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The 3 golden rules for business tax deductions

Tax deductions you can claim as a small business is always a popular subject.

Allowable deductions are subtracted from your assessable income to calculate your taxable income. Your taxable income is used to calculate your tax liability. Generally, the lower your taxable income is, the lower your tax liability. So keeping all of your business records can ensure you claim as many allowable deductions as possible to lower your taxable income and pay your fair share of tax. Being organised when it comes to your expenses will ensure you don’t miss out on any allowable deductions.

Most of the money you spend in running a business is tax deductible.

There are three golden rules for what the ATO accepts as a valid business deduction.

1. The expense must have been for your business, not for private use.
2. If the expense is for a mix of business and private use, you can only claim the portion that is used for your business. Separating out the business portion and private portion is called apportioning.
3. You must have records to prove it.

Deductions if your business is not registered for the goods and services tax (GST)

Let’s look at an example of deductions you can claim if your business is not registered for GST. If you buy a laptop for $3,000 and you only use it for your business, you can claim a deduction for the full purchase price (including GST).

However, if you use the laptop 50% of the time for your business and 50% of the time for private use, you can only claim 50% of the amount as a deduction. You would only claim a $1,500 deduction.

Deductions if your business is registered for GST

If your business is registered for GST, you calculate your deduction differently because you claim the GST component of the expense in your business activity statement.

If you buy a $3,000 laptop which includes $272 GST, you can claim the GST credit of $272 in your business activity statement and the remaining $2,728 as a deduction in your business tax return.

If you’re going to use the laptop 50% for business and 50% for private use you can claim 50% of the GST credit which is $136 in your business activity statement and 50% of the remaining amount (which is $1,364) in your tax return. You cannot claim a GST credit for the portion used for private purposes.

If you have a business that is registered for GST, you have to apportion the GST credit, if you buy something that is for both business and private use.

Companies generally don’t apportion expenses for private use. If the company is paying for private expenses, fringe benefits tax (FBT) may apply instead.

Finally, if you use an item in your business for only part of a year you generally need to restrict your claim to the period it was used for the business.

Types of deductions

You can only claim the business use percentage if an expense is only partly for business purposes.

You can’t claim a deduction for an expense that is solely for private use. If an expense relates to both business and private use, you have to work out what proportion of the expense is related to your business and claim only that amount. If you’re  registered for GST, you will also apportion your GST credit.

If you purchase goods or services for both business and private use, you can only claim a GST credit for the part of the purchase relating to your business use.

There is no limit on the amount that you can claim each year, provided the expenses were incurred when you were earning your assessable income. You need receipts or other documents to substantiate the expenditure.

Only Claim Business use

Only claim deductions against your business income for expenses associated with the business use of your assets. You need to work out the portion spent on private use and exclude this from your calculation.

Meet obligations when providing benefits to employees

Make sure you meet your tax obligations, including private company benefits and fringe benefits tax (FBT), which may apply when you provide benefits to your employees, shareholders or associates.

Keep proper records

Keep proper records for your business that can explain all transactions, including payments to and receipts from employees, shareholders and associates.

Common Mistakes

Some of the common mistakes the ATO have identified include:

• claiming deductions for private assets
• incorrectly apportioning deductions
• private company benefits giving rise to a deemed dividend (a company purchased asset used for private purposes by a shareholder or their associate)
• creating an FBT liability.

Expenditure you can’t deduct

You can’t deduct private or domestic expenses like childcare fees and clothes for your family. You can’t deduct expenses relating to income that is not taxable, for example, money you earn from a hobby. Certain expenses that are specifically non-deductible under the tax law can never be deducted. Examples are speeding fines and parking tickets.

Finally, you cannot deduct loans the business makes, and money drawn from the business by the owner.

Expense you can deduct over time

A capital expense is money spent to buy assets like plant and equipment. Some expenses can be deducted over time, such as prepayments and capital works deductions. You generally can’t claim a full deduction in the year you incur these expenses. Instead, you’re required to calculate and claim the deduction for these expenses over a number of years.

Prepayments

A prepaid expense is expenditure you incur for things to be done in a later income year, for example lease payments. Generally, a prepaid expense is deductible over the ‘eligible service period’, which cannot exceed 10 years. However, a prepaid expense may be immediately deductible in the year that it’s paid if the 12-month rule applies, or if it’s excluded expenditure.

The 12-month rule is available to small businesses with an aggregated turnover of less than $10 million.

Deductions for depreciating assets

You may be able to claim a deduction for the decline in value (depreciation) of a depreciating asset. A depreciating asset is an asset that has a limited life expectancy (effective life) and can reasonably be expected to decline in value or depreciate over the time it’s used.

Examples

Examples of depreciating assets are computers, electrical tools, photocopiers, furniture, carpets, curtains, and motor vehicles.
Generally, you can claim a deduction for the decline in value of a depreciating asset for each year over its effective life.

Limits