that cost will most likely be passed on to them under a salary sacrifice arrangement.

If an employee needs to purchase equipment for their work, they can work out a salary sacrifice with their boss to buy the equipment and reduce their personal tax bill if:

• the piece of equipment is considered to be ‘a tool of trade’

• the piece of equipment is used primarily for work purposes

• the piece of equipment is the only tool received during the year with that function, and;

• if both the employee and employer have agreed to undertake the salary sacrifice arrangement beforehand.

There are particular types of benefits an employer can provide to their employee that may trigger an FBT liability if provided under a salary sacrifice arrangement. These include cars, property and expense payments.

However, there are certain fringe benefits that are specifically exempt from FBT under the law. These work-related FBT exemptions can be beneficial to employees under a salary sacrifice arrangement. To be exempt, a purchased item must be:

• a portable electronic device

• an item of computer software

• an item of protective clothing

• a briefcase

• a tool of trade

Using the CGT discount

A capital gain is a profit made from the sale of an asset. Your capital gain is calculated as the difference between what you paid for the asset and what you eventually sold it for. A capital gain is considered by the ATO as part of your assessable income and is taxed at your marginal rate.

There is, however, a discount that may be applied to capital gains. If you have held the asset for over twelve months, you may be eligible for a 50% discount on the CGT. The CGT discount is also available to trusts and superannuation funds, although for superannuation funds the discount is only 33.3%. The discount is not available to companies.

Of course, there are occasions where you may have to dispose of an asset for less than you originally paid for it. Unfortunately, you are unable to use ‘capital losses’ to reduce your assessable income. However, you are able to carry the loss over to the subsequent income year and use it to offset future CGT liabilities.

Negative gearing for property investors

Whether you’re an established property investor or contemplating purchasing your first investment property, you may care to familiarise yourself with the way that negative gearing works.

A property is considered to be negatively geared if the owner has taken on debt in order to acquire it and the net rental income is less than the costs of maintaining the property (including the interest paid on the loan). Investors with negatively geared properties are able to claim the shortfall between their associated costs and rental income as a deduction against their total taxable income. In the event that your taxable income is insufficient to absorb the difference, then the remaining deduction can be carried forward to the next financial year.

Many Australians would not be able to enter the real estate market without taking on some form of debt. While taking on debt allows you to make investments that would otherwise have been beyond your reach, it also ramps up your risk profile because you will have a greater amount invested. Furthermore, if your investment property is underperforming, you remain responsible for making loan repayments.

Obviously, it is preferable to have an investment property that is positively geared, meaning that rental income covers loan repayments, interest and routine maintenance. Paying tax on a profit is typically considered to be a better option than minimising your tax liability while making a loss.

Even if you think that your investment property will be positively geared, understanding the benefits of negative gearing can give you a little peace of mind. You know that if the property does lose money, you will be able to offset the loss against your taxable income. When a property is positively geared, the income earned is added to your total taxable income. As such, it is taxed at your marginal tax rate. The same applies to any capital gain that you make from selling a property.

Family trusts

While the ATO continues to crack down on its tax minimisation strategies, quite a few legal pathways to paying less tax while preserving wealth for retirement or estate planning purposes still exist.

Family trusts have significant tax-saving abilities, and can save high-income earners a fair amount of money over a few years by apportioning wealth to members in lower income brackets via a strategy called streaming.

Streaming income allows trustees to place a high proportion of the trust’s earnings into the names of their adult children (who are subjected to a lower marginal tax rate). Using the kids’ $18,200 tax-free threshold also means the investment income is not be taxed, and franking credits would are refunded. However, if children are below the age of 18, it may not to use this strategy since any investment income they earn above $416 attracts a much higher tax rate.

While streaming is a great option for minimising a family’s overall tax burden, it is not always a straightforward practice and may warrant professional advice. Here are two tips when using the family trust structure for tax purposes:

Take advantage of the tax-free thresholds: Make sure to take advantage of the $18,200 tax-free threshold if you have younger members in the trust, by transferring a higher allocation of the trust’s investment income to them.

Put capital gains and franking credits with low-income earners: Placing a higher proportion of profits to low-income earners can result in huge tax savings.

Working from home deductions

Those who produce some form of assessable income at home or incur expenses from using that home as a workplace can claim for expenses and tax deductions.

Individuals can claim deductions for their home if it is used for income earning activities but isn’t a place of business, or if it is being used as the main place of business. The tax implications vary depending on which of these circumstances applies to an individual. Expenses individuals can claim generally fall into the following categories:

Depreciation on equipment: Deductions can be made for depreciating items like electrical tools and devices, desks, computers or chairs. Those who use the depreciating asset solely for business purposes can claim a full deduction for the decline in value. If individuals also qualify as a “small business entity” (make less than $2 million a year turnover), they can immediately write off most depreciating assets that cost less than $1,000. Using the depreciating asset for non-business purposes means individuals must reduce the deduction for decline in value by an amount that reflects the non-business use.

Running expenses: Running expenses are viewed as costs from using facilities in the home to help run the business or home office. These include electricity, gas, phone bills and perhaps even cleaning costs. A way of working out how much of these running expenses are used to run the business could be to use your floor to measure what was used e.g. if the floor area of your home office makes up 10% of the total area of your home, you can claim 10% of heating costs.

Occupancy expenses: Occupancy expenses can only be claimed by those who use their home as a place of business, not just work there from time to time. These individuals must have an area of their home dedicated exclusively to business purposes only. Occupancy expenses are expenses paid to own, rent or use this area. They include rent or mortgage interest, council rates, land taxes and house insurance premiums.

Building the instant tax deduction into your business plan

With the 2014-15 financial year at an end, business owners should now be planning for a tax regime that includes a $20,000 instant asset depreciation.

Since the government’s introduction of an instant tax deduction on up to $20,000 of capital items in the May budget, business owners should integrate the new rules into their cash flow and tax planning.

The instant deduction gives business owners the ability to claim the total amount of a capital purchase up to $20,000 in one go as a tax deduction. Business owners no longer have to depreciate capital purchases with a schedule or claim partial deductions over a period of four to five years. This essentially means that an owner can bring forward deductions where they wouldn’t otherwise have been able to do so.

When building the deduction into their planning, business owners should only make capital purchases if they are productive assets. If assets do not contribute to the production of revenues, they are unlikely to be eligible as business deductions.

Owners must also understand the actual benefit of the purchase in both a cash flow and taxation sense. If they run at a loss, then the instant deduction is not very useful. The instant deduction reduces the amount a business owner is taxed on. If owners are not in profit, they can carry forward some losses but then the effect of the instant deduction is gone.

Business owners planning for this year must also be aware that the instant deduction does not apply to plants or capital works such as construction. Owners should consult their accountants rather than making assumptions in regards to this.

Business owners must know exactly what the tax benefit is if they are using the rule changes to make a purchase decision. If used wisely, the instant deduction can be a real benefit to profitable small businesses that were planning on purchasing assets. But it is best for owners to speak with their accountant to be sure.