Tax debt means you owe money to the Tax Office

Managing tax debt has never been more important for business owners in Australia. The Tax Office is a powerful machine and has powers to collect what's owed. At any time, they can garnish your bank accounts, place liens on your property, or even shut down your business. Powerful reasons why you should want to get out of tax debt today.

 Addressing and eliminating tax debt is not just about fulfilling a legal obligation; it involves a strategic approach to safeguarding your business' future, maintaining its reputation, and ensuring its long-term success.

Here are the 8 reasons you should want to get out of Tax Debt Today!

1. Having no Tax Debt Boosts Your Cash and Stability

Tax debt can tie up your money, holding you back from opportunities to grow your business. Getting on top of tax debt means better cash flow, which will free up funds for new projects and keep the business running smoothly. This financial stability is crucial for maintaining day-to-day operations and for the strategic planning of future projects or expansion efforts. which can tie up cash that you might need for daily operations or investing in new opportunities. This can put a strain on your business's finances.

2. To Avoid Extra Fees

If you fall behind on paying your taxes, the Australian Taxation Office (ATO) will add penalties and interest on any outstanding tax debt, making what you owe even bigger. By addressing tax debts promptly, business owners can avoid these additional costs. This not only helps in reducing the financial burden but also demonstrates compliance and a proactive approach to financial management., which can quickly add up, increasing the amount you owe by a significant margin.

 3. Keep Your Good Name and Credit

Tax debt can harm your business. In business your reputation is everything. Owing tax can tarnish your business's reputation and hurt relationships with everyone from customers to suppliers, and banks. A history of tax debt may lead to a lower credit rating, making it more difficult and expensive to secure loans or credit in the future. Keeping up with taxes helps protect your reputation and keep your credit score healthy. 

4. Avoid Legal Consequences and Enforcement Actions

The ATO has the authority to take enforcement actions against businesses that fail to manage their tax debts. These actions can include garnishing bank accounts, seizing assets, or initiating court proceedings. Getting your tax debt sorted keeps your business safe from these drastic steps, ensuring the business remains operational and retains control over its assets.

5. So your Business Can Run Smoothly

Worrying about tax debt takes time and energy away from focusing on your business. By resolving tax issues, owners can focus on improving operational efficiency, innovating, and pursuing growth opportunities. This focus is essential for staying competitive and achieving long-term success.

 6. Build Trust all Round

Everyone involved with your business, from your team to your investors, want to know it's in good financial shape. Demonstrating a commitment to resolving tax debt and maintaining compliance can foster trust and confidence among stakeholders, which is important for business continuity and attracting future investment.

7. Ensure Compliance and Avoid Future Liabilities

Good tax practices reduce the risk of clashes with the ATO and let you focus on your main goals. This proactive approach can also prevent future liabilities by establishing good tax management practices, including timely payments and accurate reporting. Compliance reduces the risk of future disputes with the ATO and ensures that the business can focus on its primary objectives.

8. Grow Your Business

Without the burden of tax debt, businesses have more freedom to explore growth and expansion opportunities. Financial resources can be allocated to new projects, marketing efforts, or expansion into new markets. Eliminating tax debt is a step toward achieving the financial freedom necessary for scaling operations and pursuing strategic business goals.

Dealing with tax debt is time-consuming and stressful and will distract you from focusing on running and growing your business. Resolving tax issues can provide personal peace of mind, allowing you the business owner to focus on what you do best - running your business. Tackling tax debt is crucial for any business in Australia. It's about more than just finances; it's about keeping your business on track for success. By focusing on clearing tax debt, you're not just meeting legal requirements; you're making a smart move for your business's future.

Clearing your tax debt is a big step towards financial freedom and reaching your business dreams.

If you’d like to delve deeper and find out why your business cash flow cycle is critical to getting out and staying out of tax debt read more here.

Let's look at the reasons why it's hard to get out of Tax Debt

What is causing your tax debt, and why is tax debt so hard to get on top of? When looking for the issues which are causing your business to be unable to afford its tax debt, there are some that, if fixed, can have a large and immediate effect on your business’ available cash and ability to repay its tax debt.

Others, though, take longer to see the improved cash flow in your business.

We covered the “Quick Fix” issues in our previous blog, Why not to enter into a payment arrangement to fix Tax Debt https://taxdebtbusters.com.au/why-not-to-enter-into-a-payment-arrangement-to-fix-tax-debt/

In this blog, we want to look at the “Slow Burn” issues of Tax Debt and how to fix them. 

They include:

Lack of Profitability

When a business is not profitable for any period, cash problems inevitably follow, and tax is one of the first things to fall behind. 

