What is Taxation?
Taxation, the imposition of compulsory levies on individuals or entities by governments. Taxes are levied in almost every country of the world, primarily to raise revenue for government expenditures, although they serve other purposes as well.
In modern economies, taxes are the most important source of governmental revenue. Taxes differ from other sources of revenue in that they are compulsory levies and are unrequited—i.e., they are generally not paid in exchange for some specific thing, such as a particular public service, the sale of public property, or the issuance of public debt. While taxes are presumably collected for the welfare of taxpayers as a whole, the individual taxpayer’s liability is independent of any specific benefit received. There are, however, important exceptions: payroll taxes, for example, are commonly levied on labour income in order to finance retirement benefits, medical payments, and other social security programs—all of which are likely to benefit the taxpayer. Because of the likely link between taxes paid and benefits received, payroll taxes are sometimes called “contributions” (as in the United States). Nevertheless, the payments are commonly compulsory, and the link to benefits is sometimes quite weak. Another example of a tax that is linked to benefits received if only loosely, is the use of taxes on motor fuels to finance the construction and maintenance of roads and highways, whose services can be enjoyed only by consuming taxed motor fuels.
Purposes of taxation
During the 19th century, the prevalent idea was that taxes should serve mainly to finance the government. In earlier times, and again today, governments have utilised taxation for other than merely fiscal purposes. In the absence of a strong reason for interference, such as the need to reduce pollution, the first objective, resource allocation, is furthered if tax policy does not interfere with market-determined allocations. The second objective, income redistribution, is meant to lessen inequalities in the distribution of income and wealth. The objective of stabilisation—implemented through tax policy, government expenditure policy, monetary policy, and debt management—is that of maintaining high employment and price stability.
Classes of taxes
Federal income tax is levied on the taxable income of a person or a business. It's calculated on assessable income less any allowable deductions.
Assessable income is generally income your business earns - it does not include GST payable on sales you make, or GST credits.
Allowable deductions are deductions for certain expenses that you necessarily incur in relation to your business.
| Sole trader | Company | |
|---|---|---|
| What is the tax-free threshold? | $18,200 for sole traders (individuals) in the 2018-19 income year. | There is no tax-free threshold for companies in the 2018-19 income year. |
| What are the tax rates for income? | Sole traders pay tax at the individual income rate. | The full company tax rate is currently 30%. The 27.5% lower company tax rate applies to businesses that are base rate entities. From 1 July 2017, a base rate entity has an annual turnover of less than $25 million (increased to $50 million from 2018-19), and 80% or less of their assessable income is base rate entity passive income. |
| Tax-free threshold is $18,200. | No tax-free threshold for small business and companies. | |
| What small business concessions are available? | discount on Capital Gains Tax (CGT) | no discount on Capital Gains Tax (CGT) |
| income tax concessions | income tax concessions | |
| GST and excise concessions | GST and excise concessions | |
| Pay As You Go (PAYG) instalment concession | Pay As You Go (PAYG) instalment concession | |
| fringe benefits tax (FBT) concessions | fringe benefits tax (FBT) concessions | |
| What type of tax returns need to be lodged? | Individual tax return needs to be lodged each year. | Separate company tax return needs to be lodged. |
| Business income and expenses go in your individual tax return using a separate business schedule – you do not need to lodge a separate return for your business. | You must also lodge your own personal return as an individual for income you earn via wages, shares, dividends or loans received from the company or any other sources of income. | |
| If you are a director of a company or trust, benefits you receive may be subject to FBT. You must lodge an FBT return if you have a liability during an FBT year (1 April to 31 March). | ||
| Must also lodge return of any associated company trusts. |
Fringe benefits are an important part of a business and can be a useful way of attracting quality staff. However, if you're going to provide fringe benefits to your staff, you need to be aware of your taxation obligations.
Fringe Benefits Tax (FBT) is a tax payable by employers for benefits paid to an employee (or an employee's associate like a family member) in place of salary or wages. This is separate to income tax and is calculated on the taxable value of the fringe benefits provided.
Capital Gains Tax (CGT) is the tax that you pay on any capital gain. It's not a separate tax, just part of your income tax.
