Calculating financial capacity for business owners 277-04060000

A customer’s income and financial resources may not be accurately reflected in the Child Support assessment if they are linked to or associated with a business. The financial resources may provide the customer with a greater capacity to financially contribute to the support of the child(ren). See the Child Support Guide 2.6.14: Reason 8 - a parent's income property, financial resources, or earning capacity

A customer 'linked to' a business is involved in the ownership of the business. A customer 'associated with' a business is involved beyond that of an ordinary employee but is not legally involved in the ownership of the business.

Determining a customer’s income and financial resources may include:

• determining how they generate an income
• investigating any businesses they are linked to or associated with, including:
• reviewing the financial statements of the businesses
• determining any personal benefits or financial resources the customer may receive from the businesses

Note: the length and detail of the investigation depends on the individual circumstances of the customer and will vary from case to case. Consider making a decision rather than extending the investigation if a reasonable income for the customer, which is reflective of the financial resources available to them, can be determined.

Conduct an analysis of the customer’s financial circumstances including any businesses they are linked to or associated with. Analysis may include:

• reviewing tax information of the customer and businesses, see Business tax information
• reviewing the business structures to determine if they are providing a personal or financial benefit to the customer, see Business structure analysis
• reviewing the financial statements to determine if any business income, expenses or assets provide the customer with a financial resource, see Financial statement analysis. Note: requesting at least three consecutive years of financial statements will assist in determining a more reliable representation of the financial resources available to the customer
• determining the profit to be attributed to the customer. see Attributing profit to a customer
• determining if the customer has received any funds from a businesses, see Funds received from a business
• determining if any depreciation expenses represent a financial resource for the customer, see Depreciation

When the financial analysis is completed, determine if profit attributed to the customer or funds received by the customer from a business should be considered as the customer’s financial resource.

• if the customer has received funds significantly more than the profit attributed to them, consider using the funds received as the financial resource for the customer:
• depreciation expense or other non-cash expenses should not also be considered as a financial resource
• if the funds received were from retained earnings or undrawn profits from prior years, consider if the assessment has been subject to a COA, court varied assessment or an agreement, in which these funds have already been considered. If the funds have already been considered it may not be appropriate to consider the funds received as a financial resource.
• if the customer has received funds less than or similar to the profit attributed to them, consider using the profit

The income and financial resources to be attributed depends on the circumstances of the customer and will vary from case to case. A decision can vary from the above steps if the circumstances of the case support this.

Only the profit attributed to the customer or funds received should be considered as a financial resource of the customer. Including a combination of both may result in double counting the financial resources of the customer.

Determine if the customer receives any other financial resources from businesses they are linked to or associated with. These include but are not limited to:

• depreciation expenses which are available to be taken by the customer. Note: if the funds received are to be considered as a financial resource of the customer, depreciation expense or other non-cash expenses should not also be considered as a financial resource
• business expenses which provide the customer with a financial resource or personal benefit, see Step 4 in Financial statement analysis
• any use of business assets that provide the customer with a personal benefit

After analysis and consideration of all income and financial resources available to the customer from businesses they are linked to or associated with, the financial resources of the customer is either:

• the profit attributed to the customer plus any other financial resources available to the customer, including financial resources available through non-cash expenses, or
• the funds received by the customer plus any other financial resources available to the customer, excluding financial resources available through non-cash expenses.

Reviewing information from the Australian Taxation Office (ATO) may assist in determining the financial resources available to a customer.

Tax information which should be considered includes:

• tax returns, go to Step 2
• Special Taxation rules, go to Step 3
• Business Activity Statements, go to Step 4

A business tax return may provide information also found in the financial statements for a business, such as:

• income and expenses
• depreciation expenses
• total assets and liabilities
• statement of distributions for partnerships and trusts

See the ATO website for more information.

This information can be used along with the financial statements or other information obtained during the investigation to determine the financial resources of a customer.

See Business tax returns in Resources for details of information located in a business tax return.

The ATO may introduce special rules, for certain periods of time, to support government initiatives, such as:

• Accelerated depreciation for certain assets purchased in specific periods
• Small Business tax offsets
• Entrepreneur’s tax offset (applied to income years up to 2011-12)

The rules may reduce the customer's income however not the financial resources available to them. If any special taxation rules are identified see the ATO website for more information. Consider any Special Taxation rules when determining the financial resources of a customer.

Businesses registered for Goods and Services Tax (GST) must lodge Business Activity Statements (BAS) with the ATO either monthly, quarterly or annually. See the ATO website for more information.

The BAS is used to advise the ATO of activities such as:

• GST payments, go to Step 5
• Pay as You Go (PAYG) income tax instalments, go to Step 6
• PAYG tax withheld, go to Step 6

GST is a tax paid on most goods and services purchased which is collected by the business that provides the goods or services. Certain goods and services are GST free, for example most basic food, some education courses, some medical, health and care services. GST paid by a registered business in the purchase of goods and services is claimable and offsets any GST payment from GST collected.

