Business Stuctures
We strongly recommend simplicity unless there is a good reason that forces you into a more complicated structure.
These are the basic business structures in New Zealand in order of simplicity:
Sole Trader
This is just you trading; you use your personal IRD No and simply register for GST, which will be the same number. The income that you earn is taxed in your personal tax return along with any other income that you have from investment, wages or anything else.
The problem with this that might force you into a more complicated business structure is that the entire income is taxed in your own name and if the income is more than $70,000 you will incur the 33% tax rate. It is difficult to split your income with spouses or children. The second problem is that you will be personally liable for any trouble you get yourself into in business (which means you could lose your house).
Partnership This structure is usually used by two people going into business together or by a husband and wife. It is as simple as applying for a partnership IRD number and becoming GST registered. The income is returned in the partner’s personal tax returns, either 50/50 or in whatever percentage that the partners agree that it should be split in. (It enables a husband and wife to split income between them, which solves one of the problems of being a sole trader).
The liability problems of being a sole trader are not solved and are, in fact, compounded because not only are you liable for problems that you cause, but also for the problems that your partner causes. Creditors can simply claim against the wealthier or easier to get of you.
Company Companies are governed by legislation and administered by the Companies Act. They are very common and relatively cheap to administer because of their wide spread use. We form companies for $400 (plus GST) and then it is a simple case of being registered with Inland Revenue and applying for a GST number. Companies get a Certificate of Incorporation when they are formed, which is like their birth certificate and is required by banks, etc., as evidence of its existence.
There are tax advantages in using a company, because shareholder salaries can be allocated once the profit is known at the end of the year and can be allocated amongst a number of shareholders, who work for the company, and may be limited to less than $70,000. Any surplus profit over and above this can be taxed as company income at 28%. This is obviously a little cheaper than the 33%, which would be incurred by a shareholder. The catch is that ultimately the retained earnings of the company need to be paid out as dividend to shareholders (so they can spend it) and, at this point, the shareholder is taxed at their marginal tax rate, which may be 33%, and receives a tax credit for the tax paid by the company, which is only 28%, so they pay another 5%. The trust tax rate is currently 33%, so if a trust owns the shares in the company it will pay tax at 33% and receive a tax credit for the 28% paid by the company and only pay an additional 3%.
A shareholder’s liability to a company is limited to the share capital. Usually the share capital is a relatively small amount; like $1,000, and once the shareholders have paid this amount into the company they are not liable to contribute anything else to the company’s problems. However, directors of the company can still be liable for their personal actions, which caused the company’s problems. Despite this, a company is much safer for protecting personal assets than either a sole trader or partnership.
Trusts Trusts are more expensive to operate because they tend to be of a custom nature requiring legal input to decide the terms of the trust as to who should appoint the trustees, who should be the trustees, who should be the beneficiaries and a whole lot of custom wording as to how it should operate.
The advantage of trusts, and why people are forced to use them, is for tax saving and liability protection. The tax rate for trusts is 33%. But this can be reduced by making distributions to beneficiaries of income and the income is taxed at the beneficiary tax rate. Beneficiaries must be over 16 years old to take advantage of this.
Trusts are often used to hold assets, like homes, as an ultimate protection from creditors. It is very hard for a trust to actually do something that it can get sued for and owe people money for. Therefore, any assets that the trust owns, like a home, are pretty safe.
We live in a socialist world and governments like to give out money to poor people and restrict wealthier people from receiving benefits. Various government initiatives have, and will in the future, involve an asset test and perhaps an income test for an individual in assessing entitlement to benefits or grants. Where assets and the income associated with those assets is held by a trust, that asset or income is no longer the individuals, which means the individual may be entitled to government benefits. In the past this applied to the superannuation surtax, which was avoided by people with trusts and, in the past, applied to death duties, which was avoided by people with trusts. Currently, the government provides rest home subsidies to people with low assets/income, but not to wealthier people and a correctly structured trust may retain an entitlement to rest home subsidies. More importantly, the government is likely to think up new ways to tax wealthy/high income people in the future and a correctly structured trust will quite likely protect from these new charges. (By wealthy/high read more than $10000)
Trading Trusts This is just a trust that trades, but they are quite expensive to administer because, again, they are a custom entity requiring quite a lot of legal input and accounting complication. All of the benefits of a trading trust can usually be obtained by having a company that trades with the shares held by a trust. This is our recommended structure for most clients and we would only recommend a trading trust in particular client circumstances where the other alternative did not work.
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