Running a business means spending money, such as renting an office, buying vehicles, investing in software and hiring employees. However, what many small business owners in Australia may not understand is that many expenditures can be used to reduce the tax they have to pay. This is a legitimate and ATO-approved part of the tax system intended to assist businesses.
A tax deduction lowers your taxable income. Let's take an example: Assume that your business earns $180,000 but you have $40,000 in legitimate deductions, you only pay tax on $140,000. With a small business tax rate of 25% and that is $10,000 saved, which is the money that stays with your business not the ATO.
The best ways to lower your taxes with a small business are assets and equipment, vehicle expenses and home office costs. But knowing what you can claim is only half the story. You should also understand how the ATO evaluates those claims and what common mistakes many business owners make. This guide covers everything you need to know about small business tax deductions.
It is essential to understand the basic criteria for claiming any expense as a deduction before getting into more detailed ones. According to the ATO, any deduction can be claimed if the expense is relevant to the operation of the business or earning income and not used for private purposes or capital expenditure.
The criteria seem simple but it gets complicated when applied to real-life situations. For example, even though meeting with the client for lunch may seem to be a business expense, the ATO will not allow you to claim a deduction for entertainment, even with a genuine business purpose. A computer for the home office is a deductible item, but you should choose between a capital or operating expense deduction to do so.
It will be easier to avoid making mistakes by understanding the types of expenses you cannot claim as a deduction. Expenses you cannot claim include:
Sometimes it can be difficult to distinguish between deductions and non-deductions, which is why the ATO's record-keeping requirements are so strict. Each deduction has to have documentation to support it and all documentation has to be kept for five years after lodging the return. This can include invoices, bank statements and receipts. The ATO does not require you to send records with your return, but if the return has to be reviewed, the supporting documents should be presented. Without the documentation provided, there will be no claim even if the expense is accurate.
There is one issue that often confuses business people who have registered for GST: An income tax deduction has to be calculated based on the price excluding GST. Hence, if the price of an asset was $1,100 including $100 GST, then this person is entitled to get $100 back on their BAS and claim $1,000 as a tax deduction, not $1,100. Double dipping is when a person claims GST credit and tax deduction for the same expenses.
Understanding that an expense needs to be business-related is only a starting point. The ATO uses a more detailed assessment for every claim and it will definitely be helpful for you to understand this process for making better decisions throughout the year.
An apportionment refers to only claiming the business portion of an expense and it applies to many everyday expenses. One common example is a mobile phone plan. If you use your phone 70% for business and 30% for personal use, you can only claim 70% of the monthly bill. The same principle applies to mixed-purpose assets like home Internet connections, cars used for work and visiting clients, or a laptop used for both business and household purposes.
The ATO expects a reasonable estimate of business usage and applies it to the full cost. There is no specified method, but you should be able to explain and justify your estimate if necessary.
This is one of the most common misunderstandings in small business tax deductions. Revenue expenses are incurred in normal business operations, such as rent, insurance, subscriptions and repairs. These can be claimed as a deduction for the current year. Capital expenses, however, are spent on items with a lifespan of more than the current year, such as a commercial oven, delivery van and machine upgrade. These types of purchases need to be depreciated over time and not deducted in the current year except in special circumstances.
Treating a capital purchase as a regular revenue expense can boost deductions and trigger an ATO audit. Before lodging your return, check with your tax agent to ensure correct classification when buying significant assets.
The instant asset write-off allows eligible businesses to instantly deduct certain capital assets. For details, check Choco Up's guide to the instant asset write-off.
ATO has established small business benchmarks for over 100 industries, covering typical expense ratios relative to turnover. If your costs are significantly above or below industry norms, you may need to explain your expense profile to ATO.
This does not mean your claim is wrong, as some businesses genuinely have unusual expense profiles. However, it does mean you should have a clear and well-documented explanation ready in case the ATO asks. Comparing your numbers with the relevant ATO industry benchmark before lodging can save you stress down the track.
The connection between an expense and your business income needs to be direct and clear. For example, a business owner trying to claim a gym membership because “it helps to stay productive” will not get far with the ATO since the connection is too indirect. A personal trainer who claims the same membership has a clear and direct connection between the cost and the income they earn. Before claiming anything unusual, ask yourself: can you explain exactly how this expense helped you generate business income?
