Ring Fencing Rental Losses

Ring Fencing Rental Losses

A proposed new law will stop residential rental investors from offsetting rental property losses against their other income. If you have a loss-making rental investment, you need to know about this.

The new law will come into effect from 1 April 2019.

Current Situation

Currently, if you own a residential rental property and your expenses exceed your rental income, the resulting loss is offset against your other taxable income such as your salary. This reduces your total income and therefore your tax.

Generally, PAYE is calculated on your salary as if it is your only income. You then file a tax return including your rental loss and receive a tax refund. The refund helps cover the rental loss.

Proposed Situation

The law change will stop rental losses being offset against other income. Losses will only be able to be offset against other residential property profits in the current or future years.

The new rules will apply from the 2019/20 tax year, which starts on 1/4/19.

Exclusions

Rental losses from the following types of property will be excluded from the new rules and therefore can continue to be offset against other income:

  • Land taxable on sale. This includes land purchased with the intention of resale or land purchased for a property development or building business.
    NB, this exemption only applies to land that will definitely be taxable on resale. E.g, it will not apply to land that may be subject to tax under the bright-line test as that is only taxable conditionally on the property being sold within five years.
  • Holiday homes used for rental and private purposes. These properties are subject to a different set of rules called the mixed-use asset rules.
    Commercial property
    Business premises
    Farmland

Conclusion

If you are considering buying a residential rental investment, or already own one, and rely on the tax breaks to make it work, then the new rules will affect you.

Please contact me with any questions.

Residual Provisional and Terminal Tax

Residual, Provisional and Terminal Tax. What are they, and when are they due?

If your tax bill is always a nasty surprise, read this. This article aims to demystify your income tax. Once you understand how your tax is calculated and when it is due, you can plan for it. No more nasty surprises.

Everyone with business or other income that is not fully taxed at source must file a tax return and pay tax directly to IRD.

Below I explain the three tax payment terms you need to know:

  • Residual Income Tax
  • Provisional Tax
  • Terminal Tax

Residual Income Tax (RIT)

Your tax return contains your total taxable income from all sources. Your tax payable on this income, after accounting for any tax already deducted at source such as Resident Withholding Tax from interest or PAYE from wages, is your Residual Income Tax. When and how this is paid to IRD is discussed below.

Provisional Tax

Once your Residual Income Tax (RIT) exceeds $2,500, you become a Provisional Tax payer from the following tax year. You make Provisional Tax payments during a tax year towards that year’s RIT.

As you can’t calculate your final RIT until the year is finished, Provisional Tax is an estimate of your tax. The default method for calculating Provisional Tax is adding 5% to the previous year’s RIT. Three other methods are available including estimating or basing it on your current year’s actual figures as you go.

Provisional Tax is usually paid in three instalments on 28 August, 15 January and 7 May. These dates assume you have a standard 31 March year end and, if you are GST registered, you file GST returns two-monthly. If you file GST six-monthly, you have two Provisional Tax dates of 28 October and 7 May.

Presuming three Provisional Tax dates, for the tax year ending 31 March 2019, you pay Provisional Tax on:

  • 28 August 2018
  • 15 January 2019
  • 7 May 2019

Terminal Tax

As the name suggests, Terminal Tax is the final tax payment for a year. If you have not paid Provisional Tax, or your Residual Income Tax exceeds your Provisional paid, the balance payable to IRD is your terminal tax. If your Provisional Tax exceeded your RIT, your Terminal Tax is a refund from IRD. Terminal Tax is a year-end washup.

Terminal Tax is due by 7 February following the tax year end, or 7 April if you use an accountant.

For the tax year ending 31 March 2019, your Terminal Tax will be due 7 February 2020 or 7 April 2020. Again, these dates assume you have a 31 March year end.

Managing Your Income Tax

A simple business forecast will show you approximately what percentage of your earnings will go in tax. By putting this aside as the money comes in, you should always have your tax money available on the due dates.

Your first Provisional Tax date of 28 August is more than one third of the way through the year. Presuming your Provisional calculation is about right, by putting aside the money as you go, you should have more than a third of the year’s tax put aside by the time it is due.

