As you set up your small business you will need to give some thought to how and when you’ll pay tax on your profits.
Do you know about the pay as you go instalments system and how it can benefit you?
One reason a business can get into major cash flow problems is by not planning for income tax payable.
As a small business owner your business will pay tax on the business’ profits. When you lodge your annual income tax return and declare your profit, if you haven’t been contributing tax throughout the year, you will likely receive a notice of assessment showing tax to be paid. Depending on the amount, it may cause you major cash flow problems.
Example
Cassie has her own small business as a sole trader. This timeline shows Cassie’s tax obligations when she first started to make a profit.
| Date | Activity | Amount Owing | Total |
|---|---|---|---|
| July 2019 | Business start Cassie starts operating a business as a sole trader. |
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| June 2020 | End of financial year 2019-2020 The business makes a profit of $45,000 for the financial year. |
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| April 2021 |
2019-2020 Notice of assessment received The business income in her tax return also triggered her automatic entry into the PAYG instalment system for the 2020-2021 financial year. As it’s now April 2021, she will have several PAYG instalments to catch up on. |
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| May 2021 | 2019-2020 Tax payable due Cassie’s tax payable from her 2020 income tax return is due for payment. |
$8,550 | $8,550 |
| June 2021 |
2020-2021 PAYG instalment notice received As well, Cassie is advised that her first quarterly PAYG instalment for the 2022 year of $2,250 is due for payment by October 28, 2021. |
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| July 2021 | 2020-2021 Tax instalment due Cassie’s PAYG instalment tax owing for the 2020-2021 financial year is due for payment. |
$9,450 | $18,000 |
| October 2021 | 2021-20222 Tax instalment due Cassie’s first quarterly PAYG instalment for the 2022 year is due for payment. |
$2,250 | $20,250 |
By October 2021, Cassie has had to pay:
- $8,550 in May
- $9,450 in July
- $2,250 in October.
This totals $20,250. Since Cassie has not properly planned for the income tax payable on the income she is earning from her business, by not regularly putting away a percentage of her income each month, the financial shock of having to pay $20,250 in less than a six-month period could be financially challenging for her new small business.
To avoid this, Cassie could have entered into the pay as you go instalments system voluntarily when she started earning income in 2019. She would have been contributing since then to the future tax bill she receives after lodging her income tax return for that period and the contributions would have been more manageable and evenly spread out.
Things don’t always go to plan. If Cassie is unable to pay on time, she may be able to set up a payment plan to pay the amounts she owes over time. She still needs to lodge her activity statements and tax returns on time, even if she can't pay by the due date. This will show that she’s aware of her obligations and doing her best to meet them.
This example demonstrates the benefits of providing for your own tax as soon as you start making a profit in your business.
