How we should fix the 3 biggest barriers to small business success

It’s safe to say Australia has a penchant for small business. Around 90% of Australian businesses are small to medium-sized entities (SMEs). Taxes on small business are lower than they’ve been in the last decade. It’s one of our healthiest and fastest growing sectors.

A recent OECD report on taxation of SMEs in OECD and G20 countries says small businesses worldwide are doing similarly well.

“They are also strongly heterogeneous,” the report reads. “Across and within industries and sectors; in their innovation behaviours; and in their profitability and growth potential.”

But that’s mostly thanks to the SMEs themselves; global SME growth over the last few years has been more dependent on the sheer size of the sector than governmental and regulatory support.

It’s not all bad. Just this year, Australian SMEs received new and exclusive tax relief measures as part of the federal budget. The tax rate for small business companies who make less than $2 million in aggregated annual turnover is down to 28.5%, and unincorporated small business owners now have their own 5% discount. There’s never been a better time to be an SME than in Australia right now.

The OECD in its report identified three inhibitors to small business which governments should tackle:

Barrier 1: Scaling the gap between big and small
The fact remains that SMEs have a hard slog when it comes to tax compliance. As the OECD report says, the slog isn’t proportionate when you compare the big with the small. Essentially, it costs SMEs a lot more to make sure they’re compliant than it does big businesses with vast revenue streams.

“SMEs often face higher tax compliance costs, in relative terms, due to their smaller size,” the OECD report says. “When designing and implementing tax policies, governments should consider whether certain measures have a disproportionate impact on SMEs. Many countries provide special provisions and simplification measures that are designed to reduce the tax compliance costs of SMEs.”

In Australia, the federal government’s Re:think tax reform discussion paper asked for plans to minimise the burden of SME compliance. One of these was to increase the current $2 million turnover threshold to $5 million so that more business can access small business concessions – such as the $20,000 temporary immediate write-off for asset purchases. Another is fringe benefits tax (FBT) and its associated liability – transferring the tax liability from the employer to the employee for the provision of non-cash remuneration should bring down compliance costs for SMEs.

Barrier 2: Separating the start-ups from the SMEs
Although start-ups are SMEs, the OECD believes it’s important to distinguish the former from the latter more clearly; start-ups need more help because the stats say they’re more likely to go out of business.

“There may be a particular case for targeting preferences and simplification measures toward younger SMEs,” the report continues, “who are most affected by finance and cash flow difficulties, face barriers to entry and growth from incumbent firms, are more likely to grow than older SMEs, face the highest compliance cost burdens and are likely to have high spillover effects from innovation.”

Barrier 3: Make it hard for businesses to distort their status to access special measures and/or incentives
If the ongoing hullabaloo about base erosion profit shifting has taught global governments anything – or if there’s one lesson global governments should heed — it’s that businesses will morph their operations to suit the best tax arrangements out there. So if you fashion a better tax system for start-ups, you better ensure it applies to real start-ups.

“Caution is needed to ensure that tax preferences or simplification measures do not introduce further distortions,” the OECD report says. “These distortions can result in incentives to alter economic activity in unintended ways to benefit from special tax rules”.

One submission recommended that the Government look at ways to reduce such distortions when small businesses choose a structure. A structure similar to a US-style “S-Corporation” for small businesses in Australia is worth considering.

R&D Tax Incentive claims: The good, the bad, the dodgy

The Tax Office warns that it is working closely with AusIndustry to identify taxpayers involved in aggressive R&D Tax Incentive arrangements.

It says some claims made for the R&D incentive have been negligent on the compliance requirements generally expected when making a claim, with some other instances even bordering on tax avoidance and fraud.

The program offers companies a way to claim eligible R&D expenditure by way of a tax offset. The definition of R&D is very broad and applicable to all industry sectors to encourage innovation. However, the Tax Office and AusIndustry are scrutinising claims to ensure their legitimacy.

Eligible entities (see here for that definition) engaged in R&D may be eligible for:

a 43.5% refundable tax offset for eligible entities with an aggregated annual turnover of less than $20 million, provided they are not controlled by income tax exempt entities; or
a 38.5% non-refundable tax offset for all other eligible entities (entities may be able to carry forward unused offset amounts to future income years).