For businesses with employees, payroll-related costs are one of the biggest and most important ongoing deduction categories, but they are also one of the most commonly missed.
Employer superannuation contributions are fully deductible, but the timing rules are strict and non-negotiable. To claim the deduction in the current financial year, the contributions must be received by the superannuation fund before the quarterly due date. If you are even one day late, you lose the deduction for that year. Meanwhile, the delayed payment will trigger the charge for the superannuation guarantee charge (SGC), which is a government penalty that is not deductible. This can significantly increase the overall cost to your business.
The four quarterly due dates are 28 January, 28 April, 28 July, and 28 October. Building these dates into your financial calendar as hard deadlines (not just gentle reminders) is one of the simplest and most effective ways to protect this deduction.
Beyond superannuation, there is a wide range of employee-related expenses you can claim as deductions:
Contractor fees are deductible, but the rules are different from regular employee payroll. For a smooth claim, the contractor must provide a valid ABN on their invoice. Without one, you are required to withhold 47% of the payment under the PAYG withholding rules. This obligation sits with your business, not the contractor. If you ignore it, you will end up with a tax bill that you cannot deduct.
The most popular categories include vehicle and home office expenses. Knowing the ATO approved methods and choosing the proper method to calculate your deduction will help you to prepare a legitimate claim for the maximum possible deduction.
The ATO offers two methods for claiming car expenses.
Cents per kilometre method: You can claim 88 cents for each kilometre travelled for business purposes and no more than 5,000 km per car per year. You do not need to maintain a detailed logbook, just to know how to explain the number of kilometres driven when the ATO asks about it. At the maximum, this method gives you a deduction of up to $4,400 per vehicle. It is a perfect choice for business owners with light traffic and prefer minimal paperwork.
Logbook method: You are required to keep a logbook for 12 continuous weeks which records every trip with the date, destination, purpose and odometer readings. This calculates your percentage of business usage, which is also used to calculate all expenses relating to your vehicle operation, including fuel, insurance, registration, maintenance and depreciation throughout the year. A logbook remains valid for five years and there is no cap on the number of kilometres you can claim deductions for.
Choosing between these two methods can make a significant difference to what you actually claim. For instance, a business owner who drives 15,000 km annually has total vehicle costs of $14,000 and uses the car 70% for business purposes, could claim $9,800 using the logbook method against $4,400 by using the cents per kilometre method. The logbook method takes more work, but for a person driving a lot, the extra deduction can be quite substantial.
It is a misconception that commuting from your home address to your regular place of work does not constitute a business kilometre in either of these two methods. Business travel, visiting customers and sites may be eligible for deduction, while commuting is not.
There are two methods for claiming home office expenses as well. The choice depends on how much of your house you use for work and how detailed your documentation is.
Fixed-rate method: You claim 70 cents per hour for every hour worked from home and need to keep a record of total hours spent at work, either in a timesheet, in a diary or in any other form of record. This rate covers electricity, gas, internet, phone usage and stationery. It is a simple way and works well for business owners who work from home part of the time but do not have a dedicated office space.
Actual cost method: You calculate the actual business-use proportion of every relevant home expense, including power, internet, phone, and cleaning and claim that proportion as a deduction. For this method, you have to do a square footage calculation (the square footage of your business space relative to the total square footage of your home). For businesses with a significant home office, this method can produce a higher amount of deduction, but record keeping is significantly more difficult.
Neither approach allows claiming mortgage interest or rent since they are occupancy expenses instead of running expenses. Claiming these expenses is one of the most commonly disallowed home office claims.
The ATO's small business random enquiry program, which reviewed close to 2,000 lodgements, found that 25% of the small business income tax gap comes from over-claimed deductions. This is an important figure of a gap that the ATO estimated at $27.2 billion for the small business sector. Most of these are not intentional, but due to a lack of understanding of the rules and inadequate record keeping.
Below are the common mistakes and how to avoid them:
The importance of understanding deductions for small businesses is not only the refund at the end of the year, but it is also the cash flow advantage gained by claiming them properly every year. There are two important practices in every effective plan for deductions: keeping records throughout the year and working with a registered tax professional.
Once your deductions are in order and cash flow improves, the next step is putting that freed-up capital to work, whether through inventory, marketing, or expansion. Choco Up offers flexible financing solutions for the expansion of businesses in Australia to enable better cash flow utilisation. Check your eligibility for business financing.
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