The most common way of making a capital gain or loss is by selling assets, such as property or vehicles, which is a CGT event. Examples of a CGT event are when:
- you sell or give away an asset to someone else
- an asset you own is lost or destroyed
- shares you own are cancelled, surrendered or redeemed
- you stop being an Australian resident
- a company makes a payment (not a dividend to you as a shareholder).
If your home is a place of business, your business might have capital gains tax implications when you sell it.
Payroll Tax is a state tax on the wages paid by employers. It's calculated on the amount of wages you pay per month and collected in each state or territory that your employees are located in.
However, not all businesses will have a tax obligation. You are only liable for payroll tax if your total Australian wages exceed the tax-free threshold that applies in your state or territory — tax-free thresholds vary between states and territories.
Land tax is an annual tax payable by owners of land. Land tax is administered by your state or territory government and is applicable everywhere except for the Northern Territory.
The laws between states are comparable, but there are some variations.
The amount of land tax you pay is determined by the combined unimproved value of taxable property. If your business owns property then it's likely you'll need to pay land tax on it. Make sure you know what your entitlements are because land owned by some types of organisations can be exempt from land tax.
Your main home (ie permanent residence) is generally exempt from land tax.
Requirements for self-assessing entities
Organisations that fit within the description of an exempt entity that can self-assess their income tax status must meet certain requirements to be exempt.
For many of the exempt entity types, your organisation must be not-for-profit (NFP) and also meet the following conditions:
- pass one of three tests
- comply with all the substantive requirements in its governing rules
- apply its income and assets solely for the purpose it was established for
Explanation of the three tests
Some not-for-profit (NFP) organisations must pass one of three tests to be exempt from income tax. The tests are the:
- physical presence in Australia test
- deductible gift recipient (DGR) test
- prescribed by law test.
If your organisation exists, operates and incurs its expenditure solely and entirely in Australia, you meet the physical presence in Australia test. You do not need to read anything further about the three tests.
If your organisation does not exist, operate and incur its expenditure solely and entirely in Australia, read on to work out if you meet any of them.
Physical presence in Australia test
Your organisation will meet this test if it meets both of the following requirements:
- your organisation has a physical presence in Australia
- to the extent your organisation has a physical presence in Australia, it pursues its objectives and incurs its expenditure principally in Australia.
An organisation has a physical presence in Australia if it is wholly in Australia, or it has a division, branch or sub-division in Australia.
It does not have a physical presence in Australia if it is present in Australia only through an agent, or it merely owns investment property in Australia.
Objectives and expenditure principally in Australia
If your organisation has a physical presence in Australia only, it must pursue its objectives and incur its expenditure principally in Australia.
Principally means mainly or chiefly. Less than 50% of the expenditure is not considered principally.
The pursuit of objectives in Australia can include things done offshore if they are only a means of pursuing those objectives. For example, sending employees to an offshore conference to aid their efficiency for the Australian objectives will be pursuing objectives in Australia.
If your organisation has a physical presence in Australia as well as another country, you need to work out the extent to which your organisation is physically present in Australia. It is only to that extent that your organisation's purposes and expenditure must be principally in Australia.
Therefore, even if your organisation, when viewed as a whole, does not principally have its purposes and expenditure in Australia, it can still meet the physical presence in Australia test.
Disregarded amounts
An organisation may still meet the physical presence in Australia test even if it does not pursue its purposes and incur its expenditure principally in Australia, to the extent it has a physical presence in Australia. This will depend on its distribution of disregarded amounts.
Disregarded amounts are amounts that the organisation receives as:
- gifts, including testamentary gifts (that is, gifts made under a will)
- proceeds from raffles, dinners, auctions, jumble sales and similar fundraising activities
- government grants.
Distributions of these amounts are disregarded when working out where the organisation pursues its objectives and incurs its expenditure.
We assume any offshore distributions are made first from any disregarded amounts that can be distributed offshore. The assumption does not apply if a disregarded amount cannot be distributed offshore. For example, government grants made only for use in Australia, or gifts of land physically in Australia, are not assumed to be distributed offshore.
The effect of this assumption is that offshore distributions can be made, up to the total of these amounts, without affecting your entitlement to income tax exemption.
Deductible gift recipient test
The deductible gift recipient test requires your organisation to be a deductible gift recipient (DGR). DGRs are entities donors can make income tax-deductible gifts to. The income tax law determines which organisations and types of organisations can be DGRs.
