As far as I understand, a lot of self-employed people get the opportunity to defer all their tax payments until the end of the year.
I’d like to learn more about this as it seems that this a wonderful opportunity to earn money on behalf of the tax man.
So if you’re Australian and expecting to pay lots after July 1, I’d recommend doing the tax return as early as possible (July 1, 2, whatever) to find out how much you’ll owe. But here’s the key : you don’t submit your tax return until much later. You just take your tax liability, invest it somewhere, collecting the interest and only pay your tax obligation when you absolutely have to. (Ie. when the risk of potential fines outweighs the investment benefits.)
Hmmm I wonder if anyone I know does this already. And I also wonder if anyone does this on their GST contributions.
*edit* I’m still reading the voluminous works of Travis Morien as linked to below, and just bumped into him mentioning that this is why people keep their money in companies. If they don’t withdraw it as dividends from a company, they’re able to keep it in there at the lower tax rate which means the difference can then be re-invested. When reading any of his stuff remember that it may be dated. Most content - if not all - was written before 2007.*/edit*
And I wonder how a self-employed person (such as Pete) finds managing all that stuff on their own. I can imagine it would get very tedious after a short while.
Other interesting points : self-employed people can claim a deduction on their initial super contributions; home investors can claim tax on interest as much as 13 months ahead by paying interest in advance - not only this, but the lender often will give a discount on these payments; investment in agriculture is tax deductible.
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August 11, 2007 at 6:04 pm
Travis Morien
Hi, I noticed via a Google alert that someone was talking about me! I’m glad you found my site useful. While there is some dated material in there I did remove most of the out of date stuff in my FAQ update in January 2007, see http://www.travismorien.com/invest_FAQ
Companies are used for three purposes.
One purpose is to access the corporate tax rate of 30%. Where personal investors pay a tax rate which varies from 0% to 46.5% depending on the level of income, companies in Australia always pay a flat 30%.
They also give that tax back to shareholders receiving dividends via franking credits, so if dividends are paid to someone on a lower tax rate than 30% they get refunded the difference.
This means that companies can be an excellent vehicle for smoothing income. In years when you have a high income you retain profits in the company. In years when your income tax rate is less than 30% you pay those profits out as a franked dividend. This effectively caps the tax rate on business and investment income at 30% and helps ensure that opportunities to receive income during low tax years do not go wasted.
Often companies are used in a more elaborate structure involving a discretionary trust. When assets are held in a discretionary trust the income and capital gains from them can be “streamed” at the discretion of the trustee. If one of the beneficiaries of the trust is a company then the above strategy of using companies to take excessive income when tax rates are low is quite easy. The company’s shares can be owned by the trust itself, making it easy to stream that money back into the trust as a dividend when beneficiaries need it.
Companies used in this way are sometimes called “bucket companies” by those in the business, though the proper name is “corporate beneficiary”.
It is also common for companies to loan the income they have received back to the trust so that the trust can reinvest the assets, however caution should be used if the trust has other loans to people as this can get you tangled up in the whole Division 7A thing, though the rules in that area have been modified recently and aren’t as draconian as they once were. http://www.ato.gov.au/businesses/content.asp?doc=/content/40557.htm
One caution is that companies don’t get the 50% discount on capital gains, so they pay 30% tax on all realised capital gains whereas the most a personal investor will pay on long term gains is half of 46.5%, i.e. 23.25%. That’s where the discretionary powers of a discretionary trust can come in handy though, because the trustee can allocate capital gains to people and other income to the company.
Companies can also be useful for asset protection purposes however company directors are still exposed to financial liabilities especially where the company was found to be trading while insolvent. It is prudent for company directors to own minimal assets in their own names. That’s what spouses and trusts are for!
The third main use of companies is as trustees of trusts and super funds. Self managed super funds with only one member need to have a corporate trustee, and for other SMSFs with more members a corporate trustee can have some additional advantages.
I hope this is useful to some of your readers. Note that I can only speak on the Australian tax system, while the general idea is the same for many foreign jurisdictions I don’t warrant that it is valid anywhere else.
Travis Morien
www.travismorien.com
August 12, 2007 at 3:54 am
Mat
Thanks Travis
You have an obvious passion for this which shines through! Love your work!
August 12, 2007 at 8:40 am
Pete Aldin
I’m just glad for accountants I can trust and people like Travis!
Fortunately I’ve set up as a sole trader. Life is FAR simpler for me than for a friend of mine (also a self-employed coach/consultant) who set his business up as a corporation (on the advice of a silly silly accountant) and has had nothing but complexity, too much tax and other problems since.
August 12, 2007 at 12:31 pm
Mat
Yeh exactly Pete
From what I have read and been told, corporations are more justified when you have a really big income, the tax benefits of which offset the accountant costs and hassles!
Of course if YOU’RE the expert (such as Travis) it’s easier!
If you look at their website all their people run their own little corporations
August 14, 2007 at 7:50 pm
Anthony
This is one of the more interesting blogs I’ve read in a while…