Likewise, you second and third Provisional Tax dates, and your Terminal Tax date, all come after you have earned the money that you’re paying the tax on.

Tom’s Tax

As a simple example, consider Tom, a consultant charging fees of $120,000 per year and business expenses of $40,000. His taxable profit is $80,000:

Tom’s Residual Income Tax on $80,000 works out to $17,320.

Tom calculates that approximately 14.4% of his fee revenue will go on tax (17,320 / 120,000). He puts aside 14.4% from every client payment.

By 31/7/18 (after 1/3 of the tax year) Tom has received $40,000 from clients and put $5,760 (40,000 x 14.4%) into a tax savings bank account. This should cover his provisional tax due on 28/8/18.

If your tax bill has taken you by surprise, there are ways to mitigate the damage including negotiating repayments with IRD or arranging tax finance. However, understanding and planning for your tax obligations beats sorting out a mess at year-end.

Why are IRD Promoting their New Provisional Tax Method

Why IRD Are Promoting Their New Provisional Tax Method?

IRD are enthusiastically promoting their new provisional tax method to small businesses. Below is one suggestion as to why.

What is AIM?

For some time, there have been three options for calculating provisional tax with the standard method – adding 5% to the previous year’s tax and paying in two or three instalments during the year – being the default option for small business. The other two options are estimating and the ratio method – calculating provisional tax as a percentage of sales in each GST return. From 1 April 2018, IRD have added a fourth option – the Accounting Income Method or AIM.

Under AIM, you send management accounts direct from your accounting software to IRD every two months and pay provisional tax based on the profit in those accounts.

Promoted Benefits of AIM

The main benefit of AIM advanced by IRD is that your provisional tax is based on your actual profit meaning you pay more tax when business is good and less when business drops off. Your tax paid by year-end should be accurate with no significant end-of-year catch-up required. If this a significant advantage to you, AIM may be your option. However, the ratio method, where you pay provisional tax based on the turnover in each GST return, also matches provisional tax to business activity.

Another benefit put forward by IRD is that AIM stops potential Use of Money Interest. If you have been subject to IRD’s retrospective interest charges on underpaid provisional tax, where they assume you should have know what your final tax bill would be way back from the first provisional tax date 1/3 of the way through the year, this may be a tempting advantage. However, other changes to the provisional tax rules, also brought in from 1 April 2018, basically wipe out these interest charges for nearly all small business anyway.

IRD Are Taking AIM

Perhaps IRD’s biggest incentive is having direct access to your current accounting information. AIM requires the business to make adjustments that are usually only made at year-end and lay all their cards out during the year. You may or may not be comfortable doing that. But with IRD investing heavily in their new systems which are greatly increasing their ability to analyse data and target non-compliance, this access to your business information is gold.

If you think AIM may be a good option for you, give us a call to discuss.

Alternatively, read IRD’s take on AIM or this article by Tax Management New Zealand with a contrary view.

Year End Tax Planning

Year End Tax Planning

31 March is the tax year end for most of us. Here are a few things you can do by 31 March to save cut your tax bill.

Write off Bad Debts

If you have overdue debtors that you will probably never recover, you can claim a bad debt deduction for them. To claim them in this tax year you need to write them off by 31 March. The requirements are:

Proof that they are bad debts – i.e., evidence that you have chased the money
Physically write them off by 31 March – by putting through a credit note in your accounting system or recording that they are bad debts.
If the debtor does subsequently pay in the next tax year, that will be treated as taxable income.

Claim Business Mileage

If you use your personal vehicle for business, you can claim the business use. One of the simplest methods is to calculate your business kilometres for the year and claim the IRD kilometre rate (currently 73 cents/km). Fill out a logbook to calculate your business kilometres.

You can claim the kilometre rate for up to 5,000 business km’s per year. If you want to claim more than 5,000km’s, you will have to use actual vehicle costs.