To be a DGR, you must either:
- be listed by name in the income tax law – includes organisations such as Amnesty International Australia and Landcare Australia
- meet the requirements of a general DGR category set out in the income tax law – includes registered PBIs, public universities, public hospitals, school building funds, public libraries, registered cultural and environmental organisations, and ancillary funds.
DGRs that are not listed by name in the income tax law need to be endorsed by us.
Several general DGR categories require your organisation, if it is a charity, to be registered with the Australian Charities and Not-for-profits Commission (ACNC).
Prescribed by law test
Your organisation will meet this test if it is prescribed by name in the income tax regulations and it is located outside Australia and is exempt from income tax in its country of residence.
The government decides which organisations will be prescribed by name in the income tax regulations. You can send applications for prescription to us and we will forward them to the government for consideration.
If your organisation is not listed by name in the income tax regulations for exemption purposes, it does not meet this test.
Basic record-keeping requirements
Setting up the right record-keeping system for your business will help you work efficiently, meet legal requirements and strengthen customer and staff relationships.
Laws that apply to your business will determine how long you need to keep records for. If you use an electronic record-keeping system, you must also be able to produce a hard copy of a record if the Australian Taxation Office (ATO) or Australian Securities and Investments Commission (ASIC) request it.
Personal financial records must be kept for 5 years, whereas the following records must be kept for 7 years:
- financial records for your company
- most employee records
- all records of fringe benefits and capital gains
Basic records
To meet basic legal requirements, you must keep the following:
- a cash book or financial accounting program - that records cash receipts and cash payments
- bank accounts - cheque books, deposit books and bank statements
- employment records - hours of work, overtime, remuneration or other benefits, leave, superannuation benefits, termination of employment, type of employment, personal details of workers, employee personal contact and employment details
- occupational training records - for both you and employees to comply with work, health and safety laws including evacuation and emergency training attendance
- sales records - invoice books, receipt books, cash register tapes, credit card documentation, credit notes for goods returned and a record of goods used by the business owner personally
- proof of purchases - cheque butts (larger purchases), petty cash system (smaller cash purchases), receipts, credit card statements, invoices, any other documents relating to purchases including copies of agreements or leases
- work, health and safety (WHS) records - workplace incidents, risk register and management plan, names of key WHS people (e.g. WHS representative, Trained Safety Advisor (TSA), first aid attendant), chemical storage records, first aid incident register, workplace assessments, Material Safety Data Sheets (MSDS)
End of financial year records
To meet legal requirements, maximise your tax return or minimise your tax bill at the end of the financial year, keep the following records:
- details of stock on hand - at the beginning and end of the financial year
- a list of debtors and creditors - for the entire financial year
- capital gains details - records of asset purchase dates and agreements, records of sale, disposal and proceeds received, details of commissions paid or legal expenses, improvements made to an asset and any other records relevant to how you calculate your capital gain or capital loss
- depreciation details - original purchase agreements or tax invoices, a depreciation schedule, the cost of transporting the items to your business (if applicable), installation costs (if applicable)
- expense records - cheque butts, receipts, cash register tapes, copies of statements and invoices, credit card documentation, details of payments by cash and log books
- staff and wages details - full details of wages, employment contracts, tax deducted, fringe benefits, superannuation, sick pay, holiday pay
- basic accounting records - stock records, accounts receivable, accounts payable, other records
- agreements - sales and purchase contracts, loan agreements, rental agreements, lease agreements, franchise agreements, sale and lease back agreements, trading agreements with suppliers, legal documentation
- other documents - deposits with utilities, contracts with telephone companies, your business name registration certificate, capital gains records.
Best practice and record-keeping
Depending on your industry, keeping the following records may be a legal requirement, but it is best practice to keep them for 5-7 years:
- employee accreditation certificates and licences - copies of permits, registrations and licences employees need to do their jobs
- employee resumes and job applications
- performance reviews - including assessments of staff performance and agreements between you and your employees
- position statements and job advertisements
- customer records - personal details, products purchased and product enquiries that are useful for finding new customers
- customer complaints - details of complaints about products, service, staff or anything else, and steps taken to resolve them
- details of any disputes with other businesses - including how you went about resolving disputes
- quotes are given and won - specifics of jobs and time spent on them to help with future quoting
- details of advertising campaigns and success - to make it easier to repeat advertisements and plan future advertising campaigns
- insurance policies - regularly review and update your business insurance, especially when your business grows or changes.