If your business isn’t profitable every month, you urgently need to determine what the issue is and fix it. 

Issues that could be affecting your business’ profitability include:

• Incorrect pricing (e.g. your costs have all increased, but you haven’t increased your prices)
• Over-staffing (e.g. a tradie keeping his crew together even when there is not enough work)
• Job inefficiency (e.g. if you budget a certain number of hours to do a job but it takes significantly longer than that, causing you to lose the profit margin on the job)
• Expenses too high for the level of turnover
• Simply not enough work or sales to cover the expenses of the business

Determining why your business isn’t profitable and fixing that issue can sometimes be easy but is quite often difficult.  

This is often because, as a business owner, it can sometimes be hard to see the wood for the trees. In other words, it can sometimes be hard to get out of the business trenches and critically look at the potential issues and make the necessary changes to fix them. 

However, it must be done quickly if your business is to survive.

Irresponsible Spending of Business Cash

Many small business owners manage their business’ cash flow via the “Bank Account and Gut Feel” method.

This is where you mentally take the amount of money in the bank and adjust that for what you think will come in and what you can remember you need to spend to determine if you have enough money.

This method can work for a sole trader with no employees and little to no fixed costs, but the problem is that this method is, at best a very rough estimate and can only predict out about a month at the most.  

Given BAS, super, and income tax debts arise outside of that monthly timeframe; the “Bank Account and Gut Feel” method will get your business into trouble every time.

As Parkinson’s Law outlines, if there is “unallocated” money in the bank, we will either find something to spend it on or stop pushing as hard, and tax debt issues inevitably occur.

The solution to this issue is to budget your business properly (i.e., there is a real skill to this) and consistently compare your business’ performance and financial position with what was budgeted.

By doing this, you will be aware of what cash flow your business needs months into the future to allocate your business’ available cash flow responsibly.

Owner Lifestyle Issues

This is where the business owner's lifestyle is more than the business can afford. In other words, the business owner draws more than the business’ profit which obviously leads to a lack of cash in the business and, inevitably, Tax Office debt.

This is one of the most difficult issues to fix because doing so often involves selling expensive cars, taking kids out of private schools, or moving to a less expensive house, all of which are very tough decisions.

Lifestyle is very quick to increase with an increase in earnings but typically very slow to decrease when earnings decrease.

As a part of implementing a business budget, include a wage figure i.e. regardless of whether you take it as a wage or a drawing for yourself that your business can afford and adjust your lifestyle to that amount of money.

These issues are usually deeply ingrained problems and can take a lot of time and soul-searching to fix, but it is absolutely worth doing.

If you can fix these problems, you will have gone a long way toward ensuring that not only you get out of Tax Debt but that your business will be successful for many years to come.

Tax Debt Issues are on the Rise

Tax debt has become a real issue for business owners. Now that the Government’s JobKeeper and Cashflow Boost assistance schemes have finished, we are already seeing a dramatic increase in both Tax Office audit activity and also debt collection, presumably in an effort to recoup some of what was spent during Covid.

In my opinion, this will quite quickly bring to a head the issue, which will affect way more businesses in Australia than Covid did……Tax Office Debt.

Did you know that small businesses owed the Tax Office $23 Billion prior to Covid?

That’s small business only.

There are currently 2,065,000 small businesses in Australia, so that’s over $10,000 worth of Tax Office Debt for every small business in Australia.

Let that sink in for a minute…. tax debt issues are a very real problem……and tax debt is growing exponentially yearly.

So, how did we get here?

The rot first started in July 1992 when the government introduced mandatory Employee Superannuation to be paid by employers.

It then ramped up a notch in July 2000 when the GST system was introduced, a system which forced businesses to charge, collect and remit tax on behalf of the Government.

And this is where the issue lies. Small businesses don’t have the resources available to them that large corporates have. The small business owner has been charged with funding their employees’ retirements via superannuation and collecting the tax payable on their employees’ wages via PAYG Withholding as well as collecting the GST on behalf of the Government.

The small business owner usually has to take on the financial burden of hiring an accountant to assist with this task because if they calculate their obligations incorrectly or are even a day late in lodgement or payment, there can be significant penalties and interest levied.

Further still, the Government is making it increasingly difficult for businesses to structure out of Tax Office Debts. Whilst an Income Tax Debt currently remains the company's debt, did you know that unpaid employee superannuation automatically becomes a liability of the company director and PAYG Withholding, and now GST can become the liability of the company director if certain criteria are not met?

This means, and this is really important, that if your business can’t pay its Tax Office debts, you can become personally bankrupt and lose all of the wealth you have built over the years. 