Calculate Fringe Benefit Tax Exempt Days

If you are paying Fringe Benefit Tax (FBT) for a company vehicle, you do not have to pay FBT for days when the vehicle is not available for private use. Add up those days to reduce your FBT cost. Exempt days include days when the vehicle is:

  • At an airport car park while the employee is away on business
  • Out of action including being at the garage or panel beaters
  • Stored at the employer’s premises so unavailable for the employee to use
  • Used for an emergency call-out
  • Out of town on business travel for 24 hours or more

Write Off Redundant Fixed Assets

Fixed asset that have been scrapped or are no longer useable can be written off and the remaining book value claimed as a loss on disposal. Review your fixed asset schedule from last year’s accounts for any such assets.

Write off Obsolete Stock

Obsolete stock must be physically removed by 31 March to avoid including it in your closing stock value. Also, stock can be valued at cost or, if lower, resale value. If the cost of selling stock is higher than the price you will get for it, it can be valued at nil.

Register for Ratio Method or Accounting Income Method (AIM) for Provisional Tax

Under the default method, your provisional tax is based on your previous year’s tax. There are two other methods available that base your provisional tax on your results during the year, increasing your provisional tax when you make more money and decreasing it when you make less. This helps you match tax payments with your cash flow.

The ratio method calculates provisional tax as a percentage of the sales in each GST return. The new Accounting Income Method (AIM), starting from 1 April 2018, calculates provisional tax based on the profit in your management accounts.

To use either of these methods for the tax year starting 1 April 2018, you need to make an election by 31 March 2018. If you think they may be helpful, give us a call to discuss.

Note, these methods are only available for the business. You cannot use them for your personal provisional tax if you are a shareholder employee as you do not have GST returns or management accounts to base them on.

Register Look-through Companies (LTCs)

Look through companies are treated like partnerships for income tax purposes with profits and losses flowing through to the shareholders’ individual tax returns. If you have a company making losses, an LTC allows you to offset the losses against your personal income rather than being trapped in the company.

To become a LTC for the next tax year, an election needs to be made by 31 March.

Consider Paying Dividends

If you have retained profits in your company, at some stage you will want to pay them out to shareholders. If your personal income is likely to rise in future years, there may be a tax advantage in paying a dividend this year to be taxed at a lower marginal tax rate.

Pay Expenses by 31 March

Some expenses can be claimed if paid by 31 March even if they relate to the following year. Examples include:

  • Stationery, postage and courier costs
  • Subscriptions
  • Rates
  • Road user charges
  • Advertising up to $14,000 and used within six months following 31 March
  • Employee payments such as holiday pay and bonuses that are used within 63 days after 31 March
  • Insurance premiums up to $12,000 covering the following year

Should you be a GST Registered Consultant

Should You be a GST Registered Consultant?

If you are starting out as a consultant, you may or may not have to be GST registered. If it is not required, it may or may not be to your advantage to register voluntarily. This article explains why.

How does GST work?

Goods and Services Tax (GST) is collected by GST registered consultants (and other businesses), from their clients, and passed onto IRD. GST registered consultants also claim back, from IRD, the GST content of their expenses. When a consultant’s GST collected on fees exceeds GST paid on expenses, the excess is paid to IRD. If GST paid exceeds GST collected, the shortfall is refunded by IRD.

Who can be GST registered

A business, or consultant, can generally be GST registered providing they sell taxable supplies. Taxable supplies are the sale of goods or services. If you are a consultant, you almost certainly are providing taxable supplies to your clients.

GST charged on consulting fees

GST registered consultants add GST to their fees charged to clients. With a couple of exceptions mentioned below, GST is charged at the standard rate of 15%. So, if a GST registered consultant charges $100 for their service, they generally add $15 GST and charge their client $115 including GST.

Zero-rated supplies

Certain taxable supplies are zero-rated, meaning GST is charged at 0% instead of 15%. Zero-rated supplies include:

  • exported goods or services
  • sales of a whole business as a going concern
  • sales of land from one GST registered person to another.

A GST registered consultant generally charges GST at 0% on services provided to overseas clients (exported), unless the services relate to property in New Zealand.

Exempt supplies

Certain types of supplies are exempt from GST. If you are in the business of providing these, you cannot be registered for or charge GST. Exempt supplies include:

  • salary or wages
  • residential rent
  • interest (whether paying it or receiving it)
  • most other financial services
  • sales of fine metals.

Should a new consultant register for GST?