Basic records
Some of the basic records you may need to keep are:
- governing documents (for example, constitution, rules, trust deed)
- financial reports (for example, financial statements, annual budgets, reconciliations, audit reports, accounts payable and accounts receivable)
- cash book records of daily receipts and payments
- tax invoices and income tax records, such as debtors and creditors lists, stocktake records and motor vehicle expenses
- records relating to employees (for example, TFN declarations, pay as you go (PAYG) withholding, superannuation and fringe benefits provided)
- records of payments withheld from suppliers who do not quote an Australian business number (ABN)
- banking records (for example, bank statements, deposit books, cheque books, bank reconciliation)
- grant documentation (for example, when funding will be received, when acquittals need to be made, application deadlines)
- registration, certificates and accompanying documents to regulators (for example, ATO, Australian Charities and Not-for-profits Commission, and state regulators)
- contracts and agreements (for example, cleaning, maintenance and insurance contracts, finance or lease agreements)
- copies of reviews of entitlement to tax concessions
- records to help prepare tax statements and returns.
Charities – record keeping
If your charity is registered with the Australian Charities and Not-for-profits Commission (ACNC), you must keep certain financial and operational records explaining your charity's position and activities. Your charity must keep these records for seven years to meet ACNC record-keeping obligations.
Deductible Gift Receipts (DGRs) – record keeping
You must keep records that explain all transactions and other acts relevant to your organisation's status as a DGR. This requirement applies to both endorsed DGRs and listed DGRs.
The records must be in English or easily convertible to English and must be maintained for at least five years after the completion of the transactions or acts to which they relate. The penalty for not keeping proper records is twenty penalty units.
Your records must show that the following were used only for your principal DGR purpose:
- all gifts, and deductible contributions, of money or property, made to it for that purpose
- money received because of such gifts or deductible contributions.
If your organisation is endorsed as a DGR, as a whole, or listed by name as a DGR, it must keep adequate accounting and other records.
If your organisation is endorsed as a DGR for the operation of a fund, authority or institution, maintaining a gift fund will show it has used its gifts and deductible contributions and their accretions for the principal purpose of its fund, authority or institution.
If your organisation maintains one gift fund for two or more funds, authorities or institutions which it operates, the records must identify gifts and deductible contributions made in respect of each separate fund, authority or institution. You must also show how these gifts and contributions, as well as money received by the fund as a result of them, have been used to further the principal purpose of that fund, authority or institution.
Invoices you received
A tax invoice of more than $75 (excluding GST) must contain enough information to allow key information to be clearly determined, for example, your supplier’s ABN. Otherwise, you generally need to withhold 46.5% from your payment to the supplier.
If you receive a document from a supplier that is missing key information, you may still be able to treat the document as a tax invoice if the document makes clear that it is intended as a tax invoice and the missing information can be obtained from other documents issued by the supplier.
You cannot claim a GST credit in an activity statement unless you have a tax invoice. If you obtain a tax invoice later, you can claim the GST credit in the activity statement for the tax period in which you obtain the tax invoice.
Tax invoices are not required if the GST-exclusive value of the sale is $75 or less. However, you should have some documentary evidence to support all GST credit claims.
If you ask a GST registered supplier to provide a tax invoice, they must do so within 28 days of your request. Organisations not registered for GST cannot issue tax invoices.
Benefits of record-keeping
While it can be tedious, there are many benefits to keeping good records. It can help you to:
- keep track of your business’ health, so you’re able to make sound business decisions
- prepare your tax return more easily
- manage your cash flow
- demonstrate your financial position to banks or other lenders.
The legal requirements for keeping business records
By law you must keep business records:
- for a minimum of five years or longer after the record is created, updated or the transaction is completed (whichever is most recent)
- in English or in a form the Australian Taxation Office (ATO) can understand.
Storing records electronically
You’re able to store your records electronically or in a paper, but you must make sure they are:
- a true and clear copy of the original
- kept for five years
- able to be reviewed by the ATO at any time.
