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How To Turn Business Losses Into Cash Flow
First Published: Sep 2004
Last Update: Sep 2004
Author: Christopher Raynal
When the typical new business operator starts a business, they concentrate on
making the business succeed. That is necessary but not the only thing that a
business operator should concentrate on. A business depends on cash flow to
exist and grow, so business operators would do their business a good turn by
looking at sources of cash flow provided by the Government.
We are talking about the taxation authorities such as Inland Revenue Department
in New Zealand (IRD), the Australian Taxation Office in Australia (ATO) and
Inland Revenue in the United Kingdom and the Inland Revenue Service in the USA
(IRS). All of these taxation administrations, along with those in Canada and
South Africa for example, have both income tax and goods and services tax (GST)
or value added tax (VAT) that present opportunities for refunds when a
business＊ expenses exceed its income in the early stages of its life.
Initially, the start-up capital may come from savings, family and friends and
salaried employment. The last source of finance 每 salaried income 每 means that
the business operator still works full-time for a salary and part-time on their
business. This presents particular opportunities to receive
extra cash flow to fund the growth of the business 每 from value-added taxes and
income tax refunds.
It should be noted that even where the business owner does not have other
salaried (tax paid) income, they might have a husband or wife who does have
salaried income. If they become
a partner in a partnership conducting the business, or a shareholder in a Loss
Attributing Qualifying Company (LAQC) in New Zealand only, then they can share
in the business losses and receive income tax refunds.
In Australia, there was an ATO income tax ruling (IT 2218) that allowed a
partner to receive a salary 每 as long as the partnership agreement recorded it
in writing 每 and this presented an opportunity to maximize the loss for one
partner (the salaried partner), thereby maximizing the income tax refund. That
income tax ruling was withdrawn on 22nd May 2002. Australia has no LAQC
equivalent entity. However, there is nothing preventing a partnership agreement
specifying a partnership split other than 50/50, so that one partner can receive
more of the loss than the other. It would be prudent for the partnership
agreement to record the reasons for the ratio used.
So, how does it work? Most businesses start off making losses, and small
businesses and home-based businesses are not exempt from this. The total revenue
or income is usually low. It is
often below the thresholds where the business has to register for GST or VAT, so
that the business owner may be tempted to not register for GST or VAT, thereby
saving on administration
(in filing the returns) or accounting costs.
If the business owner contacts their local taxation authority, they will be
correctly advised of the income thresholds for registration and the decision
will be left to them to make. It would not be appropriate for a taxation officer
to advise the business owner on how to manage their taxation affairs, and there
is a case of the Privy Council (UK) that confirms the Inland Revenue cannot tell
a business owner how to run their business. It is certainly not obligatory on
the taxation authority to advise a business owner on a course of action that
would contravene their charter of ※protecting the revenue§ of the State.
This is why a business owner should seek the advice of a suitably qualified
accountant who is experienced in taxation and business advice. A proactive
accountant is more likely to provide this advice than a compliance accountant.
The compliance accountant＊s role is more likely to involve
complying with tax laws, rather than optimising tax situations. The compliance
accountant＊s mind is so attuned to complying with tax laws that they often do
not see the opportunities for optimising a client＊s tax position. Once the
business owner has been convinced that it is in their interests to register for
GST or VAT, the next question is for what filing period to opt? The more regular
a filing period, the sooner the GST or VAT refunds will improve the business
cash flow. So they may decide to opt for monthly or two-monthly GST or VAT
returns. There will be an administration or accounting cost that needs to be
weighed against the benefit of a quicker cash flow.
The income tax refund is an annual event that cannot be changed, except for
where the business owner is leaving the country before the end of the tax year
and applies to have a tax return processed sooner. There will be extra forms to
complete and information to provide, and it usually means that the business is
closing down. Even that income tax return should be lodged as early as possible
after the tax year ends, rather than being left to be filed with other taxpaying
business owners, so the income tax refund is received soon rather than later.
About the Author
Christopher Raynal is the Director of Master Accountants Group Limited, a tax
and management consultancy based in Auckland, New Zealand. The practice
specializes in rental properties,
wrap mortgages, small business development and asset protection structures. The
website can be accessed at
www.masteraccountants.co.nz
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