If a consultant’s fees exceed $60,000 per year, they must register for GST. Even if their fees are likely to exceed $60,000 over the following 12 months, they must register.

If a consultant’s fees are less than $60,000, the consultant has the option of becoming GST registered or not. Voluntary registration may be worthwhile depending on the consultant’s circumstances.

Advantages of GST registration for consultants

The major advantage to a GST registered consultant is claiming back GST on business expenses. A non-GST registered consultant must wear the cost of GST of all GST inclusive expenses including:

  • Vehicle running costs
  • Computer equipment
  • Books and training costs
  • Office rental (offices are commercial rents so not exempt from GST like residential rents)
  • Big items like motor vehicles or even office buildings

Note however that once an asset such as a vehicle has been purchased by a GST registered consultant and the GST claimed, GST must be charged on a subsequent sale of the asset.

Disadvantages of GST registration for consultants

There are two potentially significant disadvantages to being GST registered: GST registered consultants must charge their clients GST and they have GST compliance requirements.

Charging GST to clients

Charging GST to clients may or may not be a problem depending on the type of client the consultant has.

For a consultant selling business to business (B2B) services, GST registration may not be a problem. The B2B consultant’s clients will generally be GST registered businesses themselves and can therefore claim back the GST. Paying a non-GST registered consultant $100 with no GST to claim back equates to paying $115 to a GST registered consultant and claiming back the $15 GST.

For a consultant selling business to consumer (B2C) services, GST registration is a problem. The non-business clients will generally be unable to claim back the GST content, so it does not matter to them whether the consultant is GST registered or not. If the maximum they will pay for a service is $100, the consultant will have to suck it up and return the GST content out of the $100. The GST registered consultant is wearing the GST cost.

For a GST registered B2C consultant, the costs of paying GST out of their sales will exceed the benefit of claiming GST on expenses unless their expenses exceed their sales and they are losing money. For B2C consultants, I suggest not registering for GST until you have to.

GST compliance requirements

The other disadvantage to GST registration is the compliance obligations. A GST registered consultant must prepare and file GST returns, make payments to IRD, prepare tax invoices for sales and collect tax invoices for purchases. These records must be kept for seven years. Of course, accountants or bookkeepers can do most of this for you and modern accounting software makes it a whole lot easier.

If a GST registered consultant breaches any of their obligations, they are exposed to IRD’s penalties regime which can be very costly.

Summary

If you provide taxable supplies exceeding $60,000 per year, you must register for GST. If your supplies are below $60,000 per year, you have a choice.

For B2B consultants, I would generally recommend registering voluntarily as the GST charges should not hurt your sales and you can claim GST on expenses. I would only suggest staying non-registered if the GST on your expenses are not worth the GST compliance hassles.

For B2C consultants providing services to non-GST registered people and organisations, I recommend remaining non-registered until you must register. It may be tempting to register if you intend claiming GST on a large business asset such as a vehicle, but ultimately, if you are successful, your sales will exceed your costs and the loss of 15% of those sales will exceed the 15% reclaimed on costs.

Business Structure Sole Trader or Company

Your Business Structure: Sole Trader or Company?

Business is risky. Risk is the price we pay for the rewards we hope to get from owning a business. Risk is the reason we expect a higher return from a share investment than a bank deposit.

If investing in a portfolio of businesses via the share market is risky, it is nothing compared to investing in one small business. While we may be very happy with a 10% return on our share portfolio, a venture capitalist may look for a 30% return on his investment in small, growing companies, knowing a good portion of them will fail.

It would be foolish to go into business ignoring the fact that things can go wrong: consultants get sued by client for advice gone wrong; businesses lose key customers and can’t pay their bills; professional firms are attacked by ransomware and cannot operate. Your best defence is your business structure.

Sole trader

A sole trader is the simplest business structure. Just start doing business on your own account and you are one by default. But as a sole trader, you are the business and the business is you. You have no legal separation from the business with all its hazards.

When your business cannot pay its debts, your personal assets are fair game for your creditors. When your business fails, it is not just the value of your investment at risk, but your house, your cash and everything else you own.

When it all goes wrong, you need to be legally separated from your business and the most common method of separation is using a company to run your business.