Electronic copies of records are now generally accepted by government departments such as the ATO and ASIC. To keep your records electronically, you must make sure they are a true and clear copy of the original. The records must also be on a computer or device that:
- you have access to (including all passwords)
- is backed up in case of computer failure
- allows you to control the information that is processed, entered and sent.
- Advantages of keeping electronic records include:
- records can be easy to search and easy to create filing systems for
- it is easy to create additional copies of records
- there is software available to help you with keeping electronic financial records
- certain record-keeping software can link with the ATO lodgment systems, reducing the time you need to spend on reporting to the ATO
- electronic records require less physical storage space than paper records
- certain apps will allow you to create records on the go and organise them from your mobile device.
Paper copies
Paper or hard copies of records are often the original copies of your documents.
The advantage of keeping the original records is that they’re sometimes required if the record is used as evidence in legal matters. Paper copies of records can also be used to support any electronic records if there is a dispute over the electronic copy. If you are keeping paper copies of your records however, it’s important to store them properly, as they can:
- often be misfiled
- take up a lot of storage space
- decay over time or be destroyed by water or excessive sunlight.
What records do you need to keep?
There is a range of records that you should keep when running a business. These can be grouped into:
- financial records
- legal records
- employee records
- policy and procedures
- other business records.
Financial records
Your business’s financial records allow you to track your cash flow, prepare your tax return and understand your overall financial position. They can include documents such as:
- receipts and invoices for goods and services you buy and sell
- contracts with suppliers and other contractors
- bank statements
- a register of your business assets
- depreciation schedules
- tax documents including activity statements and annual tax returns
- documents showing how the business is financed e.g. any business loans and/or shares in the business.
Legal records
Legal records are documents that relate to the operation of your business. These documents can include:
- business registration documents
- leases
- contracts with suppliers and other clients
- insurance documentation.
Employee records (if you have employees)
Employee records include any information you have about the employees of your business including their:
- staff rosters, attendance and pay records
- financial records, such as bank accounts, tax file numbers and superannuation details
- contact details, such as addresses, phone numbers and emergency contacts
- work performance and history, including any performance issues or workplace injuries.
- Keeping good employee records means you can pay your employees correctly and meet your tax and super responsibilities.
Policy and procedures
- Policy and procedure records outline how you will manage the day-to-day operation of your business. They include:
- workplace health and safety plans
- dress standards
- sexual harassment policies
- operation manuals.
It’s a good idea to provide your staff with a copy of your policies and procedures when they start work with you. You can include it as a part of their employment contract.
Other business records
It can also be a good idea to keep other records even if you’re not legally required to, such as:
- customer records - personal details, products purchased and product enquiries that are useful for finding new customers
- customer complaints - details of complaints about products, service, staff or anything else, and steps taken to resolve them
- details of any disputes with other businesses - including how you went about resolving disputes
- quotes given and won - specifics of jobs and time spent on them to help with future quoting
- details of advertising campaigns and success - to make it easier to repeat advertisements and plan future advertising campaigns
- insurance policies - regularly review and update your business insurance, especially when your business grows or changes, including leases, advertising, quotes and tenders
Key Legal Documents for Your Business
Documents play an essential role in protecting the interests of the business and business owners over the course of a company’s lifetime. Here is a list of the 10 most common legal documents to help you determine what your business needs.
1. Company by laws for corporations
Most states require corporations to keep a written record of bylaws, although you don’t need to file the document with a state office. Bylaws define how the company will govern itself. Even if your company is incorporated in the handful of states that don’t require bylaws, they are still a good idea as they spell out your business’ structure, individual roles, and governance issues. For example, bylaws can help settle a dispute on the length of a director’s term or define if you need a simple majority to approve a decision.
2. Meeting minutes
Most states also require corporations to document what happens at major meetings. They keep an official account of what was done or talked about at formal meetings, including any decisions made or actions taken. They can help settle a dispute about what happened or didn’t happen in a past meeting.
Your minutes should be detailed enough to serve as your corporation’s “institutional memory.” They should include the type of meeting; time and place of meeting; detailed attendance; all actions taken (purchases, elections, etc.); as well as any votes including how everyone voted and who abstained.
