The right approach depends on a range of factors, including the business structure used, the industry the business is in, the business owner's age, family position, as well as circumstances such as both the business owners and the business's financial and asset protection needs. Care needs to be taken in the way such strategies are set up, particularly if there are loans involving the owners, as they could end up being taxed.
Following are six remuneration strategies that can help reduce the tax bill.
Trading through a company or trust often allows taxable income to be shared with other family members, for example a low-income spouse. This approach means a couple can earn up to $300,000 from the business before reaching the top tax rate of 46.5 per cent.
Other family members can also be paid for working in the business, or receive income distributions as shareholders or beneficiaries of the business, reducing its taxable income.
All business owners should consider maximising their tax-deductible super contributions, subject to the business's cash flow needs.
The limit for deductible contributions is now $50,000 per person (with transitional rules allowing contributions of $100,000 up to 2012 for those over 50). These contributions are only taxed at 15 per cent, within the fund, reducing the tax burden on the business. It could also be worthwhile contributing for a spouse. Contribution rules are now the same for self-employed persons as for employees, so it doesn't matter whether the spouse is working in the business or not.
It is now even more tax-effective for assets, including business real property, to be held in a superannuation fund.
While individuals may pay tax of up to 46.5 per cent on investment earnings, a super fund will pay tax of just 15 per cent on income (and 10 per cent on most capital gains), with no further tax payable when funds are withdrawn on retirement after age 60. For instance, a super fund can own the business premises and charge rent to the business entity. The net rental income, after deducting holding costs such as rates, insurance and repairs, will be taxed at 15 per cent, while the rent will be deductible to the business entity (usually paying tax at a higher rate).
This is a very effective strategy for getting money out of the business tax effectively.
This approach may not suit younger business owners as money and assets contributed to a superannuation fund are locked away until at least age 55. In addition, a super fund cannot carry on business, or borrow funds.
If a business is carried on through a company or trust (but not a partnership), the owners are usually employees of the business, and can therefore choose to receive some of their remuneration in the form of fringe benefits, resulting in tax savings.
The most notable benefit that offers a tax advantage is a car, especially where the car is not used extensively for business purposes. Often the fringe benefits tax will be less than the tax payable on the equivalent salary (even with relatively expensive cars), although it is important to do some arithmetic first.
Other concessionally taxed benefits include notebook computers, mobile phones and PDAs.
Business owners could consider receiving fully franked dividends in preference to a cash salary. This is income tax effective for the owner and it reduces employment imposts such as payroll tax and workers compensation insurance premiums.
Of course, paying dividends in lieu of salary will mean that the business will pay a greater amount of tax in the current year as the dividends are not tax-deductible.
In the case of companies which are making current year losses, but have carried forward retained earnings, there may be a significant benefit in paying a fully franked dividend in preference to payment of a salary.
This is a strategy that can be used by both business owners and executives who are 60 or older.
They can switch on a tax-free pension from the superannuation fund while salary sacrificing an amount equivalent to the pension and having it paid as a tax deductible contribution into their super fund. This effectively reduces the tax on this portion of their remuneration to 15 per cent.
Peter Bembrick is a tax partner with accountants and business and financial advisers HLB Mann Judd Sydney.