At this time of year the catch cry of many business owners is: 'I need to spend money to save on tax'.
This kind of thinking is inherently flawed:
- Firstly you have to spend the money, which can cause all sorts of cash flow problems.
- Secondly every dollar you spend you will only realise a saving of say 30% being the company rate of tax.
- Thirdly reducing your profit to not pay tax will ultimately stunt the growth of your business.
You can only build wealth through after tax income. So when you base your decisions on lowering your income to save tax you lower your ability to create wealth. Let's face it, the key indicator of wealth creation is the size of the chunk of profit you give the ATO. If the chunk is small you either didn't make enough money or you fudged the results, either way it's bad for wealth creation.
Worrying about your tax bill and deciding to spend cash to save on tax will lead to a few issues:
- Your Bank won't like it. Nowadays no profit = no lending! If you can't prove serviceability it doesn't matter how many assets you have, a bank will not advance you money.
- Missing out on opportunities. By spending to create tax deductions you deplete cash and will need to build up reserves again or pay back loans, which takes time. By not having cash available you will miss new opportunities.
- Tax savings in one year is only a deferral mechanism. It catches up eventually, you only get a benefit if the tax rate goes down the next year.
Rethink and Refocus your attitude about Tax
By all means I am not advocating that you pay high rates of tax. Do not pay more taxes than you should but refocus on building wealth rather than on saving tax.
The energy you expend worrying about tax savings is a waste, refocus that energy and growth and profit sustainability will follow.
To achieve this you can employ a few key principles:
Pay yourself a market rate wage. Even though you are the owner pay yourself like an employee and live off that. This will not only give you a realistic profit figure but it will stop you from treating profits like your own slush fund.
Retain profit until the business is fully capitalised. This means having a few months of operating expenses in the bank, without drawing on credit. A business with its own capital can seize opportunities when they arise and provide for unseen expenses.
Once business is self-sufficient you can take distributions.
Then strategically use profits to continue to create wealth, whether that is in to grow the business or make investments in property, shares or other ventures.
Be wary that you don't erode business profits with to much consumption. You need to clearly identify personal expenditure requirements and what you need to produce continued wealth. Don't get trapped into using all the profits for lifestyle.
Taxes, like death, are a part of life. Work them to your favour by having the right structure and take advantage where you can, but you will always advance further by focusing on making money and creating wealth and those should be your primary objectives.