Is your Accountant Encouraging Bad Business Decisions????
In a bid to reduce your tax, do you forgo profit?
- Do you buy up extra “unnecessary” items in the Financial Year End Sales to gain the Tax Deduction
- Do you keep your prices down because your accountant said “If you don’t watch out you will make a profit this year” or “If you earn $200 more next year you will go up a tax threshold and have to pay GST, VAT, more tax etc.”
This is quite common in the US, UK and Australia – where a culture of avoiding paying the tax-man at all costs is leading to business failures. Don’t get me wrong, I strongly believe everyone should pay their fair share of tax – exactly what is owed- not a penny extra or too little. This post examines the “benefits” of actively reducing income and profit to reduce taxes paid, and the flow-on reduction in returns and rewards that arises as a result.
Let’s start by having a look at what profit really is:
Profit is the payback you receive for taking the risk of running your own business
It is calculated as what left over from all your business revenue after paying all your business expenses
It may help to remember there are two sorts of profits; short-term or long-term:
Shorter Term Trading Profit : arises from the day-to day activities of the business as it goes about selling goods and services (after expenses of course). This is the “bottom line” referred to for annual business planning.
Longer Term Capital Gains : arises from finally selling the business. This is the ultimate “bottom line” we get when we eventually step away forever.
Just as in the corporate world, it is the same for solopreneurs;
- In big business you could work each day and receive a salary job as well as invest your time and savings in other companies on the stock-market to receive dividends (a share of profit) for risks you take – plus hopefully an increase in the share value between the time you brought and when you sell.
- In your own business you should also get fairly paid for any time you spend and investment you contribute to your own businesses in just the same way – a share of profit either annually or when you sell AS WELL AS getting fairly paid a salary for the work you provide within the business.
Side Note: For this post I am lumping any “earnings” in return for labour that an owner receives from their business the single phrase “salary” – be it as Superannuation, a fancy car, holiday perks, or cash. This article isn’t about how you categorise the money you take, there are often good tax reasons for splitting it up between profit and salary at the end of the day, the key is you make at least enough provide yourself with reasonable returns and rewards, and preferably more.
By making profits we are also able to building something more; a saleable business with its own intrinsic value. It is profitability that potential buyers will be looking for when it comes time to sell your business, not little tax you have managed to pay. If you plan to sell your business in the near future, then increasing profitability, and reducing any extra “unnecessary” expenses will also enable you to increase your asking price.
Actively avoiding profit is different to running a washed-up business – in the first instance there is the capacity to sell more and/or raise the prices to improve profit; in the latter instance there are insufficient customers/clients to sell to and therefore the problem is actually one of insufficient revenue to cover costs. Avoiding profit requires there a conscious decision; the activity of purchasing “extra and luxury” expenses that add very little value to the business, or choosing to stifle revenue streams to ensure profit is forced down.
Now, without getting complicated and tax-ey, as far as I know global corporate tax systems all have tax rates of less than 50%, and none have tax rates that are 100% or more. What that means is for every $1 dollar of profit you make (all of your income less all of your expenses) even at the highest tax rate, you still end up with 50c to either reinvest in your business or take out as a dividend, which also is 50c more than the 0c you have when you avoid making any profit in the first place.
So why would anyone avoid making profit if it is the only way you can get repaid for all the risks you have taken?