Ring Fencing Rental Losses

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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.

Year End Tax Planning

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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

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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.

New Company Car Rules

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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.

Avoid the New Business Tax Trap

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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

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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.

Entertainment Tax Explained

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Entertainment Tax Explained

As a professional or consultant, your business success relies on developing and nurturing relationships. So choosing to pay for a client’s lunch, or shouting a Christmas dinner for staff and associates, is part of doing business.

I am guessing, however, that your invitations do not normally extend to the person you’ve dealt with at IRD. Whether or not that is the reason, the taxman hasn’t quite come to the party.

The general rule, for income tax purposes, is that expenses incurred in deriving income or running your business are fully deductible. I.e., we deduct the full expense from our income when calculating our taxable profit. However, the Income Tax Act limits the deduction of certain entertainment expenditure to 50% of the cost. The rationale behind the law is that these expenses provide a significant private benefit in addition to any business benefit.

So what expenses are limited and what can we claim in full?

50% Deductible Expenditure

The Income Tax Act limits the tax deduction to 50% of spending on:

  • Corporate boxes, marquees etc at entertainment events and food and drink provided there
  • Holiday accommodation or pleasure craft
  • Food and drink provided away from your business premises, or at your premises if you’re having a social function

If you reimburse an employee for expenditure on these items, while the reimbursement may be a tax-free allowance to the employee, the cost will remain 50% deductible to the business.

Fortunately, not all expenditure on food and drink is subject to the 50% limitation.

Fully Deductible Expenditure

You can claim 100% of:

  • Meals and accommodation when travelling for the principal purpose of business, unless you are also entertaining a business contact or attending a function
  • Light refreshments provided at work including tea and coffee
  • Light refreshments at a conference or professional development workshop
  • Light refreshments that are incidental to a function, conference or seminar put on to promote your business
  • A meal at a conference where the professional development or learning time exceeds four hours
  • Meals for staff working overtime
  • Food and drink when overseas on business

Consider These Examples

  • A business consultant puts on a seminar after work for existing and prospective clients to promote the value of business planning for professionals. Drinks and nibbles provided are incidental to the primary purpose of the seminar and are therefore fully deductible.
  • An Auckland architect travels to Wellington to discuss an upcoming project with a client. After their meeting, the architect takes the client to dinner. If the architect pays for both meals, it is entertainment and therefore 50% deductible. If the architect just pays for their own meal, it is fully deductible as a travel cost.
  • The three partners of an Auckland IT Consultancy go to Fiji for an annual planning retreat. As food and drink overseas is not subject to the entertainment limitation, all expenses are fully deductible. However, if part of the expenditure is purely entertainment, this will be subject to Fringe Benefit Tax.

When Does the Expenditure Become a Fringe Benefit?

Entertainment, as above, refers to a business entertaining its staff or business contacts. If benefits are provided to employees, including shareholder-employees, which the employees can enjoy at their discretion, or it is provided overseas, it is no longer entertainment expenditure but becomes a fringe benefit.

For example, you buy your employee a restaurant voucher to use if or when they choose. This is a fringe benefit.

While Fringe Benefit Tax is a whole other area, basically, the business can claim the full cost of providing fringe benefits, but has to pay Fringe Benefit Tax on the value of the benefits.

What About Gifts?

If you give your staff cash, it will generally be considered part of their remuneration and subject to PAYE. Non-cash gifts to staff however are considered fringe benefits. As above, these are fully deductible to the business but subject to Fringe Benefit Tax.

The good news is that non-cash gifts of up to $300 per quarter (or $1,200 per year) per employee are generally exempt from Fringe Benefit Tax. Note however that if you exceed this threshold, the whole benefit is subject to Fringe Benefit Tax.

As the Fringe Benefit Tax rules apply to employer-employee relationships, gifts to clients and other business contacts are treated differently. They are generally fully deductible; however, gifts of food and drink to business contacts are subject to the 50% entertainment tax limitation. Keep this in mind when buying those Christmas hampers.

In Conclusion

The business of professionals and consultants is built on relationships, so you may choose to spend some money showing your appreciation of those relationships. But before you splash out, make sure you understand the tax implications and manage your options accordingly.

Robb MacKinlay is an accountant and business advisor to professionals and consultants, helping them convert their expertise into profitable business.

Contact us with your business questions.