As your business grows and expands, you will face choices as to how that growth is financed. In some cases, the business may be sufficiently profitable that future growth plans can be financed from internally-generated capital. In most cases, it will be necessary to look to external finance in order to secure the funds your business needs to grow.
Among the areas you might be looking to finance are:
- the acquisition of new and bigger premises, or an extension to existing premises,
- the acquisition of new equipment, fixtures and fittings,
- taking over competitor retail businesses, and
- expanding your core retail product lines.
If you borrow money to finance the growth of your business, interest paid on that finance will generally be tax deductible, provided all the borrowed funds are used for business purposes (you’ll need to apportion the interest if some of the finance is used for private or domestic purposes).
Loan payments consist of two elements:
- the repayment of the principal, which is a capital expense and not deductible, and
- the interest element (cost of finance) which will be deductible where the loan is for business purposes.
Interest is deductible immediately even where the borrowed funds are used to acquire capital assets, such as property.
Costs incurred in arranging a loan are also deductible by the business, as are costs incurred in discharging a loan. That might include:
- loan procurement fees
- guarantee fees
- legal costs
- stamp duty
- valuation fees
- survey fees
- underwriters fees
No deduction is available if the finance doesn’t go ahead.
Financing asset purchases for your business
In many cases you’ll want to raise finance to acquire new assets to use in the business, such as new POS equipment, delivery vans, better store fixtures and fittings to improve the display of your merchandise, or improved in-store security. In some cases, you’ll borrow money to acquire the asset and in others, you’ll lease the asset. The distinctions between buying an asset using hire purchase (HP), taking out a finance lease and taking out an operating lease can be quite subtle, but the tax treatments—and the legal obligations and responsibilities imposed on your business—can be very different, depending on which route you take.
Hire purchase contracts
If your business acquires an asset under a hire purchase contract, you will acquire full legal ownership of the asset, subject to any security on the asset put in place by the lender.
For tax purposes, the following deductions for assets financed under an HP contract can be claimed:
- the interest component of the HP payments
- repairs, and
- depreciation on the asset from the date of the HP contract.
Finance leases
If your business takes out a finance lease on an asset, your business will take on many of the risks and rewards of ownership of the asset without—initially at least—taking on legal ownership. Typically, after paying the lease payments for the duration of the term, your business will legally acquire the asset by paying out the residual payment to the lessor. Until that point, the entity leasing the asset to your business will be the legal owner.
For tax purposes, lease payments made under a finance lease are immediately deductible. In addition, as your business will be responsible for keeping the asset in good order, any repair or servicing costs will also be tax deductible. Your business can’t claim the depreciation on the asset—the entity leasing the asset to you will claim that.
Operating leases
If your business takes out an operating lease on an asset, it is basically renting that asset from the leasing entity, which retains ownership of the asset.
In many cases, this can be an attractive option. Because the risk of ownership remains with the entity renting the asset to your business, you avoid any of the risks of obsolescence and don’t have to worry about maintaining the asset or repairing it if it breaks down, since the lessor is usually responsible for all those costs.
For tax purposes, payments made under an operating lease are immediately deductible in the period to which they relate, provided the asset being leased is used in the business. As noted above, servicing and repairs will often be included in the headline rental cost but if charged separately, they will also be deductible.
Tax deductions for buying capital assets
As well as considering the tax implications of financing growth, you will also need to be aware of how capital assets, such as fixtures and fittings, equipment and vehicles, are treated for tax purposes.
Basically, you are able to deduct the cost of any capital assets your business acquires. This is called depreciation. In most cases, you deduct the cost over a number of years but in some cases, you can deduct the cost immediately.
For small businesses (with a turnover less than $2 million), there are simplified rules for depreciating assets and those rules will be the focus of this article. Different rules apply to non-small businesses.
The amount that you can write off is the cost to your business of acquiring the asset. In addition to the actual amount spent purchasing the asset (excluding GST), that also includes any delivery and installation costs and also any relocation costs, if the asset was previously kept somewhere else.
For motor vehicles, deprecation can only be claimed on the cost up to the Luxury Car Limit. This changes each year but for 2016-17 it is $57,581. If the vehicle costs more than the limit, depreciation can only be charged on the cost up to the limit.
Calculating depreciation for small businesses
Any assets (including in-house software) costing less than the small business deprecation threshold amount are written-off immediately in the year they are bought and used or installed ready for use.
This threshold amount has varied considerably in recent years but is currently $20,000.
TIP: From 1 July 2018, this will fall to $1,000 so the period between now and then is a great opportunity to improve the capital assets held by your business.
This is a great cash flow booster for small businesses since it allows investment on capital assets to be rewarded with an immediate deduction rather than being written off over several years. The downside is that the cash flow benefit all arises in the year of purchase, so future taxable income will be higher than where assets are depreciated over several years.
The entire cost of the asset must be less than the instant asset write-off threshold, irrespective of any trade-in amount. The rules apply irrespective of whether the asset is purchased new or second-hand.
In calculating the deduction, you can only claim in relation to the taxable purpose proportion in producing assessable income. For example, if a computer that is newly acquired for $8,000 is to be used 60 per cent for business purposes, the deduction will be $4,800. If it is to be used only for business purposes, the deduction will be $8,000. While only the taxable purpose proportion is deductible, the entire cost of the asset must be less than the threshold for a claim to be made in the first place.
If the asset for which an instant write-off has been claimed is later sold or otherwise disposed of, the taxable purpose proportion of the disposal proceeds later received for the asset must be included as income.
If the cost of an asset (other than a building) is the same as or more than the instant asset write-off threshold, the asset is placed into the small business pool and is depreciated at a rate of 15% for the first year (regardless of when the asset was purchased during the year) and 30% in subsequent years.
If the adjusted balance of the small business pool is less than the applicable instant asset write-off threshold for the year (currently $20,000) the whole pool balance must be written off.
Mark Chapman is director of tax communications at tax accounting group H&R Block.
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