I’ve seen this lead to mental health issues, marriage breakdowns, and suicide.

I personally reckon it’s a really unfair system that stacks the odds against the small business owner but it’s the one we have to deal with.

What is happening inside small businesses so they cannot pay their Tax Office debt on time?

The way I see it, there are five main causes:

1. Lack of Profit

When a business is not profitable for any period of time, cash problems obviously follow, and payment of taxes is often the first thing to fall behind. The default response is, “I’ll work harder to make the business profitable and then pay that back over the next couple of months”. However, in my opinion, this rarely, if ever works.

2. Poor Cashflow Management

A business can be profitable and still lack cash flow due to a number of issues.  Examples would be if customers owe the business significant money outside payment terms or if there is way too much stock in the warehouse.  These issues seriously affect cash flow and the ability of the business to pay its tax debt.

3. Irresponsible Spending of Business Cash

This occurs when the business owner hasn’t planned for the future cash needs of the business and spends cash now, which is required to pay Tax Office Debt down the track. This is often caused by the “Bank Account and Gut Feel” type of business management.

This is where you go “I have this much in the bank and this amount to come in, and I need to spend that amount”. The issue is that even the best at this method can only predict out about a month, which isn’t nearly enough given that BAS and super payments work mostly quarterly.

4. Overspending of Personal Money

We see this all the time. This is where the business owner personally spends more than the business makes. You might think this would only apply to poorly performing businesses, but that isn’t necessarily true. For example, a business might net $300,000, which is pretty good, but if the owner spends $400,000 on their lifestyle, this will inevitably lead to cashflow issues within the business.

5. Undercapitalisation

This is one of the most common causes in new businesses and those experiencing rapid growth and is where the business is operated with no working capital, and the Tax Office is used as a bank.

So, that’s what causes Tax Debt issues, but what should you do if you have a Tax Debt?

From my experience, small business owners wait to do something about their tax debt until it is too late.

I would suggest that if you have had two quarters where you haven’t been able to pay your BAS on time, you have a problem and need to act immediately.

I would further suggest that if you have gone to your accountant to discuss a tax debt issue and they have fobbed you off with a payment arrangement, you need to find someone else to help you.

To my way of thinking, that is like putting a band-aid on cancer.  A payment arrangement doesn’t fix whichever of the five causes of Tax Debt applies to your business. So the chances of you miraculously being able to pay future Tax Debts and pay off the outstanding debt is slim to none.

This is a steep and slippery slope to financial ruin.

Let me give you an example of why fixing the cause is so important. A few years ago, I got a new client who owed the Tax Office around $200,000. We worked through his business to find out that his debtors were way too high and his prices were way too low, leading to poor profitability and cash flow.

We helped him collect most of his debtors and implemented a price increase project which fixed the issue over the following six months and allowed him to repay his Tax Office Debt.

The sad part of it was that he had borrowed $200,000 on his mortgage two years earlier to repay a Tax Office debt, but because he didn’t fix the issue, he ended up right back where he started very quickly.

He could have saved himself two years and $200,000 by fixing the cause rather than the symptom.

My Checklist

For getting out of the Tax Debt issue and ensuring that you never get into that position again is as follows:

1. Ensure that you are structured correctly, especially in the area of directorship.  Given the ease with which the tax debt can be transferred to the director personally, only one of you should ever act as the director of the trading entity, and the other one should own all of the assets in their name or as trustee of trusts.  I’m amazed at how often I see both spouses named as directors of companies with huge risks and no benefits. So, for example, I’m almost certainly the poorest person in this room. I’m the director of our various businesses, but I literally own no assets in my name.  And that’s exactly how I want it to be.
2. Always pay your employee superannuation on time, no matter what. Not paying your employee super on time has some very bad tax consequences, and outstanding super automatically transfers to you personally, so ensure that these are always paid on time.
3. Always ensure you lodge your BASs on time, even if you can’t pay them.  Too many small business owners don’t lodge their BASs because they can’t pay them. However, lodging your BASs on time makes it more difficult for the Tax Office to transfer the PAYG Withholding and GST to you personally.
4. Act sooner rather than later.  Time is your friend when it comes to dealing with the Tax Office. It is never too early to fix a Tax Debt issue.
5. Get professional help. Contact your accountant or, if he can’t or won’t help you, find another accountant who will help you to identify which of the five causes applies to your business and take action to fix that underlying problem.
6. Open a Tax Account with a separate bank that has no access card and transfer funds on a regular basis which will cover all of your taxes and super. Your accountant can and should help you to calculate this.  Don’t touch this money except for paying tax and super.
7. Keep your business and personal finances separate. Don’t live out of the business bank account. Pay yourself a weekly wage or drawing and top that up with quarterly dividends depending on the performance of the business. This will help to ensure that you are living within the means your business can afford.
8. Budget properly. Stop managing your business via the Bank Account and Gut Feel Method. You need to have your finger on the pulse of your business’ finances.  Find a good accountant who will help you with this.
   And lastly, for no reason...
9. Negotiate a payment arrangement with the Tax Office.  There is a real skill in dealing with the Tax Office, and I recommend you engage your accountant to do this for you.