How a Company Protects You

A company is a separate legal person able to run commercial activities in its own name. You own your company and your company owns your business.

Company ownership is divided into shares. A small company may have 100 shares for which a sole-owner pays $1 each, investing $100 into the company. While the company itself carries unlimited exposure to business risks, the company’s owner’s risk is limited the $100 invested.

In practice, however, the limited liability can be compromised.

Examples of losing your limited liability

If you neglect to include your company name on agreements and correspondence, you can inadvertently form legally binding contracts in your own name. Always make it clear it is the company doing the business.

As an owner-operator of your company, you will also be a director. The Companies Act puts legal responsibilities on directors such as requiring them to act honestly, in the best interests of the company, and to not trade recklessly. Directors must also ensure their company prepares financial statements, files tax returns and complies with other legal requirements. Breaching these responsibilities can result in personal liability or prosecution.

Banks and other lenders to the company usually require personal guarantees from the company so if the loan cannot be paid, the directors must cover it.

When a company cannot pay its creditors, including IRD, those creditors can try to break through the corporate structure and go after the directors personally. You can protect yourself from this “lifting of the corporate veil” by making sure your legal duties are complied with.

Other Advantages of a Company

Tax Advantages

A company can save you tax. A sole trader pays tax on all profits at personal tax rates, up to 33%. A company pays tax at 28%, providing a potential 5% savings on profits retained by the company.

A company makes it easier to split income with others such as a spouse. With individual tax rates starting from 10.5%, even a modest share to a spouse with little other income can save thousands in tax annually.

Raising Funds

The division of the company’s ownership into shares helps capital raising. Others can invest in exchange for shares, entitling them to a share of future profits and gains. You can’t split the ownership of a sole trader business.

Cost and Complexity

No one likes adding costs and compliance requirements, but we are lucky that New Zealand is ranked one of the easiest countries to start a company. A company can be setup within a few hours at minimal cost.

Companies do require some additional compliance such as filing returns, preparing annual resolutions and maintaining legal registers. Neglecting these puts the director at risk. The good news is that, for a small privately-owned company, these things are not difficult. Your accounting firm can take care of the routine requirements as part of their annual accounting service.

Get it Right at the Start

The risks of business are real, even for one-person operations, so why stand in the firing line. Just make sure you get some advice on how to structure it before incorporating your company. It is much easier to set it up properly than try and fix it when things go wrong.

Contact us with your business questions.

New Company Car Rules

New Company Car Rules

A new Option for Claiming Company Car Expenses

Small business owners typically have one vehicle which they use for both business and personal use. A common question is whether their company should own their vehicle.

Until recently, company ownership of your car meant the company claiming 100% of the vehicle costs but paying Fringe Benefit Tax (FBT) on the private usage. The problem is that the FBT rules assume the shareholder-employee has full use of a private vehicle (with some limited exceptions) and FBT is charged accordingly. The FBT paid sometimes exceeds the tax savings from claiming the vehicle expenses.

From 1 April 2017, we have a new option. A company can prevent paying FBT by claiming only the business portion of the company car expenses. The company needs to establish the business proportion by keeping records, which can be through a logbook kept for three months to establish an average use. This has always been the default method for sole-traders and partnerships.

Which choice is best

The most tax-effective choice depends on the amount of business travel versus private travel. A company car used predominantly for private use, may be better off paying FBT. FBT is the same regardless of the private kilometres used and all vehicle costs can be claimed regardless of how few business kilometres are travelled.

The new option of claiming only the business-related costs with no FBT issues is advantageous when the travel is predominantly for business. The portion of expenses denied for private travel will be small and no FBT payable.

There are various options for dealing with vehicles that are used for both private and business purposes including keeping it out of the business and reimbursing the owner or business use. Your best option will depend on your individual circumstances so, if in doubt, get some advice.

Contact us with your business questions.

Tax Deductible Business Expenses

Tax Deductible Business Expenses

What we Can and Cannot claim

With income tax rates as high as 33%, tax majorly impacts nearly all our business transactions. So, while we should be making business decisions for commercial reasons, it is vital to understand what their tax impact them will be. Yet, business operators regularly make decisions on business expenses based on false assumptions and misunderstandings, resulting in a drastically different tax outcome than they expect.

