By: Max Newnham
Success in business is all about finding a hundred 1 per cent savings and improvements, rather than looking for the one solution that delivers a Tattslotto-like 100 per cent improvement.
This focus on looking for improvements covers everything from improvements to profitability, reductions in expenses and maximising tax advantages.
One area where many small business owners do not maximise their tax advantages relates to borrowing. Inevitably, small business owners will have a combination of business and private debt. When interest rates on business loans are higher than the interest on private loans, a decision can be incorrectly made to pay off the business debt before the private debt.
Focusing just on the rate of interest being charged on a loan, rather than the after-tax cost of a loan, will inevitably lead to a wrong decision being made.
For example, a business loan at 6 per cent, for someone on a tax rate of 34.5 per cent, results in an after-tax interest rate of 3.93 per cent because the interest is deductible. Because interest paid on a home loan mortgage is not tax-deductible, an interest rate of 4.2 per cent is actually more expensive.
This means, as a general rule, it makes sense for business owners to pay interest only on business loans, and pay off their private loans as quickly as possible. It is also important when taking out business loans to choose the type of finance that gives the highest tax deduction.
Q. I have recently opened a small personal training business from home and want to buy equipment to set up a studio gym. I was looking at getting personal finance or leasing the equipment. What would be the best option for me as a sole trader?
A. Before the introduction of the small business entity instant asset write-off, there was not a great deal of difference between choosing between a private loan or a hire purchase contract and a lease. Over the first years of a private loan or hire purchase contract, the tax deduction was slightly higher than a lease, but not to a point where there was a major difference.
Now that a small business entity can instantly write off assets that cost less than $20,000, financing the purchase of assets through a lease can be a lot less tax efficient.
Under a lease, the finance company effectively owns and claims the depreciation on the asset, and the business gets a tax deduction for the leasing costs. When an asset is financed either by hire purchase or a personal loan, the asset is owned by the business. The tax deduction each year is made up of the interest cost of the finance plus the depreciation.
In your situation, if you bought five pieces of equipment costing $5000 each, you could claim a tax deduction of $25,000 in your first year of operation, plus the interest paid. If the equipment was instead leased over five years, with a $2500 balloon payment at the end, at a 6 per cent interest rate, the tax deduction in the first 12 months would only be $4920.
Source: Sydney Morning Herald