A business must register for GST if:

• the business turnover exceeds the GST turnover limit
• it provides taxi travel as part of the business, regardless of the GST turnover

See the ATO website for more information

A GST registered business will report their:

• total sales
• export sales
• GST–free sales
• capital purchases
• non-capital purchases for the BAS period
• total salary, wages and other payments

The BAS includes:

• PAYG income tax instalments, which are instalments the business pays towards their own income tax obligations
• PAYG tax withheld, which are tax payments withheld from payments made by the business to others. The PAYG tax withheld reported in the BAS may include total salary, wages and other payments and the amounts withheld from the payments. The section includes amounts withheld from payments to other individuals or entities where no ABN is quoted. See the ATO website for more information

The BAS can be used to:

• compare annual turnover in past income tax returns and/or financial statements of the business with turnover of a more current period reported in the BAS
• check the financial performance of a business if tax returns have not been lodged
• determine wages paid to employees
• obtain up to date information on the performance of the business

The BAS may not include:

• all business income such as interest received, dividends received, trust or partnership distributions and other income that does not attract GST
• all overseas transactions
• all business expenses as they do not all contain GST such as superannuation expense, interest expense and depreciation expense

Note: a business may use the cash based accounting method for BAS and the accruals based method for its financial statements. This can result in a difference between the information reported in the BAS and the financial statements for the same period. Consider which accounting method is used to ensure income and or expenses are not omitted or double counted when calculating the financial resources of the customer.

To use the BAS to assist in calculating or verifying the financial resources of a customer:

• determine the performance of the business from the information in the BAS using the BAS analyser in the Capacity To Pay (CTP) tool suite macro. Note: sales may be reported in the BAS with GST excluded
• compare the information with information from the business tax returns or financial statements such as:
• most recent turnover or sales with past turnover or sales
• most recent expenditure with past expenditure. Note: the BAS may not include all of the business expenses
• if there are significant variances between the information, investigate the reason for the variance to determine which source of information should be used in calculating the financial resources of the customer

BAS information should only be used as the sole source of information if no other reliable information such as up to date tax returns or financial statements are available.

Business structures can provide an avenue for customers to minimise their taxable income. Examples of how income financial resources may be understated for a customer are dependent on the type of business structure:

• Sole trader, go to Step 2
• Partnership, go to Step 3
• Companies, go to Step 4
• Trusts, go to Step 5

For information about the types of business structures see Business Structures and Financial Statements for Child Support debt recovery.

A sole trader’s income and financial resources can be understated if payments are made to or on behalf of a related person, for example a spouse or entity, such as:

• wages
• sub-contractor amounts
• consulting fees
• private expenses paid via the business for a related person
• an amount recorded as a loan from the business to a related party

An individual operating as a sole trader is entitled to the profit of the business. The profit or loss made by the sole trader business must be reported in the individual’s income tax return.

A customer trading as a sole trader may have greater income and financial resources than that reflected in their taxable income due to:

• private use of a business asset such as a motor vehicle
• business paying for private or living expenses
• making payments to other persons disproportionate to their contribution to the business including paying more than the compulsory superannuation contribution. See Step 5 in Attributing profit to a customer
• drawings taken from the business, see Attributing profit received from a business
• reporting a profitable business as a hobby
• reporting a loss making hobby as a business
• if they are an employee earning a salary or wage, using a loss making business to minimise their taxable income

A customer linked or associated with a partnership can understate their income and financial resources if payments are made to or on behalf of a related person, for example a spouse or entity, such as:

• a partnership distribution
• wages
• sub-contractor amounts
• consulting fees
• private expenses paid via the business for a related person
• an amount recorded as a loan from the business to a related party

The partners are entitled to receive the profit of the partnership with the amount dependent on the ‘Partnership Agreement’. Each partner is required to report their own partnership distribution in their individual income tax return.

A customer with links to a business operated through a partnership may have greater income and financial resources than that reflected in their taxable income where:

• the distribution of the partnership’s net profit does not fairly represent each partners contribution of capital, assets, expertise and/or skills to the business, see Step 5 in Attributing profit to a customer
• drawings are taken from the business, see Attributing profit received from a business
• the business lists spouses or other associated persons as employees but they do not make any actual contribution to the business or receive payments that do not reflect their contribution to the business see Step 5 in Attributing profit to a customer
• they have private use of partnership’s assets
• the partnership may be paying for the customer’s private expenses

A customer linked or associated with a company can understate their income and financial resources if payments are made to or on behalf of a related person, for example a spouse or entity, such as:

• dividends
• wages
• sub-contractor amounts
• consulting fees
• private expenses paid via the business for a related person
• an amount recorded as a loan from the business to the related party

The shareholders of the company are entitled to receive the profit of a company which is paid as a dividend. The level of profit distributed to each shareholder will depend on the class of share and the individual’s ratio of the overall shareholding, for example if a shareholder holds one of three ordinary class shares in the company they would ordinarily be entitled to receive a third of the total dividend payments. Each shareholder is required to report the dividend they receive in their individual income tax return.

