Managing your taxes as a business owner

If you're like most small business owners, you pay an accountant or other professional adviser to handle your taxes. Even so, planning ahead for your tax can be most beneficial for you in the long run. You'll be able to identify potential tax advantages and traps in time to react and respond to accordingly. The secret is in planning ahead. The following are 7 things one should remember when planning:

1) Planning for your taxes and knowing your tax form

Tax planning can mean to evaluate options to determine when, whether, and how to conduct business and personal transactions to maximize relief absorption whilst not having to incur heavy business administration costs such as secretarial fees and administrative professional fees, ahead of time. As an individual taxpayer, and/or as a business owner one should always remember that the Form B is to be filed by 30th June of each year, but the company tax form (Form C, P & PT) is to be filed within 7 months from the close of its financial period. The Form BE is to be filed by the end of March, with an additional time extension given for individuals performing E-filing (which should be most if not all of us at this point)

Remember, when starting your business, whether you form a sole proprietorship (Form B), a partnership (Form P), a limited liability company (Form PT), or a corporation (Form C), there are significant income tax consequences that flow from each. Don't forget to weigh the tax issues against the non-tax issues, such as which type will best help you operate and grow when it comes to obtaining financing or which will make it easier for you to pass along the business to your heirs. To start, one could go to Suruhanjaya Syarikat Malaysia (SSM) to learn more on the different types of businesses one can register. Google is your best friend.

2) Defining your business

To deduct business expenses, you must be engaged in a "trade or business" an activity carried on for the purpose of gaining economic benefit or profit. According to LHDN, to constitute a trade or business, a profit motive must be present and some type of economic activity conducted. "Profit” or more accurately taxable profit is determined after adding back non-deductible expenses and deducting capital allowances, before applying the relevant tax rate to your chargeable income to obtain your tax payable amount. In situations where the business makes a loss in the financial year, unabsorbed business losses can be carried forward to be knocked off against future taxable profits of the business. LHDN has some helpful resources online with more information on this. Once again, Google.

3) Choosing your business type and accounting methods

As a small business owner, your decisions often have tax implications - whether or not you realize it. Suppose you buy a car for business use, rather than lease it, or better yet transfer ownership to your company. You can't deduct the purchase price (as you can a lease payment), but you can deduct a portion of the cost annually (subject to the applicable restrictions) as capital allowance. Some tax-related choices, like choosing to incorporate a private limited company instead of just a sole-proprietorship or partnership, have a more direct effect on your tax payable, namely a lower tax rate on the first RM500,000 of taxable profit.

Whether you’re a sole proprietor filing a Form B or a partnership or LLP filing Form P or PT, you must report your accounting method to the LHDN. There are two basic methods available to most small businesses: Actual (Cash) or Accrual. In some cases, you may be able to use a hybrid that combines elements of both. Also, owners of certain types of businesses can use special accounting methods under the tax law when treating research and development cost or industrial building allowances. Note that changing between accounting methods should only be done for the right reasons, i.e: if there is a change in the nature of the business.

4) Determining business income and deductions

Calculating your income tax requires computing your business income. This means taking your gross business receipts or sales and subtracting your cost of goods sold to arrive at your gross profit, then deducting your other business expenses. Generally, any income you receive connected with your business is "business income" and should be reported on your business tax return. Income is "connected with your business" if the payment would not have been made if you did not have the business. Other considerations:

Gross income from sales. In most cases, this will be the income you receive from actually operating your business. This should be kept organised in the form of sequentially pre-numbered sales invoices, cash sales receipts or daily collection sheets. Do remember that upon an income tax audit, supporting evidence needs to be presented to justify numbers reported.

Cost of sales. This must be computed if your business uses inventory, in order to complete the business income portion of your tax return. Other than cost of goods sold, this can be defined as cost of production, or direct cost incurred in attaining business income.

Deductions. Digging up every allowable expense is usually your best bet for reducing your taxable income and your tax payable. Capital expenditure, travel, staff meals and client entertainment expenses, business gifts, staff compensation, office utilities and vehicle expenses are all common business deductions so long as their deduction is in compliance with the rules set out by LHDN.

5) Capitalizing Assets: Capital allowances and depreciation

Almost every business must invest in major equipment, vehicles, machinery, or furniture in order to operate. Some require land, a building or franchise rights. Major assets used in your business for more than a year are known as "capital assets" and could qualify for capital allowances. You generally can't deduct the entire cost of them in the same year you acquire them, with some notable exceptions for small value asset allowance (subject to restrictions set out by LHDN).

An asset’s cost is deducted over its useful life, according to the class the asset is categorized under. You could subtract all depreciation claimed to date from the cost of the asset, to get the asset's "book value" (theoretically equal to its market value). Since the actual drop in value is difficult and time-consuming to compute, accountants use various methods of depreciation to standardize the process: the straight-line method of depreciation assumes assets depreciate by an equal percentage for each year used, while the declining balance method assumes they depreciate more in earlier years.

LHDN has specific rules governing how you are allowed to deduct capital allowances which may differ from the rules of depreciation, but which brings forth with it the idea of timing differences, and deffered taxation.

6) Net profit, loss and self-employment taxes

Once you have computed your gross business income and deducted your cost of goods sold to arrive at your gross profit, subtract your other business expenses for the year to calculate your net business income. This amount is your net profit for tax purposes. There are two important issues to consider when computing your net profit:

For sole proprietors, your net chargeable income is the amount on which you must pay income tax when filing your Form B. If your business is a partnership, LLC, or corporation, you must follow somewhat different rules. This is in regards to filing your own Form B/BE within the stipulated deadline and ensuring that the amount of salaries that you have declared within the Income Statement (matching that in your Form C,P or PT) of your company can be directly matched to that of which is declared in all the Form B/BEs for all the salaried employees of the business. Note that by 31st March of each year, the Form E should be filed with LHDN containing the company’s payroll information of the preceding year, which would also correspond to the Form EA which you would submit to salaried employees of the company.

Net operating losses are not always a bad thing when they happen. Owning a business is full of surprises. Some years your expenses may exceed your gross income, translating into a loss for the year. You may be able to deduct this loss against any other business income you have, or carry it forward to offset next years' taxable income. These unabsorbed losses can be accumulated so long as the business is a going concern and there are no changes in the nature of the business or its activities.

7) Dealing with LHDN yourself.

As a small business owner, be aware of your tax payment obligations and when they are due—even if you use a tax adviser or accountant. There's no worse feeling than watching your cash surplus disappear because of an impending LHDN payment. Be proactive, and don't be afraid to walk into your LHDN branch should you receive a letter from them for whatever reason. With a good awareness of your filing and payment obligations, you can avoid unexpected payments or late penalties. Take the initiative.