5.6 An overview of taxation implications
Taxes take many forms and are direct (income tax) and indirect (GST, excise and duties). Taxes affect cash flows when they are paid and financial managers must consider when making financing and investing decisions and in forecasting cash flows.
For example, the effect of tax payments on operating activities is always shown in the statement of cash flows (check your financial reports to confirm this). Companies also collect GST on behalf of the government when they sell goods and services and can claim refunds of GST on goods and services purchased. The difference is paid to the Australian Tax Office (ATO). So the timing of cash flows from tax collected and paid is an important feature of cash budgeting and cash management, especially for small businesses.
When making a financing decision to borrow money, the interest paid is tax deductible, which reduces the cost of borrowing and the cash paid for tax. Similarly, when making an investment decision to buy an item of plant or equipment, the annual depreciation amount is tax deductible and also reduces the cash paid in income tax (depreciation in this context is called a 'tax shield'). To sum up, financial managers must always consider the effect of taxes.
Taxation, particularly as it affects large companies, is a complicated field of study and tax planning is a complex practical activity. This brief description of some aspects of the Australian tax system (other countries have different systems) is just to alert you to the fact that taxes affect most financial decisions.
Income tax
In Australia individuals and companies pay income tax (some of you may have felt the effects of PAYG and may even have read the annual 'Tax Pack"!). The tax on individuals is 'progressive' as the rate of tax increases as taxable income increases, but companies presently pay a flat rate of 30%.
Taxable income is measured as follows:
Taxable income = assessable income - allowable deductions
For companies, taxable income approximates to, but is not the same as net profit. This is because the rules for measuring net profit are different from the rules for measuring income tax. The reason for this is that accounting rules are designed to measure business performance , while tax rules have the social purpose of redistributing income across all sectors of society.
Tax rules are sometimes framed to give incentives or disincentives to particular business activities. For example, special tax deductions are often given to encourage investment in plant and equipment. If a company incurs a tax loss (allowable deductions are more than assessable income), the loss is carried forward as an offset against future tax payable. Potential 'winners' and 'losers' usually vigorously contest changes in legislation affecting taxes as part of a process of lobbying government.
Capital gains tax
A capital gain occurs when a long-term asset (plant and equipment or share investments) held for more than 12 months is sold at a price greater than its 'indexed' purchase price. Long-term physical assets are often called 'capital assets', hence the term capital gain (or loss). The effect of this tax must be included when making and evaluating any long-term investing decisions.
Indexing eliminates most inflationary effects and the Consumer Price Index is used for this.
Capital losses are only allowed to offset capital gains or be carried forward to offset future capital gains.
Dividend imputation
Dividend imputation means that shareholders are taxed on the gross amount of the dividend which is the net dividend plus any tax paid by the company on it taxable income.
The shareholder is then allowed a credit against tax payable equal to the tax paid by the company. This prevents shareholders from effectively being taxed twice on profit earned by a company, and discouraged from investing in shares.
Goods and services tax (GST)
This is an indirect tax paid by individuals, and collected on behalf of government by businesses having an Australian Business Number (ABN) and which are registered for GST. Consumers (and businesses) pay 10% GST when they buy goods and services. As businesses are 'collecting agencies' for the government they forward the GST collected from customers with a business activity statement (BAS) and can claim back the GST they paid on goods and services bought for their own operations.
From the point of view of individual consumers the tax is described as 'regressive' because rich and poor pay the same rate. The GST is a tax on individuals, not on companies, but companies must meet the administrative costs of collecting and paying over the tax to the ATO.
Not all businesses are involved in the GST process. Any business with an annual turnover (revenue) more than $50,000 must have an (ABN) and register for GST, but
small businesses are protected from the costs of the collection process. If turnover is less than $50,000 they must obtain an ABN and but may choose whether or not to register for GST.
There is a lot in this chapter, but it is mainly a 'scene setter' for the content of other chapters.
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