Take Pete, an owner of a rapidly growing IT Consultancy. At the start of March, with one month left in the tax year, his income is almost double the previous year’s and his bank balance is looking healthy. However, he is worrying about his inevitably growing tax bill. After some creative thinking, he decides he can finally justify upgrading his business vehicle, before 31 March, cleaning out much of this year’s surplus and surely saving a pile of tax.

So, Pete, who dislikes debt, pays a car dealer $55,000 plus GST for a late model Lexus. What he doesn’t count on is it cutting only $454 from the year’s tax. We will see why below.

What makes an expense tax deductible?

Most people understand that business expenses are tax-deductible. This means that when they “claim” a business expense, it is deducted from their taxable profit, reducing the profit and therefore reducing the tax calculated on that profit.

But we can’t always fully deduct what we spend, and we can’t always claim a deduction when we spend the money. So, let’s look at what we can deduct and when.

The General Tax Deduction Rule

Understanding one simple rule will clarify whether an expense is tax deductible or not in nearly all cases:

Expenses are tax deductible to the extent they are incurred to either:

  • generate taxable income, or
  • run a business that generates taxable income.

A computer retailer buys a computer to resell for a profit. The profit is taxable income, so the computer is bought to generate taxable income and therefore the cost is tax deductible.

The same business needs somewhere to operate so it rents a shop. The rent is paid to run the income generating business, so is tax deductible.

But it is not always so clear cut, especially as business owner-operators where our expenses often benefit both us and the business.

Expenses we can Fully Deduct

The following examples are generally 100% business expenses, and therefore fully tax deductible.

  • Cost of Sales – Buying a product, or paying for a service, for resale
  • Rent – Business premises or equipment
  • Wages or Subcontractors – Including related costs such as Kiwisaver contributions and ACC levies.
  • Interest – Paid on money borrowed and used for business purposes. NB, repayments of loans are often a combination of interest and principal. Only the interest portion is tax deductible.
  • IRD Interest – IRD charge Use of Money Interest on underpaid tax. NB, Interest that IRD pay you on overpaid tax (at a much lower rate than they charge you) is taxable income.
  • Advertising
    Travel and Accommodation – On business trips. Entertaining customers while away will come under the entertainment rules below.
  • Professional Development – Ongoing training to help with your current business is deductible. A degree or diploma to become a professional is not.
  • Telecommunications – Business telephones and internet.
  • Depreciation – As explained below, we can deduct for the cost of business assets such as business tools, equipment and vehicles, but the cost is spread over the asset’s life.

Expenses we can Partly Deduct

These expenses usually provide a business and a private benefit, so we can deduct the business portion.

  • Home Office – When we live and work at the same place, we can deduct the business portion of shared expenses such as electricity, rates, insurance, rent or interest on mortgage payments, and maintenance on the overall property. The business percentage is generally calculated on a floor area basis.
  • Motor Vehicle –If used for both business and private purposes, we must apportion ownership and running costs. The business percentage is usually calculated by keeping a log book of business travel.
  • Travel and Accommodation – When combining a business trip with a holiday, we must apportion costs that relate to the whole trip, such as air fares, usually based on time spent on each.
  • Telephone – Telephone rental and data used for both business and privately.
  • Entertainment – When entertaining staff or business contacts, the tax deduction is limited to 50% of the cost. This includes costs of functions, events, food and drink, holiday accommodation and pleasure craft. Limited exceptions allow a 100% deduction for overseas entertainment, promotional functions open to the public, and food and drink at seminars and training sessions

Expenses we Cannot Deduct

Tax deductions are denied on some expenses even if we feel they benefit our business.