Want to solve your Tax Debt issues for Good?

Our advice is, if you have a tax debt, don’t just immediately enter into a payment arrangement

Don't immediately enter into a payment arrangement when you have tax debt. When small businesses find themselves in debt to the Tax Office, they tend to do one of two things:

1.  Ignore it, with the intention of paying the debt back over the next couple of weeks or month; or

2.  Call the Tax Office and enter into a payment arrangement to repay the debt over a period of time.

Problem solved; now let’s get back to work.

The issue, though, is that the problem has not actually been solved.

Sure, the symptom (i.e., stress that I owe the Tax Office money and haven’t done anything about it) might have been soothed, but the problem remains.

Address the Real Issue of Tax Debt

Entering into the payment arrangement does not address why your business could not pay its Business Activity Statement or income tax liability when it was due.

That’s the real problem, and until that is resolved, you will find yourself in the Tax Debt Trap for some time to come.

The reason for this is that if your business is in a position where it couldn’t pay, for example, its BAS this quarter, unless something fundamentally changes, it’s not going to magically be able to pay next quarter’s BAS as well as the additional amount required to repay this quarter’s unpaid BAS.

What’s the REAL Issue?

Before you can fix the issue that resulted in your business being unable to pay its tax debt, you first need to identify the issue.

There are a number of issues which, if they are the problem and can be fixed, can provide your business with a lump sum which can often clear its tax debt or reduce it to manageable levels, whilst fixing other issues are more of a slow burn.

The “Quick Fix” issues include:

Undercapitalisation

This issue is seen most often in new businesses and those experiencing high levels of growth.

New and rapidly growing businesses need capital to fund their sales, production, and collection cycles. Without these backup funds, GST and PAYG Withholding money is often used to prop up the business’ cash flow, and that money isn’t there when it is needed to pay the business’ tax debt.

To fix this issue, you need to determine your business’ ongoing cash flow needs and inject those funds either personally, through a bank, or through an investor.

Poor Cashflow Management

A business can be profitable and still lack cashflow due to several issues, such as:

1. High Trade Debtors

Unless you keep a close eye on it, the amount owed to your business by customers for work performed (Debtors) can creep up without you realising it.

There are a number of factors that affect debtor levels, but the main ones are:

• Ensure that expectations are set at the outset around the cost associated with your work and what the payment terms are;
• Invoice for work as soon as it is completed so that your customer mentally associates the invoice with the work undertaken;
• Make it easy for your customer to pay (e.g., provide your bank details, accept credit card and/or PayPal payments, etc.);
• Have both an automated and personal follow-up system so that the payment of your invoice isn’t left for any length of time (i.e., the longer it takes to pay your invoice, the less attachment the invoice has with the work performed and the harder it is to get paid);

2.  High Stock Levels

Stock on the warehouse shelf is money that is not in your bank account, and if stock levels are too high, your business’ cash flow will suffer.

You need to be constantly on top of your stock levels, walking the tightrope between enough stock to ensure you can supply your customers when they purchase but not too much stock that excess money is sitting on the shelf.

If you have old stock, consider selling it for a discounted price or even at cost to realise the cash flow associated with it.

Conduct regular stocktakes to ensure that you know exactly what your stock levels are.

If your accounting system is not accurately measuring your stock levels, invest in software that will do this properly for you.

3.  High Work in Progress / Poor Job Efficiency

Work in progress is the service provider’s stock and represents the costs (i.e., labour and materials) that have been paid for, for a job that is yet to be invoiced.

The longer it takes you to complete a job to invoicing stage, the more cash flow is tied up in that job, so your goal is to be as efficient as possible in completing work to realise that cash flow.

Regardless of what the issue is, whatever you do, don’t simply call the Tax Office and enter into a payment arrangement.  It won’t fix the problem.  Work out which of the above five issues applies to your business and fix it.

If you can’t determine where the problem is, or if you don’t know how to solve it, call us at Tax Debt Busters, and we’ll help you through the process.

