If I run my business at a loss I can avoid paying taxes right?
It’s a question that as an accountant, I hear quite often.
In the basics of tax we learn that we calculate tax as a % of profit. Profit is what you get after subtracting expenses from your income. There are a lot of things you can claim as business expenses, such as:
- Cost of buying materials
- Staff wages
- Rent
- Electricity bills
- Phone/Internet bills
As long as there is a direct relationship between the expense and your income you should be able to claim the expense for your business.
Then claiming more expenses means I can avoid paying taxes right?
Not exactly. As a business owner you want to be claiming as much expenses as you LEGALLY can. This is why you get an accountant to help you manage your finances and advise you on tax matters.
Sometimes, business owners start pushing the boundaries of business expenses. I have had business owners ask me if they can claim their children’s daycare fees as a business expense (because it frees their time to run their business) – no you can’t. If you are in doubt, double check with an accountant.
In other words, claim more expenses, pay less taxes. Just make sure you are claiming expenses correctly. If you overstate your expenses and are running at a continuous loss year on year on year, this will get you flagged and the tax people WILL come after you.
Then if I spend MORE on actual business expenses, I avoid paying taxes right?
SIGH
Yes. But you would do so at the expense of your business’ profitability.
Look. If you are a business owner – your main objective is to make your business profitable. If it’s not running at a decent profit, you need to improve they way you do business.
One of the cool things about being a business owner is that anything you buy for your business is discounted by your tax rate. Remember that expenses reduce your profit and you are taxed on your profit. Say for example:
Yuu runs a counselling service and purchases a new tablet costing $900 for his business. The company tax rate is 28%. Since a tablet is a legitimate business expense, he can use it to reduce his tax obligation by 28% of $900 ($252). If Yuu were an employee and bought this tablet for work use, he wouldn’t be able to claim it and use it to reduce his tax obligation.
This ‘discount’ only works if you are actually making a profit. If you’re spending waaaaay too much on your business, you aren’t making any profit. In most countries you can carry business losses forwards to the next year (which is good if you are planning on growing the business). But if your objective is to run a business without paying taxes by running it at a loss – then you are wasting your time (and are likely to attract the attention of the tax people).
How should I be spending business expenses then?
The main financial goal of any business is to make a profit. If your main goal in running a business is to pay less taxes then you’ve got it wrong. For example:
Fellemo purposely chooses to use the most expensive business services he can find because he wants to claim as much business expense as possible. So he uses the most expensive accountant, the most expensive marketing firm, the most expensive advertising and the most expensive office supplies. He likes expensive things because he likes paying less taxes.
Fellemo is just wasting his time and money. He would end up spending MORE unnecessary money on his business than he would on paying taxes.
A good business owner will look for value in their spending. Only spending on products and services that ADD VALUE to the business. Spending decisions must always be treated as an investment that helps generate a decent profit and return for the business.
I’ve just started up and I’m spending more than I’m earning in the business – am I in trouble?
No you’re not. You are fine.
It’s normal for new businesses to run at a loss. This is especially true for businesses with high set-up costs, like restaurants, contractor work, farms etc. However, once you’re set up and have had a good few years of business, you should naturally be making profits. As a business owner, you will instinctively know if you are making a profit. In years where sales are bad, you are likely to run at a loss. When sales are good, you should be making a profit.
If, at the end of the financial year you are thinking of things to spend money on to pay less taxes – then you’re being silly.
Remember, a business exists to make profit! If you dislike paying taxes, then set up a charity instead!
Stay positive!