  • Clothes – Even if we buy a suit solely for work, we cannot claim it. Only protective clothing or uniforms are deductible.
  • Health Costs – Doctor visits, gym memberships, glasses, hearing aids or massages. Even if they restore our health so we can work they are not deductible.
  • Life Insurance – But income protection insurance is deductible.
  • Fines and bribes – Whether incurred while doing business or not, most fines and bribes cannot be claimed.
  • Income Tax – No deduction for tax payments. Income tax is the government’s share of our income, not a cost of earning the income.
  • GST – For GST registered businesses, GST paid to suppliers, collected from clients and paid to IRD all fall outside our income tax calculations. GST is a tax collected by business on behalf of the government. For non-GST registered businesses, however, GST inclusive expenses are deductible as the GST forms part of the final cost.
  • Tax Penalties – As with fines, tax penalties are non-deductible.

Timing of Tax Deductions

Why did Pete’s $55,000 Lexus only save him $454 tax? Assuming it was a 100% business vehicle, the cost is fully deductible. The problem is not if he can deduct it, but when he can deduct it.

Tax laws follow the “matching principle”, meaning expenses are matched to the income they are used to generate. Pete’s Lexus should last for several years but is only used briefly in the tax year he purchased it, so he can only deduct a small portion in that year.

While most business expenses are used up in the short-term and can be fully deducted when incurred, or invoiced, here are two examples where deductions are delayed.

Fixed Assets

Fixed assets, such as vehicles and business equipment, benefit our business over more than one year. We do not deduct the cost when we buy them but “depreciate” them by deducting a portion each year, thus spreading the cost over its expected useful life.

Pete’s Lexus cost $55,000. IRD allow us to deduct 30% of a vehicle cost in the first year, $16,500 for Pete ($55,000 x 30%). However, Pete purchased the Lexus in the last month of the year so can deduct for that month only. He deducts depreciation of $1,375 ($16,500 / 12). If Pete is paying 33% tax, he saves $454 tax ($1,375 x 33%). Not the greatest immediate return on $55K.

Cost of Sales

In another attempt to tame a tax bill, a reseller may make a big stock order just before year end. The problem is, we can only deduct the cost of goods sold when we sell them. The cost of stock unsold at year end is carried forward to the following year.

Here’s a simple cost of sales calculation for the tax year ended 31/3/17:

The $24,000 of stock remaining becomes the next year’s “opening stock” and will be deducted in that year.

Conclusion

Bad business decisions are usually uninformed business decisions. While the outcome of many decisions involves some guesswork, the tax impact of our spending decisions does not have to be one of them. If unsure, get some advice before spending your money.

Contact us with your business questions.

Avoid the New Business Tax Trap

Avoid the New Business Tax Trap

Whether we like it or not, a lot of our money goes on tax. With up to 33% of our profits going to income tax alone, tax has a major impact on our business’s cash flow. But when we start a new business, it can be up to two years before we need pay a cent, making it too easy to put our head in the sand.

It does catch up with us. Facing two years of tax, payable within a month, can be enough to knock a fledgling business over. This is one bill that a new business owner must have a plan for.

The start-up

Take Sally, an Interior Design Consultant. She starts some private work in April 2016 hoping it might lead to a fulltime business. After a couple of successful projects, referrals start coming in from a busy boutique architectural firm. By January 2017 she is flat out. Money is coming in but also pouring out.

The busier she gets, the more she spends to save time – a house cleaner, child-care and eating out several times a week.

Sally also worries that her personal image isn’t compatible with her profession. Rolling up to a new prospective client’s home in her trusty 14-year-old station wagon wearing an old sweatshirt isn’t inspiring confidence in her as a style expert. So, she starts regularly upgrading her wardrobe. She also trades the station wagon for a respectable four-year-old SUV.

Sally’s second year in business gets even busier. She knows something must give and plans to hire some administration help, if only she had time to advertise and interview. Other than visiting an accountant when she first started up, who tried to explain her tax requirements and registered her for GST, she has done everything herself.

By February 2019, Sally knows she needs to sort her accounts out. She puts aside a day, collates her financial records and visits the accountant who helped her at the start. It is a relief to finally hand a job over, but she isn’t prepared for what is coming.

On the 20th March, her accountant emails her financial statements and a tax return showing a $75,000 profit in the tax year ended 31 March 2017. She finds it hard to believe as there sure isn’t $75,000 in her bank.

He also tells Sally she has $15,670 income tax payable for that year, due in 18 days. Right now, Sally isn’t feeling too good. She knew she should have been putting money aside for tax, but always needed things for the business.