AusIndustry’s compliance work focusing on the eligibility of R&D activities while Tax Office work focuses on the R&D tax offsets allowable in respect of those activities. Both parties work together to undertake complementary risk assessment and compliance work.

The Tax Office says that it is concerned businesses and tax agents could be following R&D consultant advice without substantiation of expenditure or objectively assessing the advice.

Errors often slow down the processing of any refund, as the Tax Office then has to verify the information submitted and confirm eligibility. The revenue collection agency has the following tips to help avoid those errors and prevent delays:

Check registration – check that you have registered your R&D activities with AusIndustry. You must register each year before lodging your R&D claim, and your annual registration number must be included on your R&D schedule. Check each year the timing when this needs to be done and if you use an agent then you may be able to get an extension of time.
Ensure BAS lodgement is up-to-date – if you have overdue activity statements, lodge these before claiming. BAS outstanding can impact your income tax.
Review grouping rules – to determine if you are eligible for an R&D tax offset, review the grouping rules (although note that the Tax Office quotes the old rates of 45% refundable and 40% non-refundable). If you have an aggregated annual turnover of $20 million or more, you are not eligible for the refundable tax offset, but may be entitled to the non-refundable tax offset

Here are the R&D incentive schedule instructions 2015, and for the Tax Office’s FAQ page on the incentive, click here.

Is franchising still worth it?

7-Eleven and the franchising sector have been in the headlines lately, but for all the wrong reasons.

Allegations of wage theft have surfaced, and further claims that a “half-pay scam” had the complicit involvement of senior management. The claims include fiddling with time sheets, “ghost” workers, nil penalty payments and alleged rates of as little as $10 an hour.

The Fair Work Ombudsman is investigating several cases involving the 7-Eleven franchise chain. Its head office has issued a statement of course, but the outcome for its future is still working through the appropriate channels.

In light of these headlines, it begs the question as to whether franchising remains worthwhile for budding franchisees.

Look before you leap
The reasons people go into a franchise vary of course, but it seems one big motivator is that, unlike other start-up businesses, they are starting out with an already established brand and sales systems in place. And although theoretically this may seem to guarantee success, the fact is that this is not always the case.

In fact a study conducted earlier this year by Griffith University and the University of NSW on the effectiveness of due diligence when starting a business, and the differences between buying into an independent small business or a franchise (read it here), found that overall due diligence undertaken prior to entering into a franchise agreement “was relatively unsophisticated with few exceptions of rigor and planning”.

The study’s authors also concluded that “where prospective … franchisees were entering business for the first time their appreciation of business was naïve. A steep learning curve followed during which they often recognised flaws in their initial research.”

With the latest 7-Eleven debacle, even former ACCC chairman Allan Fels has weighed in with his dim view of the franchising business model. Fels told the ABC: “My impression, my strong impression, is that the only way a franchisee can make a go of it in most cases is by underpaying workers, by illegal behaviour.”

Don’t forget tax and super obligations
Most of the current 7-Eleven allegations centre on breached employer obligations to employees and their entitlements, and as so are not limited to the franchising model.

Nonetheless, it is important the all businesses ensure that they meet their employer obligations for federal and state taxes. This includes obligations such as PAYG withholding on employee salary and wages, superannuation guarantee, fringe benefits tax and state payroll taxes.

The Tax Office has published a handy employer obligations checklist that can help every business owner meet all the tax and superannuation obligations required when a new worker starts, while they are employed, and when they leave.

Still keen?
For those still keen on being their own boss through the franchising route – there is plenty of free guidance out there.

The ACCC has published a guide for potential franchise business operators you can download for free (The Franchisee Manual). The not-for-profit trade organisation Franchise Council of Australia also has various resources available.

From a tax view point, the Tax Office says that starting and running a franchise business is much like any other small business, but there are some additional considerations to make with transactions between franchisors (the person who grants the right to produce or distribute a product or service) and the franchisee (the person receiving that right). It has also provided guidance on tax obligations for the franchising business model (read it here).

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