Tax deferral options usually one-way traffic

By BRUCE SHEPPARD

In examining planning options as a result of rising tax rates, no review would be complete without considering your business' tax deferral strategies.

Tax deferral generally involves bringing forward expenditure and pushing out income. Expenditure, for example, is incurred in March rather than April, and income derived in April rather than March.

In growing businesses, tax deferral is a one-way street. What worked in year one will work in year two, but to an even greater degree. As a result deferrals grow until one of three things happens:

* You die (and your business ceases).

* Your business declines sharply and you go broke.

* You sell the business.

With the change of Government, a fourth event can be added: tax rates are increasing and you decide to review your strategy.

Obviously, if you defer tax from one income year where you would suffer tax at 33 per cent to another year where the tax rate is 39 per cent, it has an implicit cost of 18 per cent. Reversing deferral tactics is not a free ride. If deferral tactics are reversed, additional tax may be payable in the year 2000.

Top-up tax should be paid before March 31 to avoid the IRD levying use of money interest on any tax obligation that might arise as a result of reversing deferrals. Use of money interest is levied at an annual rate of just over 12 per cent.

Some of the things that require consideration are as follows:

* Bad debts. Are they really bad?

* Stock. Is it really obsolete or should it be valued at cost price regardless?

* Pre-payments. You have historically expensed them. Is it now appropriate to accrue the future benefits of such pre-payments as rates, insurance, marketing and overseas travel?

* Is it worth considering changing your depreciation base from diminishing value to straight line, reducing your depreciation claim in the current year? Is it also worth considering whether such assets are available for use, thereby deferring depreciation deductions to a further year?

* Have you really incurred the liabilities you believe you have?

* Have you built up accruals, staff bonuses, directors' fees or other emoluments? If so, is it worth paying them out before March 31?

* Is that job really finished and are you entitled to bill for it? Or did it actually finish after April 1?

In addition to the expenditure side, your business structure may well involve collecting cash in advance of income being earned. You need to consider whether it is appropriate to adopt deferral practices in respect of income.

If you form the view that deferral of income streams in March 2000 is no longer appropriate, you will have some difficulty in forming the alternative view in the year ended March 2001.

On the bright side, there is no requirement for consistency with tax accounting. However, under the Financial Reporting Act you are obliged to adopt generally accepted accounting practice and apply it consistently. If you are not a reporting entity this is not an issue.

In preparing financial statements and tax returns, it is clear that significant judgment is required. The approach to that judgment may well need to be different in the current year and, if you choose to adopt a reversal strategy of past deferrals, there will be a cashflow consequence which needs to be considered.

* This is part two of a three-part series. Part one appeared yesterday and part three will run tomorrow. Bruce Sheppard is a partner in Gilligan Sheppard, an Auckland accountancy firm.