How a Business Qualifies as a Small Business - Assignment Example

Running header: Tax laws Student’s name: Instructor’s name: Subject code: Date of submission: 1. How a business qualifies as a small business and what the advantages are regarding possible deductions Facts of the case The business run by Buzz and Fuzz is a courier service run by the brothers. The business relies on a single client for its income although the client uses other couriers also. The business has converted Fuzz’s garage into an office from where the business is carried. The business owns three vehicles used in providing the courier services. The business’s total value of assets is estimated to be $800,000. The business’s last year’s turnover was about $1m with considerable business related expenses. Does the business by Buzz and Fuzz qualify as a small business? S328.110 ITAA (1997)1 sets out the criteria that have to be satisfied for a business to be considered a small business for tax purposes. The criteria include the following; a) If a business is being carried on in the current year. b) $ 2m aggregate turnover test Are Buzz and Fuzz carrying on a business? The factors to consider in determining whether a business is being carried on include the motif to make profit, the business size, the effort and the business records. From the facts above, it seems that the courier service business is being carried on with a purpose of generating profits. The size criterion has also been satisfied since the facts above i.e. Turnover of $1m, assets valued at $800,000 including three vehicles and the presence of an office leads one to conclude that the courier service is of a relatively large size. It has also been established that the partners expend their effort into running the business while one can deduct that records have been kept for the business from the figures given above. As such, the courier service by Fuzz and Buzz meets the business criteria in the small business test. The 2m aggregate turnover test S328.110 (1) ITAA (1997)2 details out the 2m aggregate turnover test. This is either based on the look back test where the tax payer’s collective revenue for the preceding year is below $2 million (s328-110(1)(b) ITAA (1997) or the look forward test where the tax payer’s collective revenue for the present year is expected to be below $2 m. In this case, the courier service business satisfies the look back test since we are told that it had an aggregate turnover of $2 million. Based on the criteria described above, the courier business satisfies the two criteria for small business and hence the as partners may apply to the commissioner for its registration as a small business for tax purposes. Advantages regarding possible deductions Having satisfied the criteria for small business entity test, the courier service by Buzz and Fuzz will upon registration by the commissioner receive certain advantages in relation to such matters as accounting for income, claiming deductions, depreciating assets and accounting for trading stock. S328.10 ITAA (1997)3 details out the types of concessions available for small business tax payers such as the courier business with regard to assets. These include CGT 15 year exception, CGT 50% active asset reduction, CGT retirement exemption and CGT small business roll-over. Thus a small business can apply for a specific concession depending on its circumstances. Apart from the above capital gains concessions, other advantages accruing to small businesses for tax purposes include; i) Simplified depreciation – this means that the tax payer can straight away write off every assets which costs below $1,000 while some assets can be pooled for depreciation with an aim of achieving better rates. ii) Trading stock –there simplified trading stock rules for small businesses. This implies that where the business’s trade stock did not change in worth during the year in consideration by amount exceeding $5,000, the tax payer may opt to avoid stock taking at the year end and report on the previous year’s amount as though there is no change that has taken place as far as stock value is concerned. iii) Pre-paid expenses -small businesses may obtain tax deductions immediately for some types of expenses paid in advance. iv) GST – Taking care of small business GST is simplified since the eligible businesses only require accounting for GST when payment is received. GST can also be paid in installments which tax office can help in working out. 2. The derivation method to be used by the courier service business (Cash receipts or accruals) It has been established above that the courier services offered by Buzz and Fuzz qualify as a small business. As such, the business has an obligation to account for its income for tax purposes. As such, the business has to choose an appropriate derivation method that suits its circumstances. Derivation for tax purposes means obtaining , acquiring or getting income as was held in C of IR v Farmers Trading Co Ltd (1982) 5 NZTC 61, 2004. Derivation happens at the point when income comes home to the tax payer. The income tax act provides for two derivation methods. This includes the cash method where income returns are made in the income period in which it which it is in fact / constructively received; and the accruals method in which income returns are made in the income period during which the various events that determine the right to receive the income take place. It should be noted that the cash/receipts method is mostly used by private individuals who earn salaries and wages as well as some professionals. On the other hand, the accruals method is mostly used by business tax payers. Although it has been established that Buzz and Fuzz carry out a business, there would be no strict requirement for it to use the accrual method but the derivation method to be adopted will depend on the business’s circumstances. This is in line with the suggestions in FC of T v Dunn 89 ATC 41415 where it was stated that the taxpayer must choose the