Taxes. Everyone’s favourite topic, but especially so if you can figure out ways to minimise your tax obligations!
Digital business owners are like any others in that they’re generally required to pay taxes in their country of residence, however it can get complicated when you bring in factors like taxes in the jurisdictions where you sell, such as VAT in the European Union.
Factors that qualify you to minimise tax will vary according to the tax authority you are under, which means you should always consult with a qualified tax professional in your area. For that reason, we’ve put together a few general tips and pitfalls to be aware of that tend to apply for most jurisdictions.
Avoid These Common Tax Mistakes
The majority of digital businesses out there are small affairs, often with just a solopreneur or one or two staff. This means that all the pieces that go into managing the business as a whole are managed by one or two people, making it easy for things to slip through the cracks.
Unfortunately, mistakes with taxes are all too common, sometimes even resulting in the downfall of small businesses. In the EU, most SMEs consider taxes to be the most burdensome policy area that affects them, and it is certainly of concern in other parts of the world too.
Here are some of the common mistakes that occur.
Mixing Business With Pleasure
Taking a client out to dinner? For most tax jurisdictions, activities that are directly involved with bringing in new business will be tax deductible. But if you’re going on a date, make sure those expenses are paid for with your personal account.
The problem arises when too many expenses are blurred, so you’ve paid for business activities on a personal card and are trying to claim them, while you’ve also got personal expenses that have been placed on a business account and need to be removed from the accounting for your business.
Where the lines become too blurred between the two, most tax jurisdictions are going to lean on the conservative side and expect a minimal number of deductible expenses. The best way to avoid this? Keep it clean and easy for them to understand. Make sure all business expenses come from your business account while personal expenses are all paid from your personal account.
Poor (Or No) Filing System
For every expense you’re going to claim, you need to have a receipt. Businesses commonly run into trouble where they’ve lost receipts or have a poor system for filing them. Get into the habit of filing every receipt for business expenses immediately. This way you shouldn’t be digging through boxes, pockets or vehicles at tax time.
Choosing The Wrong Business Structure
Business structure is another aspect that varies depending on your country, but each type has different implications for tax and legal obligations. A small digital business in Europe will probably be set up as a sole trader or perhaps a partnership, while in the United States you may have a sole proprietorship, a partnership, an S corporation, or even an LLC.
Businesses who set up with a legal structure that is not appropriate for their size and business can find themselves required to pay much more tax than they would have otherwise – get legal advice!
Not Filing On Time
Sometimes it takes you a bit of time to get all of your filing information together, but diarise it in early so that you meet the required dates for filing taxes. In most jurisdictions there are penalties to be paid for filing late, which is money down the drain for a small business.
There are 28 member states of the European Union, each with their own rates and rules for the charging of VAT. No wonder it can become a mess for small businesses to manage.
If you undercharge the customer for VAT, you could well end up having to pay the difference yourself. Tax authorities do not want to miss out on their share; here’s an example from UK law:
Hmm, how likely do you think it is that your customer will come back to you for a replacement invoice if you’ve undercharged them?
Our suggestion for avoiding this is to ensure that you’re using good, automated checkout software that will calculate the correct VAT for you (like Quaderno!).
Claim Those Expenses!
Again, what you can claim is going to vary from state to state, but many small businesses are failing to minimise their tax obligations because they simply don’t claim the expenses they’re entitled to.
In a brief Telegraph piece, it was reported that 31% of small business owners were either not claiming expenses at all or failing to claim back all of which they were entitled. Understandably, many business owners are put off by the administration involved, but you have to look at it from the point of view of how it can impact your overall revenue and ability to pursue growth activities.
Claimable expenses can soon add up, even those small ones which you may be tempted to ignore. Overall, here are some of the types of expenses which you may be able to claim (check with your accountant for any specific to your country):
- Equipment for your business.
- Marketing costs.
- Home office costs.
- Utilities and insurance.
- Software or other membership services required in the running of your business.
- Vehicle mileage and travel costs.
- Charitable donations.
- Contributions to retirement schemes.
- Entertaining clients.
Set Up Offshore?
Where you choose to set up your business is really an entire topic in itself, but many digital entrepreneurs have minimised tax obligations by finding a more “friendly” jurisdiction in which to set up their business.
Panama, the British Virgin Islands, and Hong Kong are all countries that are regularly discussed by tax planners and on entrepreneur forums, but just bear in mind that setting up offshore doesn’t necessarily absolve you of tax obligations in your country of residence.
Many countries are involved with tax treaties which require them to report fiscal information back to the country of residence of the business owner. We wrote about this recently with regard to Hong Kong.
So, while you may be able to minimise your total tax obligation by looking offshore, just remember that there is a key difference between minimising tax and illegal tax evasion. As with any other part of your business set up, seek professional advice before going ahead.
Tax planning should be a year-round activity done in consultation with your accountant. If you wait until the last minute for tax preparation and planning, there is a good chance that you will miss opportunities available to you.
For example, in some places it might make sense to defer income until the following year, or you might need to make a decision about whether or not something gets listed as bad debt. You might be entitled to depreciate some assets or write some off altogether. It’s possible that your accountant may advise that you make further charitable donations or contributions to a retirement fund. For anything like these, it’s better to be organised ahead of time so that you can maximise your opportunities.
If you are a small, digital business owner, then you may be limited in terms of the resources which you have available to manage your accounting or to pay for professional help.
Whichever stage you are at, minimising your tax obligations can be greatly helped by seeking professional advice early so that you’ve at least had someone qualified look at your set up and put you on the right path. You don’t want to be coming to them late in the piece having already made some of the common tax mistakes.
Ensure that you are keeping a good system to monitor your business finances, including saving receipts and recording all expenses. Finally, make tax planning an all-year activity for your business to put yourself in a better position to make the most of all opportunities to minimise tax.
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.