The $20,000 immediate assets write-off for small business has been widely welcomed and has been passed by parliament this week. However, our modelling shows some small unincorporated businesses could actually be worse off under this measure.
Most unincorporated businesses (that is, individuals, trusts and partnerships) are taxed on the basis of the marginal tax scale for individuals. That is, the more that is earned, the higher the percentage rate of tax.
The proposed measures do not change the overall deductibility of the asset, just the timing of the deduction. Under the existing simplified depreciation rules for small businesses, an asset costing more than $1,000 is depreciated 15% in the first year and then 30% thereafter until the taxable value of the asset pool is less than $1,000, at which point the remaining value can be written off.
But the issue for small unincorporated businesses is that while an up-front deduction may reduce tax in the year that it is made, that business will not benefit from further depreciation deductions in later years, and may be worse off depending on the tax brackets it ends up in.
For example, take an unincorporated business which is subject to individual tax rates. This business has a total taxable income of $21,000 before taking into account any asset depreciation deductions. If this business were to purchase an asset worth $20,000 under the proposed measures, it would end up with a total taxable income of $1000, and as this is less than $18,200 it would pay no tax in 2014-15.
Under the old rule, the 15% deduction (or $3000) would leave it with a taxable income of $18,000, which is also less than $18,200 and as such it wouldn’t have paid any tax anyway.
The problem for this business is that under the new measures it will not be entitled to any future deductions in relation to the asset, while under the previous system it would still have had $17,000 of deductions available, which could potentially lower the amount of tax payable in future years as well.
We have modelled the new measure against the former depreciation rules for the purchase of one asset of $20,000 over a 10-year horizon, using the assumptions that tax rates and thresholds remain unchanged and that there is an annual growth in net taxable income of 2.5%. We use a 2.5% discount rate for the time value of money.
In our initial analysis we ignore the 5% tax discount (up to $1,000) also announced in the federal budget, to see what the effect is without that measure. On that basis, we find that most businesses are worse off under the proposed depreciation rules, with those in the lowest tax brackets and those moving tax brackets in the first year the most penalised.
Adding the 5% tax discount (up to $1,000) into the analysis improves the outlook, with many businesses better off, but not by a great deal. The overall reduction in the amount of tax paid in today’s dollars is less than 1% in many cases – and this is purely driven by the 5% discount, rather than the immediate asset write-off.
Of particular concern is that some small businesses will be substantially worse off.
For example, our modelling indicates that for unincorporated small businesses, those with an assessable income before asset deductions of $30,000 or less will actually pay more tax in real terms if they were to buy a $20,000 asset before June 30, 2015, and fully write it off.
At an extreme level, a business with only $20,000 in assessable income before depreciating any assets would pay 49% more tax with the immediate write-off, compared to the existing rules. This analysis excludes any borrowing costs, which would make the situation worse.
So, while on the face of it an immediate deduction may seem like a positive thing for small business, any benefit is highly dependent on the circumstances of the individual business.
Not all small businesses may be winners and anyone about to step into a showroom for the end of financial year sales should take a moment, and perhaps think about talking to their tax adviser first.
David Bond is a member of the Chartered Accountants Australia and New Zealand
Anna Wright is a Fellow of Chartered Accountants Australia and New Zealand
Authors: The Conversation