The drop in the top rate will reduce incentives for tax structuring, as the tax gap between the top personal and trust rates will go. However, the tax changes do not negate the other benefits of holding assets in trust, for example, asset protection and succession issues faced by most SME owners.
The tax reductions are largely financed by a rise in the GST rate to 15% and with 1 October 2010 looming fast, SMEs need to start thinking through the impact of the pending rate rise on their businesses to ensure a smooth transition.
While the challenges around technology and processes have been widely discussed, many businesses may find it difficult to make decisions about pricing. The working assumption seems to be that all prices will automatically be 2.2% higher on the morning of 1 October 2010 than they were the night before. It’s not that straightforward for many SMEs, especially in the business to consumer space.
Of course, the starting point will be to try and pass the cost of the GST rise on to customers. This may be a reasonably simple process in industries that sell goods and services to GST registered customers. Pricing will usually be on a GST exclusive basis and the rise in GST will be reflected as a flow through to the next registered party.
However, many other SMEs, for example most retailers, sell to unregistered customers and their prices typically include GST. Any attempt by these businesses to recover the increased GST will directly result in increased prices. Competition and the importance of pricing points can impact on their ability to pass on costs, leading to margins being squeezed further.
On the other hand, some businesses may feel this is an opportunity to increase prices by more than the rise in GST, to recover lost margins due to the recession. However, it is difficult to see that this strategy will be widely implemented, as most SMEs operate in extremely competitive environments.
The other main source of revenue needed to fund the tax cuts will come from the property sector. The removal of depreciation on buildings was largely anticipated, and not as far as the government could have gone. We now have confirmation that commercial and residential buildings will be impacted by the change. This will mean SMEs that own their business premises will have an increase in their tax liability from the 2012 income tax year, eroding the benefit of the reduced corporate tax rate.
Also included in depreciation changes is the removal of loading on new assets. Many SMEs will view this as disappointing, as it was one of the few tax incentives for small business to invest in productive assets.
Perhaps what is surprising in this area is what the Government did not do. Measures to ring fence rental losses, tax gains from property held for short periods, and deny interest deductions on negatively geared properties did not eventuate. In many ways residential property investors could consider themselves lucky.
The Government has moved to tidy up rules for Working For Families to ensure taxpayers cannot become eligible for tax credits by offsetting rent losses against their other income. The loss attributing qualifying companies rules will also be amended so that qualifying companies and LAQCs will become flow-through entities for tax purposes. Income and losses will be treated as if they are derived and incurred by the shareholders personally. We think these measures strike a good balance.
Many SMEs are likely to be disappointed with the previously announced R&D policies, which are clearly the Government’s replacement for the tax credit regime it removed last year. Most SMEs will miss out on the major funding announced in this package, as they do not have sufficient revenue or spend on R&D to qualify. The voucher scheme is limited and potentially bureaucratic, which does not provide enough incentive for most owner managed businesses to spend valuable time and money applying.
Finally, businesses should be aware of the additional announced funding to be provided to Inland Revenue for enforcing current tax law. Coupled with the already increasing emphasis on compliance seen recently, and the Budget factoring in the increased revenue through additional enforcement, businesses can expect to face a more aggressive Inland Revenue Department seeking to meet its targets.
Overall the announcements in Budget 2010 are positive for owner managed businesses. Most owners will benefit from decreased corporate tax and personal tax rates, in spite of increases in GST, the loss of depreciation on buildings, and the end of depreciation loading. However, we feel there is still opportunity for the government to do more for SMEs through a greater focus on small business R&D, and more generous low-value asset write-offs.