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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.

Claiming for your Home Office

Claiming for your Home Office

Can you claim costs for an office at home?

Many consultants, especially sole-operators without staff, work from home. This article looks at claiming the costs of running a home that is also a place of business.

Business v Private Costs

The general rule is that you are entitled to a tax deduction for expenses to the extent they are incurred in deriving income or necessarily incurred in running a business. When running a business
from home, you have to determine whether your household costs are incurred for the business, for private purposes or both. Expenses incurred solely for business, such as your office stationery, are fully tax deductible. Private expenses, such as repairing your washing machine, are not deductible. Expenses that provide both a business and a private benefit, such as the power bill for the whole property, have to be apportioned between their business and private use with the business portion only being tax deductible. It is the splitting of these shared expenses that provides the challenge.
Such shared expenses often include:

  • Rates
  • House and contents insurance
  • Electricity and gas
  • Repairs and maintenance on the property

Calculating the apportionment by floor area

IRD generally accept an apportionment based on the portion of floor area used for the business. If a part of your home is used exclusively or primarily for your business, you can calculate its percentage of the total house area and claim this percentage of the shared costs. For example, Bill is an IT Consultant working from his home. He uses his 8 sqm fourth bedroom as an office, and a 12 sqm room behind the internal garage for storage of computer equipment and parts. This gives a total of 20 sqm used solely for business. His total house area is 125 sqm, so he can claim 16% (20 / 125 x 100%) of his shared costs. However, while a floor area calculation is the default method of home office calculations, it is not always appropriate.

Expenses proportioned by other methods

Some costs that may require alternative methods are:

Telephone

A separate business line is 100% deductible. However, if you use your home line for both private and business use, you should apportion the cost.
For the line rental, IRD will accept a 50:50 split, unless another split better reflects the actual use. For calls that incur a separate charge such as tolls and cell phone calls, you should separately analyse them and claim only the business calls.

Internet

Again, if used for both private and business, use a suitable split depending on the level used for each.

Electricity and Gas

This is especially relevant for businesses using power-hungry plant and machinery. Consultants often only power a laptop and a kettle, but you may feel your business use exceeds the floor area
apportionment. If so, a calculation that truly reflects the business use should be used to justify the higher claim. This could involve a separate meter for the business area or some other calculation.

Insurance

Again, the floor area split is the default method for home and contents insurance. However, high value business assets may justify a higher claim based on their portion of the total value insured.
Alternatively, you could separately insure your business assets and claim 100% of those premiums.

Repairs and maintenance

Repairs and maintenance costs relating to the house generally, such as water blasting the exterior or maintaining grounds, will normally be split on the floor are basis. Internal maintenance usually relates to a particular area of the house. If you repaint the office, claim 100%. If you fix the laundry door, it will be private expenditure.

Sky Television and other media subscriptions

I have had a few clients keen to claim their Sky TV subscription. If you are genuinely paying for Sky for business purposes, you should be able to make a deduction. However, an allocation is needed between private and business use.

In 2009, IRD issued a ruling regarding agricultural and horticultural workers claiming the subscription costs of Country TV. To subscribe to the Country TV channel, you have to have the Basic Sky TV package then pay additionally for Country TV. IRD ruled that the Country TV subscription was tax deductible if used for business purposes, but the standard package remains a private cost. Costs of other
channels providing a business benefit should be treated in a similar way. Likewise, newspaper and magazine subscriptions are deductible to the extent they are incurred for business purposes. If you buy a trade magazine or a newspaper specifically for business purposes, you can claim 100% of the cost.

GST on home office costs

Where household costs include GST, the GST content of the business portion can be claimed in your GST returns. Such costs will include rates, insurance, telephone and power. Domestic rent and mortgage interest are exempt from GST however. You can either claim GST on your costs in each return, or leave it to your accountant to calculate at year end.

Making your claim

In summary, if you run your business substantially from home, you should be entitled to claim the cost of providing the business area. The default calculation for many costs is a floor area
percentage. Make sure you keep a record of your calculation in case IRD ever ask for it, and records of the actual costs. The business can either pay for the business portion directly or reimburse you for the cost. The easiest way is often to keep records and let your accountant make one calculation at year end.

If you feel a claim based on floor area is not appropriate for some costs, discuss it with your accountant.

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.

Entertainment Tax Explained

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.