The good news is that if any of these issues are causing your business’ cashflow issues, they can often be fixed relatively quickly, and a significant amount of cash flow can be cycled back into your business, which can help to pay off the tax debt in a lump sum.

We cover the “Slow Burn” issues and how to fix them in our next blog.

Getting out of tax debt isn’t easy.

Why your business cash flow cycle is critical to getting out and staying out of tax debt

Understanding your business’ cash flow cycle and planning your business’ funding to match that cash flow cycle is crucial to your business's success and ensuring that you don’t find yourself in the Tax Debt Trap.

What is the Business Cash flow Cycle?

In essence, a business’ cash flow cycle is the amount of time it takes between when the business pays for stock (i.e., for a wholesale or retail business) or wages (i.e., for a service or manufacturing business) and when that business gets paid for its product or service.

Let’s look at a new wholesale business’ cash flow cycle to illustrate how critical this issue is in ensuring the success of your business.  It’s essential that you know your business’ cash flow cycle to plan for its cash flow needs, ensuring that your business is not undercapitalised, which is one of the main reasons businesses find themselves in the Tax Debt Trap.

Example of a new wholesale business cash flow cycle

In this example, the business is new, so it doesn’t have any supplier accounts so it must pay for stock COD.  

This business also has implemented 30 days payment terms for its customers; on average, the stock sits on the shelf for 35 days (i.e., stock days). 

Wages are $1,000 per week, and they sell the stock with a 100% markup.

Day 1 Purchase $10,000 in Stock

Day 7 Wages of $1,000

Day 14 Wages of $1,000

Day 21 Wages of $1,000

Day 28 Wages of $1,000

Day 35 Wages of $1,000

Day 35 Stock Sold for $20,000 

Day 36 Purchase a replacement $10,000 in stock

Day 42 Wages of $1,000

Day 49 Wages of $1,000

Day 56 Wages of $1,000

Day 63 Wages of $1,000

Day 65 Receive Payment of $20,000

Day 70 Stock Sold for $20,000

Day 70 Wages of $1,000

Result

As you can see in this example, in the period shown, the business has made a profit of $20,000 after wages but is down $10,000 after 70 days and, at its peak, needed $29,000 of working capital to fund its business cashflow cycle.

Undercapitalised businesses often use the PAYG Withholding, employee super, and GST money to fund this cash flow need, thinking they will pay it back down the track when they get paid.

The Problem

The issue is that it often never happens because, as the business grows, the cash flow drain increases rather than fixes itself.

This is also why, paradoxically, the business owner’s first instinct to “work harder” to fix the business tax debt problem just worsens the problem.

The harder the business owner works, the more the business sells, and the worse the cash flow drains on the business.

Understanding the Cash flow Cycle

It’s not until you understand your business’ cash flow cycle that you can make a plan for it, and potentially make the changes necessary to ensure your business is successful.

So, in the above example, what could the owner do to ensure the business doesn’t find itself in the Tax Debt Trap?

Avoid the Tax Debt Trap

1. Given the highest level of cash needed in the above example was $29,000, the owner could inject $30,000 to $40,000 of their own money into the business as seed capital.

2. The business owner could borrow $30,000 to $40,000 from a bank to fund the start-up of the business.

3. The business could apply for a Debtor Funding facility which funds 75% to 85% of the business's debtors until those debtors are paid, or they reach 90 days. In this scenario, at 80% funding, this would mean that the business would receive $16,000 on Day 35, which reduces the total amount of capital funding the business needs in the above example to $15,000. Obviously, the business is less profitable due to the interest on the Debtor Funding facility but the cash flow needs of the business have been nearly halved.

4.  The business could apply for an account from its suppliers.

5. The business could reduce its customer payment terms from 30 days to 14 or 7 days.

6.  The biggest thing this business could do is reduce its stock days from 35 days as much as possible.  At 35 stock days, the business has to pay five lots of wages while the stock sits on the shelf, and even a 30-day supplier account won’t help much because the stock days are longer than even a 30-day supplier payment terms.  

The reality is that the best way to fix this issue is to implement a number of different strategies at the same time. 

If this business could reduce its stock days to 10 days in conjunction with 30-day supplier payment terms, its cashflow requirement would reduce from $29,000 to $15,000.

This amount would still need to be funded personally or from a bank.

If a debtor funding facility was put in place, the amount of funding required to float the business reduces to $1,000.

As you can see, knowing your business’ Cash Flow Cycle, understanding what it means for the cash requirements of your business, and taking steps to ensure that your business has the cash it requires to operate is essential to the long-term success of your business.