The small business tax cut: how will it work?

3rd April, 2017

Small business owners will have read the weekend papers with a fair degree of joy in their hearts after a tax cut was announced – but it may not work out the way the government intends.

In case you missed it, thanks to a deal cut between the government and independent senator Nick Xenophon small businesses will enjoy a tax cut gradually decreasing to 25 percent.

This financial year, businesses with turnover of less than $10 million will have their tax rate reduced to 27.5 percent.

In 17-18 this rate will kick in for businesses with up to $25 million in turnover, and $50 million the year after that.

The rate will gradually drop to 25 percent.

According to the government, these cuts will reach 3.2 million small businesses around Australia.

What’s the hope?

The government is doing this because it’s looking squarely at what’s happening in other countries and getting ready for a swathe of other countries to cut their tax rate.

New US president Donald Trump has signalled his intent to reduce the company tax rate to just 15 percent, down from 35 percent.

When the US does something that big, other countries follow, not wanting to be left behind.

“If what Donald Trump and the GOP want to do around company tax comes to fruition… there’s the possibility that we’ll become even more uncompetitive from a company tax regime perspective on a global scale,” KPMG chief economist Brendan Rynne told The Pulse.

Apart from becoming more competitive with a global average, the government is also hoping to stimulate activity in the economy.

Because small business owners will have less tax to pay, the hope is that they will spend the extra cash on things needed for the business.

“When you think about a small business cut, it’s designed to get small business owners to invest in their business with the extra money they gain – whether that’s investment in new equipment or staff,” said Rynne.

This, in theory, will lead to second-order and third-order effects because businesses are running much more effectively and hiring new people – who are paid a wage which the government can then collect on.

Treasurer Scott Morrison, speaking to the ABC’s Insiders program on Sunday said that together with access to pooled depreciation and an instant tax write-off, the new cuts would give businesses an opportunity to invest in themselves.

“If you give businesses the opportunity to invest back in their business, then that leads to growth which leads to secure jobs and higher wages,” he said.

“They can invest, look at new markets, look at investing more and taking more people on.”

However, economic theory and reality sometimes have a way of being worlds apart.

How will small business owners invest?

KPMG helped the government with modelling the broader package of tax cuts the government was chasing – so it doesn’t have any hard dollar figures on what effect the compromise deal will have on the economy.

However, Rynne said the government shouldn’t bank on re-investment back into the business.

“What we’re likely to see happen is that many small business owners will end up accruing that extra income as a dividend, and it becoming personal income,” said Rynne.

“The $64 million question is what proportion of the cut will be applied to the businesses themselves and what will go towards personal income for the small business owner”.

So, if the extra savings aren’t re-invested into the business, is that a bad thing? According to Rynne, that depends on your perspective.

“If it becomes extra personal income for the small business owner, that’s still a good thing as it will go back into the economy; but compared to investing the additional tax savings into productive assets, it’s less of a good thing,” he said.

So small business owners may pocket the extra money themselves, and the point Rynne makes is that this has a second-order effect, because the owners spends money elsewhere in the economy.

Either way, extra money goes towards supporting a business.

MYOB research has also found that quite often, small business owners pay themselves last.

In September last year MYOB found that a third of small business owners weren’t paying into their own superannuation.

For some they were hoping that selling their business could be the silver bullet solution for retirement, but for others paying their own super was a ‘luxury’.

Giving small business owners more capacity to invest either in themselves or their business is a positive, no matter which way you spin it.