A customer with links to a business operated through a company may have greater income and financial resources than that reflected in their taxable income due to:

• retaining profits in the company rather than distributing it in the form of salary and wages, dividends and/or director’s fees, see Attributing profit to a customer
• distributing profits by loaning money to shareholders or directors, see Assessing funds received from a business
• the allocation or ownership of shares so some shareholders receive a greater distribution of profits disproportionate with the labour and assets they contribute to the business, see Step 5 in Attributing profit to a customer
• selling or transferring shares to another person for less than their commercial value for example, shares being transferred to new spouse at a nominal price that presents the spouse as the sole or major shareholder
• the business paying for the personal expenses of the customer, shareholders, directors or related parties for example, providing a motor vehicle to their spouse or paying the customer's rent
• paying salary or wages to associated persons disproportionate with the labour or assets they contribute to the business, see Step 5 in Attributing profit to a customer
• paying more than the required compulsory superannuation amount for an employee or related party

A customer linked or associated with a trust can understate their income and financial resources if payments are made to or on behalf of a related person, for example a spouse or entity, such as:

• distributions
• wages
• sub-contractor amounts
• consulting fees
• private expenses paid via the business for a related person
• an amount recorded as a loan from the business to the related party

The beneficiaries of a trust are entitled to receive the profit of the trust. The Trustee must distribute profits in accordance with the trust deed to the beneficiaries. A beneficiary of a trust is required to report the trust distribution in their income tax return.

A customer with links to a trust may have greater income and financial resources than that reflected in their taxable income due to:

• lending money to beneficiaries or related parties, see Assessing funds received from a business
• distributing profits to beneficiaries in a manner disproportionate to the true value of their real connection or involvement in the business for example, children, spouse, step children or other entities made beneficiaries, see Step 5 in Attributing profit to a customer
• the business paying for the personal expenses of the customer or related parties for example, providing a motor vehicle to their spouse or paying the customer's rent
• paying salary or wages to associated persons disproportionate with the labour or assets they contribute to the business, see Step 5 in Attributing profit to a customer
• paying more than the required compulsory superannuation amount for an employee or related party

Financial statement analysis involves reviewing the financial statements of a business to determine the income, property or financial resources of a customer. For information on the:

• Profit and loss statement, go to Step 2
• Balance sheet, go to Step 6

A Profit and Loss (P&L) is a summary of income and expenditure over a period of time. The P&L may have three components:

• the income, go to Step 3
• the expenses, go to Step 4
• the net profit or loss, go to Step 5

See Business Structures and Financial Statements for Child Support debt recovery.

The income component may include the following:

• Sales and general business income – usually comprises of the primary income of the business
• Gross Income & Cost of Goods Sold (COGS) – the direct costs incurred to purchase or produce the items sold by a business (COGS) may be deducted from the business’ total sales when calculating the business’ Gross Income. The details of the costs of sales may be included in a separate trading statement. Note: not all businesses will incur COGS. Generally businesses that manufacture or buy and resell a product will incur COGS
• Interest and dividend income – indicates if the business has or had an investment such as term deposit, bank account, shares etc. that produced income during the period reported on.
• Gains on sales of assets – indicates if the business has made a profit on the sale of a business asset.
• Employee contributions to offset FBT– indicates if one or more employees of the business received a non-monetary benefit from the business. The amount they contribute is effectively a reimbursement to the business for providing this benefit.
• Grants, rebates and other benefits and subsidies – indicates if the business has conducted activities or incurred expenditure that entitles them to a grant, rebate or other form of benefit. An example is the Diesel Fuel Rebate which indicates that the business operates motor vehicles or machinery that used diesel fuel in connection with primary production or other eligible business activities.
• Other income – other income of the business that does not come under one of the specific headings listed above.

Note: there is no requirement for a business to use these exact headings.

Analysing the income component

The income component should correspond, but may not exactly match with information in the:

• Business Activity Statement
• business tax return
• business bank statements of the business

The gross sales can provide an indication of the gross profit or turnover trend of the business. The turnover trend can be an indicator if the business is growing or contracting.

When reviewing the business income, consider:

• what has caused any significant income change (increase or decrease) since the previous year
• if the costs of sales is a reasonable proportion of the gross turnover of the business. Note: the Australian Taxation Office (ATO) prepares benchmarks for certain industries. See ATO benchmarks
• the reasons why any increase/decrease in purchases of COGS does not match increase/decrease in business activity. COGS, stock or materials that do not indicate a reasonable proportion of the gross turnover or increase/decrease in purchases that do not match increase/decrease in business activity may indicate:
• the customer is not declaring the whole business income or is drawing a cash income
• the business stock is being used by the customer for personal use

Expenses have the effect of decreasing profit. Consideration must be given to whether the expenses are reasonable and necessary in producing income.

Expenses vary from business to business and may include:

• accounting fees
• advertising
• bank charges
• bad debts
• depreciation
• employee amenities
• insurance
• interest
• motor vehicle
• stationery
• salary /wages
• subscriptions/seminars/travel
• superannuation
• telephone/internet
• workcover

Note: there is no requirement for a business to use these exact expenses.

Analysing the expense component

The expense component should correspond, but may not exactly match, with information reported in the:

• Business Activity Statement
• business tax return
• business bank statements

When reviewing expenses consider:

• if the customer has derived any personal benefit from the business expenses, for example:
• consider if any private use of motor vehicle, telephone, internet and laptop has been excluded from the business expense
• is the rent expense for a separate commercial property or for a portion of the customer’s own place of residence which may be a non-cash business expense
• consider if travelling expenses includes any private benefit component, for example is the expense for a personal holiday
• check if any salary and wages, sub-contractor expenses, commissions, director’s fees that are paid to the customer or an associated person and if the amounts paid are reasonable for the work undertaken
• are there any interest expenses which indicate there should be a loan or loans in the Balance Sheet. Consider what the loan is, such as shareholder loans or hire purchase expenses for a motor vehicle may provide a personal benefit to the customer. See Funds received from a business
• if the expenses are typical for the business considering historical costs incurred, expense expected for that type of business and other factors that can be reasonably expected to impact on current and future expenses. Check for any anomalies or unusual trends. Note: the ATO prepares benchmarks for certain industries. Consider the following:
• does employer sponsored superannuation contributions for employees exceed the compulsory contribution of the employee’s earnings base (total remuneration) and the standard contribution for the particular industry
• if a sole trader is reporting a personal superannuation expense, determine if the expense is based on the income attributed to the sole trader and the current compulsory superannuation levy amount for an employee earning a similar amount
• if expenses have been paid to independent third parties or a person or entity related to the business or business owner, for example, interest charges, management fees, leasing costs and rents paid to related persons or entities can be made at non-market rates and/or reflect book entries that are not supported by actual payments or enforceable liabilities
• determine if there are any non-cash expenses which would result in a reduced net profit, but not reduce the cash available to business owner to withdraw from the business. Examples of non-cash expenses can include depreciation, double counts, estimated costs or costs determined by a formula

Net profit equals gross profits less expenses. How the net profit of a business is distributed depends on the structure of the business:

• a sole trader business earns its net profits for its owner/operator. The net profit or loss is attributable to the owner and will be included in their tax return. A sole trader may offset a business loss against other sources of income such as a salary or wage from an unrelated party
• a partnership distributes all its net profits and losses to its partners. It does not pay tax itself; its partners do by including their share of the partnership net profit as their income. Partnerships may distribute the loss to each partner and the loss reported may reduce the taxable income the partner receives from any other source of income
• a company pays company tax of 30% on its net profits. A company cannot distribute a loss but may distribute profit as dividends or retain the earnings. A company’s loss may offset past or future taxable income
• a trust usually seeks to distribute all its net profits to beneficiaries. A trust cannot distribute losses. A trust loss can only be carried forward to offset against the trust’s income in future years

See Attributing profit to a customer, for further information on how to attribute net profits or losses.

The Balance Sheet provides a summary of the value of:

• assets, go to Step 7
• liabilities, go to Step 8
• owner’s equity, go to Step 9

at a particular point in time and is usually prepared on 30 June of each year. The Balance Sheet represents the accumulated value of assets and liabilities of the business since its inception.

The assets component should report all the assets owned by the business. The fair value of these assets can indicate potential income, property or financial resource of the customer.

The assets component may include:

• current assets
• non-current assets

Current Assets

Any asset expected to be used within one year is considered a current asset and includes:

• Cash at Bank – indicates how much cash the business has on the day the Balance Sheet is generated. The bank statements of the business over a period of time may provide a better indication of the amount of cash available to the business
• Trade Debtors (Accounts Receivable) - money owed to the business from past sales, that is made on credit
• Other Debtors – money owed to the business from past non-trading operations
• Closing Stock on hand – indicates the value of stock, inventory or products held by the business to be sold or made into saleable items

Non-Current Assets

Any asset expected to last for more than one year is considered a non-current asset and includes:

• Motor vehicles – indicates the motor vehicles owned or used in the business. It is useful to establish how the vehicle is used in helping produce business income
• Office Equipment – office equipment can vary from new desks, networked computers and equipment
• Tools, Plant and Machinery and other assets – the nature and condition of plant and machinery can vary widely. Verify the nature, type, link to income production, cost and value of all plant and equipment if there is any doubt about its relevance and fair value or personal use
• Property – property (homes, buildings and business premises) is usually reported at cost price. Buildings may include any improvements and revaluations or improvements and revaluation may be reported separately. Buildings and improvements may be depreciated
• Land - land may be reported in a separate account at its cost price or re-valued amount. Land cannot be depreciated
• Loan to Director/s or others - indicates a loan provided to a director, associated party or unrelated entity
• Other assets – may include details of shares in other companies, intangible assets such as goodwill, trademarks

When analysing the assets component consider:

• if the customer has derived a personal benefit from the assets, for example:
• has the business made a loan to the customer or an associated person or entity, see Funds received from a business
• has the asset been used to provide the customer with a benefit, for example the business owns a motor vehicle or real estate which is available to the customer for private use. Note: the value of the assets is not the value of benefit attributed to the customer. To determine the value of the benefit quantify what the benefit would cost the customer if it was not paid for by the business
• the level of cash reserves held by the business. If the cash reserves are in excess of what could reasonably meet ongoing business needs, then it is reasonable to assume the cash reserves may be available as an additional financial resource for the owners of the business. An increase in assets other than cash reserves may impact negatively on cash available to the business which may impact on the ability of the owner to distribute profits
• accumulated depreciation, see Depreciation

Liabilities are claims against the business’ assets and can include money the business owes to others.

The liabilities component may include:

• current liabilities
• non-current liabilities

Current Liabilities

Any liability expected to be paid within one year is considered a current liability and includes:

• Trade Creditors (Accounts Payable) - money owed to suppliers for materials or other items used in the production of the products sold by the business
• Other Creditors – money owed for goods and services purchased or used by the business. An example might be electricity that is payable quarterly, rates or telephone bills
• Payroll Liabilities - may include other liabilities owed or accrued by the business such as Superannuation Payable
• GST and or Income Tax Liability – the net amount owed to the ATO after calculating the net GST payable (may be an amount the ATO owes the business if this item appears in parentheses), PAYG Payable and other tax liabilities

Non-current Liabilities

Any liability expected to be paid over one or more years is considered a non-current liability and includes:

• Loans – may include loans that have a contract or other form of agreement whereby repayment occurs over 12 months or longer. For example, loans from financial institutions, loans from the owners, directors, related or other unrelated parties to the business. Note: the amount may be owed to the business if this item appears in parentheses

When analysing liabilities consider:

• if the customer derives any financial benefit such as loan repayments and interest income from the business liabilities. If the business has made a loan to the customer or the customer has made a loan to the business, see Funds received from a business
• if there has been any significant changes in the value of the liabilities that would affect the ability of the business to distribute profits. Note: reductions (payments) in liabilities will reduce cash reserves but not the profitability of the business

Owners’ Equity reflects the financial value of the business for the owners and shows:

• the contribution to a business by the owner, for example capital introduced
• profits paid to/or money drawn by owners of the business
• profits retained within the business, see Attributing profit to a customer
• the equity held in the company by the owners

Owner’s Equity may include:

• Opening balance - reports on the balance of owner’s equity at the start of the period of the Balance Sheet
• Current Year/Net profit – equals the net profit amount reported in the P&L for the business (assuming it ends on the same day that is used for the Balance sheet)
• Drawings – drawings from the owner’s investment in a business reduce an owner’s equity. Drawings is any benefit (such as funds or goods) obtained from the business for the owners own personal use. Drawings only apply to sole traders and partnerships. A sole trader or partnership cannot employ themselves and therefore cannot pay wages. Drawings are their way to obtain a benefit for the effort they apply to their business
• Retained Profits/Earnings – retained profits are the total of the net profit made over the time the company has been in existence which have not been distributed to the shareholders of the business through the payment of dividends. Note: retained profits most commonly relates to businesses conducted in a company structure however it is possible for businesses operated via a trust to also retain profits
• Total Equity, Shareholder’s Equity or Closing Owner’s Equity – the balance of Owner’s Equity as at the date referred to on the Balance Sheet. The equity of a partnership and trust may be referred to as the Partnership’s funds or Proprietors’ funds in the business tax return. The equity of a company is referred to as the Shareholders’ funds in a company tax return.

When analysing Owner’s Equity consider:

• if profits are being retained within the business
• payments to the owners of the business. The term used for payments to the owner depends on the business structure:
• Sole Trader – Drawings
• Partnership – Drawings
• Company – Dividend
• Trust – Distribution

A business may have net or retained profits which can provide a customer with an income or financial resource.

To determine the profit that can be attributed to the customer as a financial resource from a business they are linked to or associated with, determine:

• the net profit of the business, go to Step 2
• the net or retained profit available to be drawn by the customer, go to Step 4
• if any net profit has been alienated, go to Step 5

The profit that can be attributed to the customer is any net or retained profit that is available to be drawn plus any profit that has been alienated.

To determine the net or retained profit, review the businesses:

• profit and loss statements, see Financial statement analysis
• balance sheets

Determine the businesses the customer is linked to or associated with and if these businesses have derived a net profit or have retained profits.

To determine the net profit if the profit of the business varies from year to year, consider using one of the following approaches:

• Averaging the net profit – average the profit out over 3 years where there is no identifiable or predictable trend in the net profit declared by the business. For example, a business has declared net profits of, $95,000 in 2011, $65,000 in 2012 and $125,000 in 2013 average the profit out over 3 years
• Averaging net profit with an isolated unusual result removed – when there is an unusual net profit result in the past 3 years and these changes have occurred due to circumstances which are unlikely to be repeated, average the profit out, but exclude the unusual year. For example a business has received income for a unique event such as the sale of an asset or the business did not trade for a period of time in 1 year because the owner was unable to work for health reasons
• Trending – if the evidence shows that a business’ net profit has been trending up or down, consider the net profit amount or likely net profit amount for the current and future child support periods. For example, a business has net profits of $95,000 in 2010, $100,000 in 2011, $102,000 in 2012 and $105,000 in 2013. As the average annual increase of the business’ net profit has been $3,333 over the 3 years consideration can be given to allowing for net profit growth in the current and future years
• Use the most recent year – use the most recent year of reported net profit if it provides the best representation of the business’ current performance and expected net profit for the business now and into the future
• Use the year most similar to current circumstances - use the net profit from the year that most closely represents the current circumstances. For example, if the BAS and the bank statements for the business reveal total sales similar to the amount earned two years ago, it may be appropriate to determine the net profit of the business based on the profit generated two years ago.

If a business has reported a loss, consider:

• if the current taxable income of the customer or business has been reduced by a loss from a previous year being carried forward
• multiple businesses or business activities in the same entity where a loss from one business has reduced the net profit of another business
• if the loss has been generated due to a non-cash expense such as depreciation

If the taxable income for the customer or business has been reduced by a prior year loss consider:

• how the loss was incurred:
• if the losses in the prior years would not have been incurred (or would have been significantly reduced) if not for the business claiming a non-cash expense, such as depreciation, then it may be appropriate to disregard the loss
• if the losses in the prior years would not have been incurred (or would have been significantly reduced) if not for the business claiming an expense that provides a personal benefit, it may be appropriate to disregard the loss
• how the business met the expenses associated with the loss:
• if the business obtained a commercial loan to meet the loss which is still being repaid, it may be appropriate to consider the loan repayments in determining the appropriate amount of prior year losses to allow
• if the business has declared bankruptcy, then it may be appropriate to disregard any prior year losses unless there is evidence that payments are being made in accordance with a reasonable bankruptcy agreement or the statutory calculated repayments to creditors
• if the business used prior retained earnings to meet the loss, it may be appropriate to disregard the loss in determining the business income for the current year
• how the prior year losses have impacted the current business cash flow. If the owners of the business are able to draw, or have drawn, an amount equivalent to the profit of the business in the current year, it may be appropriate to disregard the prior losses

If the net profit has been reduced due to a loss in an inter-related business determine if the loss has been used to intentionally minimise the financial resources of the customer. If the loss has been used to intentionally minimise the financial resources of the customer, consider disregarding the loss.

A business may not distribute all of the net or retained profit because:

• the business does not have sufficient cash or financial resources available to distribute the profit, for reasons such as:
• the slow collection of accounts receivable or debtors, for example when a credit sale is made it will increase the profit, if the cash for the sale is not collected in a timely manner it may impact negatively on the cash available to the business
• the business has obligations to meet capital repayments of loans or other payments for ‘Balance Sheet’ accounts which will reduce the available cash in the business to distribute the profit
• the profit is being held in reserve for replacement of operational assets
• the Directors made a decision to retain the profits to:
• expand the business
• improve the capital or liquidity position of the business
• reduce income tax obligations or personal income

Determine the net and/or retained profit that is available to be drawn by the customer:

• determine the amount of net profit that is available to be drawn by the customer. Consider the total net profits available to be drawn from the business and the portion the customer is legally entitled to receive. See Attributing profit to a customer
• determine the amount of retained profit available to be drawn by the customer. It may be appropriate to consider earnings retained from prior years. Consider;
• if the retained profits are reflected as a cash asset of the business balance sheet. If they are not reflected as a cash asset, the customer may not have the ability to draw upon the funds
• if there has been a COA, court varied assessment or agreement where the funds have already been considered
• if the retained profit is being used for a genuine business purpose, it may not be appropriate to consider the funds as a financial resource
• if the retained profits were from a period prior to the parents separation they may have formed part of the asset pool for a property settlement. If the profits were part of a property settlement it may not be appropriate to consider the funds as a financial resource
• if the business has sufficient cash reserves to pay the net or retained profit and meet the ongoing expense of the business then it is likely the business could distribute some or all of the profits

Profit alienation occurs when the net profit a customer receives from a business they are linked to or associated with does not reflect the assets or labour they have contributed to the business.

To determine if profit alienation has occurred consider:

• the nature of the customer’s business activities
• the extent to which the income depends upon the customer’s own skill and judgment
• the extent to which the business assets are used to derive the income
• the number of employees and others engaged in the income-producing activity
• the time at which the business was established. A customer may have ceased operating his business at the same time his new partner commenced a similar business
• who contributed the assets and labour used by the business

See the Child Support Guide 2.6.14: Reason 8 - a parent's income property, financial resources, or earning capacity for more information

Examples of profit alienation can include:

• where a customer has a 50-50 ownership of a business with his new partner. The customer contributed all the labour and assets to the business, however only receives 50% of the profit. As the customer contributed 100% of the labour and assets it may be fair to attribute 100% of the profit
• where a customer's new partner is the legal owner of a company (where they own 100% of available shares) and the income is only generated due to the skills and labour of the customer. For example, the company has no assets as the customer provides their own tools. The new partner only performs administration duties for the business one day a week and the company pays the customer the minimum wage. As the customer contributes the majority of labour and supplies their own tools, it may be appropriate to attribute the majority share of the business profits to the customer
• where a business operated as a partnership may equally share the net profit between its partners for tax and other purposes. However, the net profit can be 100% attributed to the customer if they are the only source of assets, skills and labour used by the partnership in conducting its activities during a particular period. For example if a customer has the training, qualifications and talent to operate the business and does all of the work, 100% of the net profit could be attributed to that customer. If a second person in the partnership contributed a vehicle, tools and equipment, labour or expertise a share of the net profit could be fairly attributed to that person

Determine if profit alienation has occurred and the amount to be attributed to the customer as a financial resource.

If a customer has links to more than one business apply the steps above 1 to 5 to each business.

If the customer is associated to or linked with businesses that are interrelated determine which business derives the initial or primary income. The business that derives the initial or primary income should be the business considered first when determining if any net or retained profit can be attributed to the customer. Then consider the other businesses in an order which follows the flow of profit between the entities. To determine the income to be attributed to the customer for each business entity, do not consider any wages, income or distribution of profit paid to the interrelated business to be alienation of income. Any income, wages or distribution of profit paid to other entities or persons should be considered when determining alienation of income.

Examples of businesses that may be considered inter-related include:

• transactions between related entities, for example Company A pays rent to a Company B and the customer has a business relationship with both companies
• Company A may hold shares in Company B (identified on the Balance Sheet or MASCOT search)
• an earthmoving company splits into two businesses, where one business operates the machinery and hires equipment and the other business undertakes the contract work
• a parent franchise company that is the sole shareholder in three companies. The first company interacts with the franchisees, the second company holds the property that the business operates from and the third company operates its own franchise

When considering businesses that are inter-related ensure that the profit is only considered once. For example if Company A operates a business where all the profit is paid in dividends to Trust A, only consider the profit of the company or trust. See Funds received from a business.

A customer may receive funds from a business they are linked or associated with, these funds may include:

• drawings, go to Step 2
• dividends, go to Step 4
• loans, go to Step 5
• trust distributions, go to Step 6

Note: when determining the financial resources of the customer consider if income alienation has occurred, see Step 5 in Attributing profit to a customer.

Only businesses operated as a partnership or sole trader can derive drawings from a business. See Business structure analysis.

To determine if a customer has received drawings and the amounts review the business Balance Sheet. See Financial statement analysis.

If the Balance Sheet is not available:

• review the customer’s individual bank statements and the business bank statements. To determine drawings identify:
• transactions such as bank transfers between the business bank account and the owner’s personal bank account or cash withdrawals made by the owner. Consider transactions in and out of the business account as the customer may deposit funds into the business account to offset drawings taken
• withdrawals from the business account that can be identified as being of a personal nature, for example a customer’s bank statement shows regular withdrawals at a supermarket consistent with what would be their personal grocery needs
• obtain verbal information from the customer or business accountant, such as:
• does the customer draw an amount from the business to meet their personal expenses and if not, how do they meet their personal expenses
• does the customer use any goods from business for personal purposes. For example a café or restaurant owner may prepare meals at work or a builder may use materials from the business for personal use on a private residence

Go to Step 3 to determine if drawings should be grossed up.

Drawings should be ‘grossed up’ if the funds withdrawn from the business provide the customer with a taxation advantage.

For a customer to receive a taxation benefit through drawings, the value of the drawings they receive must exceed the net profit attributed to the customer from their business. See Attributing profit to a customer.

If the drawings by the customer are more than the net profit attributed to the customer, determine if the drawings are available due to non-cash expenses, a redraw of capital or increase in debt. If the funds have been taken by a redraw of capital or increase in debt they should generally not be grossed up. If the additional drawings are from non-cash expenses, the drawings should be ‘grossed up’.

To 'gross up' drawings:

• calculate the net income derived by the customer from the business. To calculate the net income, deduct the income tax paid by the customer from the gross income they derived from the business. Note: the customer's income tax return will provide the amount of income tax the customer has paid on their total gross income
• calculate the difference between the funds drawn and the gross taxable income from the business the customer has declared in their tax return. To calculate the difference, deduct the ‘gross income’ the customer has declared in their income tax return from the drawings
• calculate the customer's total net income by adding their net income from the business to the difference between the drawings and gross taxable income
• use the Tax calculator in the Capacity To Pay (CTP) tool suite macro to gross up the net income

The financial information such as funds drawn, the gross taxable income and net income derived by the customer must be for the same financial year to enable the drawings to be grossed up correctly.

Note: the customer’s income tax return will provide the amount of income tax the customer has paid on their total taxable income from all sources. If income has been earned from other sources then the tax paid will be based on all the customer’s income and will not be a true representation of the tax margin for the business.

If the customer has not lodged a tax return where the drawings can be compared to the net business income, to determine if drawings should be considered are a financial resource of the customer consider:

• the amount of drawings received by the customer
• the likely net profit that may be declared by the business
• whether or not the drawings provide an income tax advantage
• if the drawings reflect an ordinary salary and wage earner’s net income
• the potential income tax payable by the customer

If the drawings are considered a financial resource of the customer, consider if they provide any tax advantages to the customer. Add any tax advantage to the amount drawn by the customer.

To determine if a customer has received a dividend:

• search the ATO systems, see the External Searches Guide
• review the customers tax return
• review financial statements of any businesses the customer is linked to or associated with

A dividend is a payment of a share of a company’s profits to its shareholders or members. Unfranked dividends have had no Australian company tax paid on the profits from which they are paid. Franked dividends are paid out of profits on which the company has already paid tax and includes a franking credit. A franking credit is a credit to a person owning shares for the tax that has already been paid by the issuing company on their dividends.

A dividend may be paid to a customer because they:

• are investors who have shares in publicly listed companies such as BHP, Telstra, Woolworths etc. If a customer has shares in a public company no further action is required as any dividends will be reported in the customer’s tax return
• have shares in a company where their relationship goes beyond that of financial investment, that is they are involved in the operation and management of the business. The dividend is reported in the customer's tax return. If the dividend does not reflect the labour and assets the customer contributed the business, see Step 5 in Attributing profit to a customer. Note: if the dividend has been paid from profits from a previous financial year, consider if the dividend has been included in a previous decision

The value of the dividend is:

• if the dividend is unfranked, the total value of the dividends
• if the dividend is franked, the franked dividend plus the franking credit

Do not include dividend payments in the calculation of the customer's financial resources if the net profit of the business is going to be included in the calculation.

A customer may make a loan to a business. Repayments of the loan by the business to a customer may represent a financial resource. If the business is claiming an interest expense that relates to the loan the interest received by the customer may be considered as a financial resource.

A business may lend money or assets to a customer. To determine if a customer has received a loan from a business:

• review the financial statements of the business. A loan may be reported on:
• the Balance Sheet as an non-current asset showing the customer owes an amount to the business
• on the Profit and Loss Statement (P&L). The income component of the P&L may show the business is receiving interest payments which could indicate there is a loan between the business and the customer or another party
• review the business bank statements. Money paid between the business and the customer may indicate a loan arrangement
• verbal evidence from the customer or third party, such as their accountant or the other party, may provide information which suggests that there could be a loan arrangement in place

Note: loans refer to loans made by a business that the customer is linked to or associated with, not a loan from a financial institution.

To determine if a loan is a financial resource of the customer consider:

• the purpose of the loan. For example if the business provided the customer money for a specific purpose such as to purchase a home or go on a holiday this may indicate there is a formal loan arrangement in place. If money is drawn by the customer over a period of time this may indicate the loan is being used by the customer to draw a wage from the business
• the terms and repayments schedule, if can they can be obtained. A written loan agreement specifying the interest rate and term of the loan is more likely to be treated in the same manner as a loan from a traditional lender which is not a financial resource

Note: under Division 7A of Part III of the Income Tax Assessment Act 1936 (Division 7A) loans to shareholders or their associates are, unless they come within specified exclusions, treated as dividends. This may result in a customer reporting the payment of a dividend on their tax return which may not be reflected in the distribution of the net profits of the business for the same period. Only the loan or dividend should be included in the calculation of the customer's financial resources and consideration given to the period the dividend or loan relates too. For further information about Division 7A see the ATO website.

If a loan is considered a financial resource, to determine the value of the resource consider:

• the increase of the loan from the last financial year on the balance sheet, or
• the amount of funds transferred from the business bank account to the customer's bank account

To determine if a customer is receiving trust distributions:

• review the financial statements of the business
• review the tax return of the business and customer

The value of the trust distributions is the amount reported on the customer tax return or financial statements of the business.

Note: profit alienation may occur in the profit distribution of a trust, see Step 5 in Attributing profit to a customer.

Depreciation is the process of a business expensing an asset that has a life span of more than 12 months. The depreciation expense is a ‘paper based’ or ‘non-cash’ expense. It has the effect of reducing the recorded value of an asset and increasing the expenses of the business. As depreciation is a non-cash expense, some businesses may use part of or all of the amount to reduce debt, purchase assets or put aside part or all of the cash amount into a bank account to purchase a replacement of the asset. See Child Support Guide 2.6.14: Reason 8 - a parent's income, property, financial resources, or earning capacity for more information.

Consider if there are any current special taxation rules for depreciation, see Step 3 in Business tax information.

There are several methods for a business to calculate the depreciation expense:

• Straight line or Prime Cost method - the depreciation expense is the acquisition cost spread equally over the useful life of the asset
• Diminishing Balance or Diminishing Value method - this method assumes that the decline in value each year is a fixed percentage of the remaining value and produces a progressively smaller decline over time
• Simplified depreciation – small businesses can immediately expense assets costing less than $6,500. Assets costing more than $6,500 are depreciated at the annual rate of 30% except in the first financial year where they are depreciated at a rate of 15%, regardless of the date of acquisition.

To determine if a depreciation expense is a financial resource:

• Consider if the depreciation amount is being applied to other business purposes. If so, it is not considered a financial resource of the customer:
• any amount of the depreciation expense allocated to a capital replacement fund or a depreciation fund or provisioned for asset replacement purposes is not considered a financial resource of the customer. This can be determined if:
• the business’ Balance Sheet shows an ‘Asset’ account indicating money has been put aside for the replacement of the business assets or has resulted in a corresponding increase of the cash assets
• if the business has a separate business bank account where they have put money aside to replace assets in the future
• any amount of the depreciation expense applied to the reduction of business debt may not be considered a financial resource. This can be determined if the business’ Balance Sheet shows a reduction in one or more of the liability balances
• any amount of the depreciation expense used to purchase new assets for the business is not considered a financial resource. This can be determined if the business’ Balance Sheet shows an increase in either the asset balances other than cash and bank assets or receivables (Debtors). Compare any new assets to any new liabilities reported on the balance sheet to determine if the assets have been purchased through a loan.
• Determine if the depreciation is a reasonable representation of the actual depreciation of the asset by considering:
• if the asset is being depreciated over a reasonable period of time. Use the Australian Taxation Office effective life table, from the ATO website to test reasonableness. If the asset is not being depreciated over a reasonable period of time, the excessive depreciation expense can be considered a financial resource
• if the depreciating asset is being used for private purposes. If so a portion of depreciation expense that reflects the private use can be considered a financial resource
• if the depreciating asset was purchased by the business from the customer or an associated person or entity, consider if the original value of the asset is reasonable. An exaggerated purchase value could lead to an increased depreciation claim. The excessive depreciation expense can be considered a financial resource

The depreciation amount can be considered a financial resource if:

• the depreciation amount is not being applied to other business purposes or a depreciation fund, go to Step 3 for more information
• the depreciation is not a reasonable representation of the actual depreciation of the asset for business purposes, go to Step 3 for more information

Note: if the debt is being paid at a rate faster than the debt arrangement, the additional funds being paid can be considered a financial resource.

If the depreciation represents a financial resource and the business is operated:

• as a sole trader, then all the depreciation will be the financial resource of the customer
• as a partnership, company or trust, then the depreciation should be split at the same rate that any profit attributed to the customer from the same business has been. If no profit has been attributed to the customer then the financial resource should be split in accordance with the customer's entitlement to receive the business net profit