Simplified tax system: fact sheet

What is the simplified tax system (STS)?

The STS is an alternative method of determining taxable income for eligible small businesses with straightforward financial affairs. It began on 1 July 2001.

The STS has three main elements:

  • a cash accounting method that recognises most business income and expenses only when they are received and paid
  • simplified trading stock rules where businesses only need to conduct stocktakes and account for changes in the value of trading stock in limited circumstances, and
  • simplified depreciation rules where depreciating assets costing less than $1,000 each are written off immediately. Most other depreciating assets are pooled and deducted at a rate of 30 per cent.

In addition, STS taxpayers can claim a full deduction for certain prepaid expenses.

Participation in the STS is optional.

If you choose to enter the STS you must use all three elements, where they apply.

The STS applies to whole income years only and not to parts of a year.

How will the cash accounting method help small businesses?

The cash basis of accounting allows most small businesses to more closely align their income tax accounting with their GST accounting, making it easier to prepare their activity statement and income tax return.

What is the STS cash accounting method?

This is a method based on cash accounting rather than accruals accounting. It recognises most business income and expenses only when they are received and paid.

In your assessable income at the end of the year:

  • you exclude sales for which you have not received payment (debtors);and
  • you do not claim any business expenses that you still owe (creditors) at year end - these expenses only become deductible in the year that you pay them (or someone else pays them on your behalf).

What income does the cash accounting method apply to?

Cash accounting covers most income received while operating a business. Examples include income from sales of goods, services, professional fees and commissions. This type of income is called ordinary income.

What income is not treated in this way?

The STS cash accounting method does not apply to ordinary income if another provision of income tax law includes an amount at a time different to when you receive it. For example, the profit received on the sale of a second wool clip in one income year can be included in assessable income in the next year.

The STS cash accounting method does not apply to statutory income. This is income that is included in your assessable income under specific provisions elsewhere in the income tax law, such as a capital gain made on the sale of an asset.

How are deductions treated under the cash accounting method?

Generally, an STS taxpayer can claim a deduction for:

  • expenses incurred in carrying on their business (called general deductions), such as operating expenses, wages, rent of business premises and purchases of stock and consumables;
  • tax-related expenses; and
  • expenses for repairs

when they are paid.

The STS cash accounting method does not apply to deductions that receive specific treatment elsewhere in the income tax law (except for tax-related expenses and expenses for repairs). These specific deductions include:

  • expenditure incurred by a primary producer to install mains electricity supply;
  • borrowing expenses such as stamp duty and legal expenses incurred in borrowing money for business purposes; and
  • bad debts.

When is income received and when are expenses paid under the cash accounting method?

The following table lists various methods of receipt and payment. It explains when receipts should be included in your assessable income and when payments should be claimed as deductions.

Methods of receipt and payment / When is a receipt included in income? / When is a payment claimed as a deduction?
Cheque / Date cheque is received / Date cheque is posted or handed over
Postdated Cheque / Date cheque is received / Date cheque is posted or handed over
Credit Card - in person / Date recipient signs docket / Date recipient signs docket
Credit Card - remotely / Date card details, etc, are given / Date card details, etc, are given
Debit Card / Date transaction accepted / Date transaction accepted
Direct Credit / Date credited to account / Date payment authorised
Direct Debit / Date of transfer / Date of transfer

What happens if a cheque is dishonoured?

  • If you receive a cheque and it is later dishonoured, you exclude the receipt from your assessable income in the income year the cheque was originally received.
  • If you make a payment by cheque and it is later dishonoured, you exclude the payment from your deductions in the income year the cheque was originally posted or handed over.

How are prepaid expenses treated?

Generally, a prepaid expense is immediately deductible to an STS taxpayer if:

  • the payment is made for a period of service of 12 months or less; and
  • the period of service ends in the next income year.

Prepaid expenses are also immediately deductible if the amount is specifically excluded from the prepayment rules. For example, where the amount involved is less than $1000.

If the prepaid expense does not meet these requirements a deduction can only be claimed over the period during which services under the agreement are provided. For example, where an STS taxpayer prepays rent expenses of $6000 for a period of 3 years the deduction is spread out over those 3 years.