technique which is designed to give a significantly correct reflection of the tax payer’s accurate income. The cash/receipt method occurs when actual or constructive receipt of cash by the tax payer has occurred. In ClR v The national bank of New Zealand (1976) 2 NZTC 61, 150 Cook J6 , it was found that cash method in general applies to mainly salary as well as wage earners, to private persons who are not professionals and do not carry out businesses to a few professionals. Based on this, Buzz and Fuzz are carrying out a business and not a profession. Neither do they earn salary or wages for their services. In addition, it seems that the nature of their business does not favor the cash system since most likely they are invoiced for their services and are not paid on a cash basis. In Fincon (construction) Ltd v C of IR (1970) NZLR 4627, the accrual method was described as that where both costs and revenue are recognized as they are incurred or earned as opposed to when money paid or received and matched together as long as their relationship can be assumed reasonably; and dealt with in the profit and loss account for the period to which they relate. The accrual method was that deemed as the most appropriate for business tax payers. Furthermore, the accrual method also depends on the contractual arrangement between the taxpayer and the payer. As has been established, Buzz and Fuzz business is a contractual arrangement to carry out courier services. Furthermore, its nature implies that payments and receipts for the business do not occur on a cash basis. As such, the best derivation method to be applied by Buzz and Fuzz for tax purposes is the accrual derivation method. Whether Buzz and Fuzz’s carrier services business is a personal service business (PSB) or personal service entity (PSE)? S87.15 ITAA (1997)8 lays down the criteria for determining whether a service business such as the courier service is a personal service entity (PSE) or a personal service business (PSB) for tax purposes. Personal service business could be viewed as a company, partnership or trust whose ordinary or statutory income consists of personal service income of one or more individuals. On this basis, it can be argued that Buzz and Fuzz are carrying on a personal service business by deriving income from providing courier services. S.87.15 ITAA (1997)9 provides the following criteria for a PSB determination. It should however be noted that the threshold condition for this determination is that 80% or more of the personal service income come from one source. In the case of the courier business, this condition has been met. The rest of the tests are outlined below; a) The business derives its payment from results and not just time spent. This is a condition that has been met by the courier service business since they are paid for the courier service they offer to the company s87-60(5) ITAA (1997)10. b) The business is obligated to provide own equipment and plant as well as tools to produce the results for which payment is received. In this case, Fuzz and Buzz supply the equipment which they need in offering their courier services for which the are paid. As such this condition (s87-60(5b) ITAA (1997)11 has been satisfied. c) The taxpayer is also required to be responsible for the price of rectification of defects in work carried out (s87-60© ITAA (1997)12. Although this has not been stated, it would be expected that Buzz and Fuzz would be held liable for any defects in work performed due to the nature of the work they do. As such, this condition is implied and has been met. d) The employment test- s87-25 ITAA (1997)13 requires that the business engages one or more entities to perform work that performs at least 20 percent of the business’s principle work during the year. Buzz and Fuzz run their courier service alone and there is no indication that anybody has been employed to help them run the business although it indicated that they have three vehicles which they use in providing the courier services to the company. e) S87-30ITAA (1997)14 provides the business premises test that the personal service business has to meet. This test is met if the business maintains and uses business premises during the given year for tax purposes. In this case, Fuzz has converted his garage into an office from which the courier service business is run. The office is separate from the premises of the employing company and one would have to assume it is also separate from the premises of an affiliate of the employer company. This being the case, this criterion has been met. Based on the analysis of the determination criteria above, it is clear that the courier business has met the criteria set for a personal service business determination. As such to maximize the possible deductions under tax legislation, Buzz and Fuzz ought to apply for such determination from the commissioner. This will help them escape the restrictions of the personal service income provisions. This will imply that they will be treated in much the same way as a tax payer deriving salary and wage income. It is worth noting that that determination by the commissioner will enable the income they derive to be assessed in the hands of those who earn it and not the business. In addition, the two individuals who own and run the courier business will be entitled to deductions that are normally availed to employees as opposed to those normally received by tax payers carrying on a business. Further actions that they should take to maximize the deductions under tax legislation that they should take would include; i) Demonstrating the connection between the expenses one incurred in the generation of their income ii) Substantiating the expenses through production of receipts whenever required iii) Inclusion of all the receipts in their own taxable income rather than distributing it to their dependants iv) Inclusion of the partnership income in their taxable income in the year of receipt as opposed to leaving it in the company. Read More