Taxation is an expense that all profitable businesses have to deal with, and for this reason it is a cost which should be planned for and managed like any other. If tax is not planned for properly it can be a significant burden on any organisation, particularly a new and growing business. You should from the outset consider all the various taxes that your business has to pay as an important part of your business plan.
Factor them in as business costs to be provided for like any other and put funds aside for them regularly so that they can be paid as and when they arise. Failure to do this is probably one of the most common mistakes made by many new businesses and one of the most common reasons why many new business owners get into trouble with the tax authorities at an early stage.
Tax planning means acceptable tax avoidance, not tax evasion. Some people seem to think that identifying exactly where this boundary lies is the holy grail of tax planning. Tax evasion is illegal - it should not be contemplated at all. Anyone attempting tax evasion will almost certainly face prosecution, heavy fines and possibly even a custodial sentence.
Below mentioned are some strategies that help in planning taxes efficiently.
Adopt a holistic approach
It is important to reiterate that it is essential always to regard the business and yourself as separate persons and also to have a holistic approach to taxation. All tax liabilities and all aspects of your business and personal financial affairs should be regarded as potentially interlinked. One may affect the other.
This is especially the case in a limited company because companies and people are separate bodies by law. With unincorporated businesses this is not strictly the case, but it helps the planning process considerably to keep the two areas of finance - business and personal - rigorously separate. By regarding all businesses as separate entities you will probably gain a better idea of what the effects of business and personal transactions will be on your overall tax position.
Proper Accounting Practice and Timing Issues
When you prepare your tax returns each year the most important aspect of this process is the preparation of the business' financial accounts. Tax law requires that accounts and financial statements have to be prepared using GAAP in order to properly reflect the financial results of the business so as to produce the right taxable profits to go on your tax returns. For most people this will mean the use of an accountant to produce accounts and tax statements - this is not a legal obligation for the unincorporated business but it is probably advisable.
Accounting principles follow long established financial reporting standards that qualified accountants have to follow when preparing your financial statements. It is important to recognize that these can have a specific and major impact on when and how the profits of your business were earned and hence when the taxable profits arise.
When Expenses are Incurred
Certain principles, for example cost recognition under the prepayments and accruals concepts, mean that expenses are deemed to arise when they are incurred, which is not necessarily at the same time at which they are paid. Thus, if you incur an expense before the end of your financial accounting period and receive the invoice for that expense then it has been incurred for the purposes of those accounts and must be reflected therein as a closing creditor at the end of the year. It is a fundamental principle of modern tax law that, generally, tax calculations will follow good accounting practice unless there is a rule of tax law in a particular area that overturns or contradicts those practices and principles.
Similarly, other expenses which arise over time, or in relation to specific periods, for example rentals and rates, can be regarded in some instances as accruing on a day-to-day basis, so that the appropriate proportion has to be charged in the P&L account for a particular period even though the expenses may have yet to be paid.
It is thus of crucial importance to the proper preparation of financial statements, and hence the correct calculation of the tax liable profits of a business, that your records are detailed and adequate to enable your accountant to properly reflect all accrued expenses therein and to identify which expenses need to be properly treated as creditors at the end of the financial year. Otherwise your taxable profits may end up being higher than they need to be.
A step further along this road is asking yourself, as the year end approaches, what expenses the business has coming up shortly and whether or not incurring any of these prior to the end of the financial year will defer tax liabilities significantly. If your expenses can be accelerated slightly, this might be rewarding as you may be able to defer liabilities for a whole year. An example might be identifying any specific repairs or maintenance costs which you are planning to carry out in the near future. A short acceleration in timing might only affect your cash flow slightly but could significantly accelerate the tax deduction for these expenses from one year to the earlier one. Clearly the commercial drivers of your business are of paramount importance, but bringing forward expenses by a short period of time so that liabilities are deferred for a long period of time can impact the tax relief you receive and how soon your business tax bills arise.
Knowing Expenditure Relief
When your business incurs an expense you may expect that you can get tax relief on it. However, not all expenses may actually be relieved against profits for tax purposes. There are two fundamental principles involved here:
1. An expense must be a revenue expense and not a capital expense for it to be deductible against your business profits.
2. An expense must be incurred wholly and exclusively for the purposes of the trade or business.
A strategic approach should also be taken with income recognition. Here, expert advice should be sought. There are specific rules and accounting standards which apply to the recognition of income, especially for stock valuations, recognition of the value of work-in-progress, long-term contract work, when professional services should be recognised as completed and hence billable services, and so on. All these rules have to be properly followed.
It is important to pay close attention to the annual and seasonal patterns of trading and as the financial year end approaches it should be ensured that no unnecessary acceleration of the recognition of income is occurring in the financial accounts. For example, a hotel business receiving deposits this year for next year should normally account for those as income of the following year not in the year of receipt. It is important to ensure that the business accounting systems recognize this difference accurately so that taxable profits are not accelerated incorrectly.