3. The operating agreement for LLCs
Although not required in most states, an operating agreement is recommended for every LLC, particularly when there are multiple members involved. This document outlines an LLC’s financial and functional decisions. If there is more than one member, it becomes all the more important to define how key business decisions will be made, how profits and losses will be distributed, what are the rights and obligations of members and what happens when someone wants out of the business. Once members sign the document, it becomes an official, binding contract.
4. Non-disclosure agreement
Whether you realize it or not, your business has information that should remain private, such as customer list, financial records, or ideas for a new pricing plan. An NDA is your first line of defense to protecting this information. This legal document creates a confidential relationship between your business and any contractors, employees, and other business partners who might get a behind-the-scenes look at your operations.
5. Employment agreement
This contract sets the obligations and expectations of the company and employee in order to minimize future disputes. Not every hire requires an employment agreement, but the document can be a useful if you want to dissuade certain new hires from leaving your company too soon, disclosing confidential information about your business, or going to work at a competitor. The contract should be reviewed by an experienced employment law attorney before given to an employee to sign.
6. Business plan
A business plan may not be a legal document, but it’s required should you ever decide to seek financing or sell your business. Your business plan can be one page or a hundred pages, as long as it provides clarity on your business’ opportunity and your roadmap to get there.
7. Memorandum of understanding
An MOU falls somewhere between a formal contract and a handshake. It documents any important conversations you have with suppliers, potential partners and others involved in the business. MOUs are great ways to lay out the terms of a project or relationship in writing, but do not rely on the document to be legally binding.
8. Online terms of use
While not required by law, any business with a website should include their terms of use. These pages can limit your liability in cases where there are errors in your own content, as well as information contained in any hyperlinks from your website. Furthermore, your Terms should let visitors know what they can or can’t do on your site, particularly in cases where visitors can comment on blogs or share their own content.
9. Online privacy policy
If you gather any information from your customers or website visitors (such as email addresses), you are legally required to post a privacy policy that outlines how this information will be used and not used.
10. Apostille
Businesses involved in international trade with other Hague Convention countries may need a certificate, known as an "apostille,'' that authenticates the origin of a public document (like articles of incorporation) so they can be recognized in another country. Apostilles are only valid in countries that are members of the Hague Convention.
In most cases, you don’t need to create any of these documents from scratch. You can find free templates online to serve as a starting point. While these legal documents are important part of staying compliant with your state requirements, they are more than empty formalities. By taking the time to think about the various elements on each document, you are setting the right foundation for your business.
11. Emails and Memorandums
Co-workers typically use email to convey information to each other. Before email became prevalent, memorandums were used for intraoffice messages. Memos are still used in situations where a message is meant to accompany a specific file and in cases that require more privacy than an email.
12. Business Letters for Outside Communication
Business letters are used to communicate with individuals outside of the office. Recipients may include customers, colleagues in other businesses, service providers, professionals who advise the business, government officials and job applicants. A business letter is usually formatted in block style, in which all of the elements of the letter, except the letterhead, are aligned with the left margin.
It can be emailed or delivered by mail. If a letter is sent in the text of an email, the sender includes his name, job title and contact information at the bottom of the email.
13. Business Reports for Conveying Information
Business reports convey information in a format that is more formal and usually longer than a letter. Reports cover a variety of topics, such as safety compliance, sales figures, financial data, feasibility studies and marketing plans. They may include statistics, charts, graphs, images, case studies and survey results. Some reports are published for the benefit of investors. If a report is periodic, such as a monthly sales report, a template is used for convenience and to enable comparison with previous reports.
14. Transactional Documents to Conduct Business with Clients
A company uses documents to transact business with its clients. To save time, these documents may be formatted as a form, such as an order form, transmittal page, invoice or receipt. The types of transactional documents used vary somewhat by the nature of a business. An insurance agent, for example, generates insurance applications and policies, while a lender uses loan applications and mortgage documents.
In some fields, businesses enter into agreements and contracts with others; these documents might be drafted by the company’s lawyer.
15. Financial Documents to Manage the Business
A business uses financial documents to stay within its budget, prepare budget proposals and file tax returns. These documents include receipt records, payroll reports, paid bills, bank statements, income statements, balance sheets and tax reporting forms. These documents may be prepared by the company’s accountant.
A business owner uses these documents to determine the financial success of the company and to identify areas that are unproductive. A department head might use financial documents to prepare a budget proposal.
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