barriers to small business success

How we should fix the 3 biggest tax barriers to small business success

It’s safe to say Australia has a penchant for small business.

Around 90% of Australian businesses are small to medium-sized entities (SMEs). Taxes on small business are lower than they’ve been in the last decade. It’s one of our healthiest and fastest growing sectors.

A recent report by the Organization for Economic Cooperation and Development (OECD) on taxation of SMEs in OECD and G20 countries says small businesses worldwide are doing similarly well. “They are also strongly heterogeneous,” the report reads. “Across and within industries and sectors; in their innovation behaviours; and in their profitability and growth potential.”

But that’s mostly thanks to the SMEs themselves; global SME growth over the last few years has been more dependent on the sheer size of the sector than governmental and regulatory support.

It’s not all bad. Just this year, Australian SMEs received new and exclusive tax relief measures as part of the federal budget. The tax rate for small business companies who make less than $2 million in aggregated annual turnover is down to 28.5%, and unincorporated small business owners now have their own 5% discount.

There’s never been a better time to be an SME than in Australia right now.

However, in its report, the OECD identified three inhibitors to small business which governments should tackle:

Barrier 1: Scaling the gap between big and small

The fact remains that SMEs have a hard slog when it comes to tax compliance.

As the OECD report says, the slog isn’t proportionate when you compare the big with the small. Essentially, it costs SMEs a lot more to make sure they’re compliant than it does big businesses with vast revenue streams.

“SMEs often face higher tax compliance costs, in relative terms, due to their smaller size,” the OECD report says. “When designing and implementing tax policies, governments should consider whether certain measures have a disproportionate impact on SMEs. Many countries provide special provisions and simplification measures that are designed to reduce the tax compliance costs of SMEs.”

In Australia, the federal government’s Re:think tax reform discussion paper (download here) asked for plans to minimise the burden of SME compliance.

One of these was to increase the current $2 million turnover threshold to $5 million so that more businesses can access small business concessions – such as the $20,000 temporary immediate write-off for asset purchases.

Another is fringe benefits tax (FBT) and its associated liability – transferring the tax liability from the employer to the employee for the provision of non-cash remuneration should bring down compliance costs for SMEs.

Barrier 2: Separating the start-ups from the SMEs

Although start-ups are SMEs, the OECD believes it’s important to distinguish the former from the latter more clearly; start-ups need more help because the stats say they’re more likely to go out of business.

“There may be a particular case for targeting preferences and simplification measures toward younger SMEs,” the report continues, “who are most affected by finance and cash flow difficulties, face barriers to entry and growth from incumbent firms, are more likely to grow than older SMEs, face the highest compliance cost burdens and are likely to have high spillover effects from innovation.”

Barrier 3: Make it hard for businesses to distort their status

If the ongoing hullabaloo about base erosion profit shifting has taught global governments anything – or if there’s one lesson global governments should heed — it’s that businesses will morph their operations to suit the best tax arrangements out there and access special measures and/or incentives.

So if you fashion a better tax system for start-ups, you better ensure it applies to real start-ups.

“Caution is needed to ensure that tax preferences or simplification measures do not introduce further distortions,” the OECD report says. “These distortions can result in incentives to alter economic activity in unintended ways to benefit from special tax rules”.

One submission recommended that the Government look at ways to reduce such distortions when small businesses choose a structure.  A structure similar to a US-style “S-Corporation” for small businesses in Australia is perhaps worth considering.