To top it off, the “Provisional Tax” that the accountant had warned Sally about at that initial meeting has also reared its ugly head. Sally has $16,454 of provisional tax, for the year to 31 March 2018, due by 7 May.

That is over $32,000 of tax due in the next seven weeks.

How did it get to this stage?

By 7 May 2019, when the $16,454 provisional tax is due, Sally has been working for just over two years. Her tax payments on 7 April and 7 May 2018 are the tax liabilities on two years’ profits.

When starting a business, it is easy to ignore a bill that you won’t see for up to two years, especially when there are more pressing, and more interesting, things to focus on. But as soon as you are making money your debt to IRD is accumulating.

How to plan for tax payments

Every business should have a financial plan, including a cash flow forecast, to plan for major financial commitments including purchasing equipment and paying tax. The plan will show you what percentage of your income received needs to be put aside for commitments such as income tax, GST and ACC levies. Once you have these commitments clearly scheduled into your plan, it is easy to find the discipline to put the money aside. Not so when they are a big unknown on the horizon.

It is well worth a modest investment at the start of your business journey to get professional help with your financial plan and take control of your business commitments before they take control of you.

Contact us with your business questions.

Should I have a Trust

Should I have a Trust?

The media seems to portray trusts as vehicles for the super-rich, money launderers and tax dodgers. But, while they are sometimes misused, just as companies and other commercial structures are, trusts are a well-established and legitimate structure.

What is a it?

A trust is an arrangement whereby a person (the settlor) transfers money or assets (the trust property) to one or more other people (the trustees) to manage for the benefit of others (the beneficiaries). The settlor no longer legally owns the trust property.

The person creating the trust will be the settlor and may also be a trustee and a beneficiary.

The Purpose

A trust protects your assets or wealth. When you transfer assets into a trust, they are no longer in your legal ownership so are not exposed to your personal risks.

Reasons to have one

  • To protect your assets from potential legal problems. If you are sued and found liable, your own assets are fair game for your creditor, but trust property, which may include your family home, is safe.
  • To control who benefits from your assets after you die. If you have children, your assets will typically pass directly into their ownership. If your child is in a relationship, those assets will likely become part of their relationship property, entitling their partner to half on a break-up. A trust can hold the assets so your child benefits from them without them becoming part of their relationship property.
  • To prevent your assets being included in your wealth for means-assessed benefits such as a residential care subsidy.
  • To keep your asset ownership private. Trust property is in the trustee names, not your name, making it harder for the public to see what you do and don’t own.
  • To enable distributions of income and/or capital to beneficiaries at the discretion of the trustees.
    Avoiding tax is not a reason to have a trust. Contrary to some impressions, your income will be taxed whether in a trust or not. A trust does, however, provide the most flexible means of distributing taxable income among different beneficiaries.

Disadvantages

  • You no longer own the assets. If you are a trustee, you are legally an owner, but only in your capacity as a trustee. The ownership is on behalf of the beneficiaries and you cannot treat the assets as your personal property. You can mitigate this loss of control by:
    being a trustee,
    retaining the power to appoint who the trustees are, and/or
    instilling your wishes in the trust deed or a memorandum of wishes.
  • A trust requires administration. Decisions must be made by all trustees, considering the needs of all beneficiaries, and resolutions recorded. A trust may require financial statements and a tax return.
  • There are costs. A trust can be setup for around $1,200 upwards and there may be ongoing annual fees such as tax return preparation and professional trustee fees.

Can a Court Just Overturn my Trust?

Only if the trust is a sham.

If you already have a legal problem, and setup a trust to put assets out of reach, a court may deem the assets to still be yours.

If you do not include other trustees in decisions, and treat the trust assets as if they are still yours, a court may deem that no trust in effect exists.

If you have a trust, you must treat it as such.

So, is it Worth Having one?

If you are personally involved in any risky commercial endeavours, or have significant assets to protect, then a trust will likely provide your best protection and the benefits should outweigh the costs.

Trust law is complex and always evolving through changing legislation and court decisions. Make sure you get some professional advice before forming one.

Contact us with your business questions.