If the prepaid expense relates to tax shelter arrangements special rules apply. Generally, deductions can only be claimed over the period in which the services under the agreement are provided.

What happens when I enter the STS?

When you enter the STS, you may need to make adjustments to prevent omission or double-counting of income or deductions.

For your first year in the STS, you exclude from your assessable income any ordinary income that you included, or should have included, in a previous year's assessable income. This ensures that income derived under the accruals method of accounting before you enter the STS is not taxed again when you actually receive it.

Similarly, any business expenses that you deducted, or should have deducted, in a previous year under the accruals method, are excluded from your deductible STS expenses. This prevents expenses incurred under the accruals method of accounting from being deducted again when you actually pay them.

Example

Sylvia chooses to become an STS taxpayer for the 2005-06 income year. In the previous year she derived ordinary income of $27000 but had not received it, and incurred business expenses of $12000 but did not pay them until the following income year.

The $27000 was included in her assessable income and the $12000 allowed as a deduction for the 2004-05 income year because she was using an accruals basis of accounting.

The income is not included again when Sylvia receives it in the 2005-06 income year, nor can the expenses be claimed again when she pays them.

What happens when I leave the STS?

Any ordinary income owing to you, but not received, while you were in the STS is included in your assessable income in the first year you stop being an STS taxpayer.

Similarly, any general business expenses owing but not paid for are deductible in the first year of not being an STS taxpayer.

How will the simplified trading stock rules help small businesses?

Many small businesses will not have to account for changes in the value of trading stock or conduct stocktakes unless they wish to.

How is the treatment of trading stock simplified under the STS?

If you are an STS taxpayer you only need to conduct a stocktake and account for changes in the value of your trading stock if:

  • the value of your stock on hand at the start of the income year; and
  • the reasonably estimated value of your stock on hand at the end of that year,

varies by more than $5000.

While in the STS, you can of course still choose to conduct a stocktake and account for changes in the value of trading stock in any income year, if you wish.

How do I make a reasonable estimate?

This will depend on your particular circumstances. For example, your estimate would be reasonably based if:

  • you maintain a constant level of stock each year and have a reasonable idea of the value of your stock on hand; or
  • your stock levels fluctuate, but you are able to make an estimate based on appropriate records of what stock has been purchased.

The Australian Taxation Office (ATO) will develop guidelines to help you make a reasonable estimate of the value of your trading stock on hand.

What if the value of my trading stock varies by more than $5000?

If the value varies by more than $5000 you must:

  • value each item of trading stock on hand at the end of the income year; and
  • account for the change in value in your assessable income.

How do I account for variations in the value of my trading stock?

If the value of your trading stock on hand at the end of the income year is greater than at the start of the year, you must include the difference in your assessable income.

If the value of your trading stock at the end of the income year is less than the value at the start of the year, you can claim a deduction for the difference.

What will the value of my trading stock on hand be at the start of the year?

The value at the start of the income year is the same as the amount you took into account at the end of the previous year.

The value at the start of the year is zero if you do not have an end of year value of trading stock on hand at the end of the previous year.

Example

Raife starts a second-hand bookshop on 31 May 2002. Because he did not have this business at 30 June 2001, he had no closing stock at 30 June 2001. The value of his opening stock at the beginning of the 2001-02 income year will be zero.

What will it be at the end of the year?

If the value of your trading stock varies by $5000 or less, you are not required to account for this difference. The value of trading stock on hand at the end of the year is deemed to be the same as at the start of the year.

Example

Angela is an STS taxpayer who sells riding gear. At the start of the 2003-04 income year, the opening value of Angela’s trading stock is $30000. Using her reliable inventory system, she estimates the closing value to be $34000. The closing value for the 2003-04 income year, and the opening value for the 2004-05 income year, will be $30000.

However, if the value varies by more than $5000, or you choose to account for a change in trading stock, the value at the end of the year will depend on:

  • the results of your stocktake; and
  • the valuation method you use (that is, cost, market selling value or replacement price).

How will the simplified depreciation rules help small businesses?

The simplified depreciation rules provide small businesses with significant concessions. These rules involve simpler calculations as well as removing the need to calculate depreciation separately for each asset.

How are depreciating assets that I held before entering the STS treated?

