Written by Nathan Watt

Mr Speaker...

"Over 99 per cent of businesses, employing over 11 million workers, can write off the full value of any eligible asset they purchase."

- Josh Frydenberg Budget Speech 11 May 2021 

Thanks Josh, but umm...

what is a write off and how does it work?


Ask any Australian and they’ll tell you, you can “write it off on tax”.

Ask them what that means and you’ll get a variety of answers from, paying less tax, to the government giving you the full amount of write off back. Imagine that!

In technical terms a “write off” is just a deduction. The best way to think of a deduction is think “expense”.  It gets subtracted from the income.  You then pay tax on the net amount, for example;


$$

Sales

$100,000

Deduction

$40,000

Taxable Income

$60,000

Tax Payable (@26%)

$15,600

After Tax Income

$44,400

If you didn't have this deduction it would look like this;


$$

Sales

$100,000

Deduction

$0

Taxable Income

$100,000

Tax Payable (@26%)

$26,000

After Tax Income

$74,000

So your $40,000 deduction has saved you $10,400 in tax ($26,000 minus $15,600).  

$10,400 divided by $40,000 = 26%.  That's not a coincidence.  That's just maths and (hopefully) illustrates that your deduction aka write off, is only as good as your tax rate. 

It also should show you, that even after the reduction in tax you still have less cash $74,000 vs $44,400.

That's why spending money to save tax is a ridiculous strategy.

Now that should be simple enough, but here's the rub;

Not everything you spend money on is an expense when it comes to tax (and accounting).

Things that have a life span of many years, are not “expenses"  or "deductions” in the year you pay for it.  Take a computer for example.

You expect that computer to last a few years before it’s cactus and you need another one.  Planned obsolescence, sure.  Reality of the world we live in. Absolutely.

So for tax purposes, the whole cost of that computer isn’t deducted from your income in year 1.  Instead the deduction (known as depreciation) is spread out of the “useful life”.  This has been the way the tax law operated for as long as I’ve been doing this.  They’ve tinkered with it here and there for small business, but essentially, any asset over $100 needed to be depreciated over several years.

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This is in stark contrast to your cash flow, which is where many people struggle to get their head around it.  To them it’s an expense because they’ve paid for it, so they have less money, so they should pay less tax. I get the thought process, but that’s not how this works.

How do you work out the useful life?

Well you can self assess the useful life under the tax act, but the easiest way to find out the useful life is to click this, and use the tax commissioner’s table of effective lives (handy hit use crtl + f to find things).  

It lists a multitude of assets in varying industries and gets updated every year.  So until recently before you depreciated that stuffed crocodile, you had to make sure you checked the useful life.

Not even kidding;

Alas, the stuffed crocodile is no longer listed.  Perhaps it’s no longer useful…..

Anyway, all that has now changed, at least temporarily.

Temporary Full Expensing

This is pretty much the instant asset write off (which has ended btw). But now covers a lot of the big end of town.  In fact unless your business has revenue greater than $5,000,000,000 (that’s 5 Billys) then you’re covered.  So for any “eligible asset” purchased after 6 October 2020 and installed ready for use by 30 June 2023, you can now “write it off” in full in the year it is installed and ready to use.

Temporary Full Expensing was released in the 2021 budget (you know the one in October 2020), and has now been extended for another 12 months to June 2023.  So a little less temporary than we thought.

So all those people who think of cash outflow as an expense, you are now correct (at least until June 2023).

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How Much Tax Will It Save?

The government would like you to think that this will save you more tax.  That is most likely not the case for most businesses.  Why?  Because like most tax minimisation tactics, it’s a timing difference.

A timing difference is as it sounds.  We make use of different timings to “manage tax”.  It doesn’t make tax go away, it just moves it around from one tax period to another, but you still end up paying the tax.  My spidy sense tells me an example is needed here;

Let’s assume you’ve bought a new machine for your widget factory.  It cost $100,000 and has a useful life of just 4 years.  Crazy, but it's just an example that fits nicely in a table.

Old Way

Year

11

2

3

4

Total

Sales

$100,000

$100,000

$100,000

$100,000

$400,000

Depreciation

$25,000

$25,000

$25,000

$25,000

$100,000

Taxable Income

$75,000

$75,000

$75,000

$75,000

$300,000

Tax (@ 26%)

$19,500

$19,500

$19,500

$19,500

$78,000

After tax income

$55,500

$55,500

$55,500

$55,500

$222,000

Temporary Full Expensing

Year

11

2

3

4

Total

Sales

$100,000

$100,000

$100,000

$100,000

$400,000

Depreciation

$100,000

$0

$0

$0

$100,000

Taxable Income

$0

$100,000

$100,000

$100,000

$300,000

Tax (@ 26%)

$0

$26,000

$26,000

$26,000

$78,000

After tax income

$0

$74,000

$74,000

$74,000

$222,000

So the tax saving over the asset's effective life is $0.  But, clearly the benefit is paying less tax in year 1, because a bird in the hand and all that.

This is the timing difference I was talking about,  the temporary full expensing method is just bringing forward the tax saving into this year. Helpful sure, but it doesn’t actually “save tax” unless you have differing tax rates year on year. 

How can you have different tax rates each year?

If you operate your business through a company you’ll be paying a flat rate of tax.  Currently 26% for small business.

If however you’re operating as a sole trader, you will have a different tax rate each and every year depending on your taxable income.  If one year your business goes nuts and you make $1,000,000 profit, you’ll be paying tax at 47% for each dollar over $180,000.

If next year you’ve taken most of the year off to #vanlife and park in a side street of Byron Bay and make $20,000 as “influencer” you’ll pay $0 in tax.

In this case it would absolutely save you tax, to write off the asset in year 1, because in year 2, you’ve got no tax to pay.

The same principle will go for partnerships and trusts.  Because in each of those structures, the ultimate owners/beneficiaries pay the tax, not the partnership or trust.

So should I buy that thing I've had my eye on?

If you’re buying it because you business needs it, or you just really want it.  Maybe.

If you want to buy it to save tax, absolutely not.

Need a hand with your taxes?  Then check out what we do here.

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