- Businesses either fail, stay in the same place for years or they continuously grow and expand. There are reasons behind these growth patterns.
- Business growth needs finance in order to ensure growth through expanded premises, more resources, new machinery, etc.
- With these financial responsibilities come tax and financial subtleties that you should know about.
- Read on to learn all about financing your small business including taking out loans and the various types of leases available.
As your business grows and expands, you will face choices as to how that growth is financed. In some cases, the business may be sufficiently profitable that future growth plans can be financed from internally-generated capital.
In most cases, it will be necessary to look to external finance in order to secure the funds your business needs to grow.
Which Areas of Business Do You Require Financing For?
Among the areas you might be looking to finance are:
- the acquisition of new and bigger premises, or an extension to existing premises,
- the acquisition of new plant, equipment, fixtures and fittings,
- taking over competitor businesses through mergers and acquisitions, and
- development of new product lines.
If you borrow money to finance the growth of your business, interest paid on that finance will generally be tax deductible, provided all the borrowed funds are used for business purposes (you’ll need to apportion the interest if some of the finance is used for private or domestic purposes).
How Do Business Loan Payments Work?
Business loan payments consist of 2 elements:
- the repayment of the principal, which is a capital expense and not deductible, and
- the interest element (cost of finance), which will be deductible where the loan is for business purposes.
Interest is deductible immediately even where the borrowed funds are used to acquire capital assets, such as property or plant.
Are There Any Tax Deductible Loan Costs?
Costs incurred in arranging a loan are also deductible by the business, as are costs incurred in discharging a loan. Tax deductible loan costs may include:
- loan procurement fees
- guarantee fees
- legal costs
- stamp duty
- valuation fees
- survey fees
- underwriters fees
No deduction is available if the finance doesn’t go ahead.
How to Finance Your Small Business
There are 4 main options to finance your small business:
- Finance asset purchases
- Hire purchase contracts
- Finance lease
- Operating lease
What is a finance asset purchase?
In many cases, you’ll want to raise finance to acquire new assets to use in the business, such as plant or machinery. In some cases, you’ll borrow money to acquire the asset and in others, you’ll lease the asset.
The distinctions between buying an asset using hire purchase (HP), taking out a finance lease and taking out an operating lease can be quite subtle, but the tax treatments — and the legal obligations and responsibilities imposed on your business — can be very different, depending on which route you take.
What is a hire purchase contract?
If your business acquires an asset under a hire purchase contract, you will acquire full legal ownership of the asset, subject to any security on the asset put in place by the lender.
For tax purposes, the following deductions for assets financed under an HP contract can be claimed:
- the interest component of the HP payments,
- repairs, and
- depreciation on the asset from the date of the HP contract.
What is a finance lease?
If your business takes out a finance lease on an asset, your business will take on many of the risks and rewards of ownership of the asset without, initially at least, taking on legal ownership. Typically, after paying the lease payments for the duration of the term, your business will legally acquire the asset by paying out the residual payment to the lessor. Until that point, the entity leasing the asset to your business will be the legal owner.
For tax purposes, lease payments made under a finance lease are immediately deductible. In addition, as your business will be responsible for keeping the asset in good order, any repair or servicing costs will also be tax deductible. Your business can’t claim the depreciation on the asset — the entity leasing the asset to you will claim that.
What is an operating lease?
If your business takes out an operating lease on an asset, it is basically renting that asset from the leasing entity, which retains ownership of the asset.
In many cases, this can be an attractive option. Because the risk of ownership remains with the entity renting the asset to your business, you avoid any of the risks of obsolescence and don’t have to worry about maintaining the asset or repairing it if it breaks down, since the lessor is usually responsible for all those costs.
For tax purposes, payments made under an operating lease are immediately deductible in the period to which they relate, provided the asset being leased is used in the business. As noted above, servicing and repairs will often be included in the headline rental cost but if charged separately, they will also be deductible.
How do you intend to finance YOUR business growth in the future?
Mark is a regular commentator on tax matters for a variety of Australian broadcast and print media outlets. In addition to his columns in Money Magazine and My Business Magazine, he has written for a variety of national publications such as the Australian Financial Review, The Daily Telegraph, The Age and The Business Spectator. Previously, Mark was a tax adviser for over 20 years, specialising in individual and small business tax, in both the UK and Australia.