Generally these assets are allocated to STS pools at their adjustable value and depreciated as a single asset.

The adjustable value of an asset is its cost less its decline in value since you first used it, or installed it ready for use, for any purpose whether business or private.

Under the STS there are 2 pools:

  • the general STS pool; and
  • the long life STS pool.

You include assets with an effective life of less than 25 years in the general STS pool.

Depreciating assets acquired prior to entering the STS that cost less than, or had an adjustable value of less than $1000 must be included in the general STS pool.

You include assets with an effective life of 25 years or more in the long life STS pool. However, you can choose not to allocate an asset to the long life STS pool if it was first used, or installed ready for use, for a taxable purpose before 1 July 2001. You must make this choice in the year you first become an STS taxpayer and, once made, it cannot be changed.

Generally, a depreciating asset is used for a taxable purpose if it is used to produce assessable income.

Generally, the effective life of an asset is the period it can be used by anyone for any purpose.

Each pool is treated as a single asset and deducted at a pool rate of:

  • 30 per cent for the general STS pool; and
  • 5 per cent for the long life STS pool.

Are any assets excluded from the STS depreciation rules?

Yes. Certain types of depreciating assets are excluded from the STS depreciation rules. Instead they are deducted under the Uniform Capital Allowance (UCA) provisions. These include:

  • assets that are leased, or will be leased out, other than under a hire purchase or short term hire agreement;
  • assets allocated to a low-value pool prior to joining the STS; and
  • horticultural plants including grapevines.

Deductions for most buildings and some structural improvements are not available under either the UCA or the STS provisions. They are dealt with under other provisions for capital works.

Do I have to pool all depreciating assets?

No. You can claim an immediate deduction for the taxable purpose proportion of most depreciating assets costing less than $1000 in the year that you first use it or install it ready for use provided you commence to hold the asset while you are an STS taxpayer.

What if I'm a primary producer?

Certain depreciating assets that you use to carry on a primary production business attract specific UCA provisions such as those applying to landcare operations, water facilities, electricity connections and telephone lines.

For these assets you can choose whether to use the STS or the UCA provisions.

You can make this choice in respect of each eligible asset but once the choice is made you cannot change it.

What about depreciating assets that I acquire part way through a year?

As an STS taxpayer you can claim a deduction at half the pool rate for the first year that the depreciating asset is used or installed ready for use. This amounts to:

  • 15 per cent for the general STS pool, or
  • 2.5 per cent for the long life STS pool.

You allocate the asset to either the general STS pool (30 per cent depreciation rate) or the long life STS pool (5 per cent depreciation rate) at the end of that income year.

What if a pool balance is below $1000?

If the balance of a pool (after taking into account any additions and disposals but before calculating any deduction) is below $1000 you can claim a deduction for the remaining amount.

Example

Keisha is an STS taxpayer. The opening pool balance of her general STS pool is $1100 for the 2003-04 income year.

During the year Keisha purchased a new computer for $1800. Keisha estimates her business use of the computer to be 80 per cent. The taxable purpose proportion of its adjustable value is $1440 ($1800 x 80%).

Keisha also sold her car, used 100 per cent in her business, for $1950 during that year.

She calculates the balance of the pool as follows:

Opening pool balance + acquisitions - disposals

$1100 + $1440 - $1950 = $590.

Keisha can claim a deduction of $590 for the income year because the result is less than $1000. The closing pool balance then becomes zero.

What if I use an asset only partly for a taxable purpose?

If you use an asset only partly for a taxable purpose you allocate only the taxable purpose proportion of its adjustable value to the relevant STS pool. Similarly you can only claim an immediate deduction for the taxable purpose proportion of assets costing less than $1000.

Example

John is an STS taxpayer. During the year, he purchased a car for $4000. He estimates that the car will only be used 75 per cent for business purposes.

Only 75 per cent of the car's cost ($3000) can be added to the pool. The deduction in the first year is calculated at half the pool rate (15%) so John can claim a deduction of$450 ($3000 x 15%). At the end of the year, the general STS pool balance is increased overall by $2550 ($3000 added and $450 subtracted). This is deducted in the pool at 30 per cent in subsequent years.

What if the extent of my business use changes?

You must make a new estimate of the taxable purpose proportion of assets allocated to: