Paying for something now that covers the months ahead, such as insurance, a subscription or a rent payment, can sometimes bring the deduction forward into this tax year. For eligible small businesses the rules are friendlier than for everyone else, but they have limits.
The 12 month rule
The ATO says a small business entity can immediately deduct a prepaid expense if two things are true. The service period must be 12 months or less, and it must end on or before the last day of the income year after the one in which you paid. A small business entity is one that is not linked with another business and has turnover under $10 million.
If the rule is not met, the deduction is spread over the service period, or 10 years, whichever is shorter. The ATO gives an example of a prepayment covering 395 days. That is over 12 months, so there is no immediate deduction.
Where people trip up
- The period is a few days too long. A 13 month policy fails the test, even if you paid it at the right time.
- It is not really a prepayment. The expense has to be incurred and paid. If you use the simplified accounting method, the expense also needs to be paid before you can claim it.
- You are not a small business entity. If your business is linked with others, check the combined turnover.
What to do
- Look at your upcoming renewals. Insurance, software and memberships are common candidates.
- Check the service period dates. Make sure they run for 12 months or less and finish by 30 June 2028 if you pay in this income year.
- Think about cash flow first. A deduction is not worth much if paying early leaves you short for BAS or payroll.
- Keep the invoice and proof of payment. Both go with your tax records.
- Talk to your accountant before 30 June. They can confirm you qualify and whether it suits your year.
A prepayment only changes when you get the deduction, not whether you get it, so it is a timing tool rather than a saving.