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An Example Business Structure

An Example Business Structure

Clive and Carla

Clive is escaping the corporate world after 20 years as a marketing executive to become a freelance consultant. He is leaving the world of high cost marketing campaigns to help small business owners build brands on a budget.

Clive’s wife Carla is a qualified accountant and will help with the business admin and finances in whatever time she has left after looking after their two preschool kids.

Their only major asset is their home with a mortgage to service.

How should they structure their affairs?

Their Questions

Clive and Carla have three criteria:

  • Risk – They don’t want to lose their house if things go badly.
  • Tax – They want to ensure they can pay their tax, without paying too much.
  • Complexity and Cost – They want to keep things as simple as practical and their costs to a minimum.
    With some research and advice, they have come up with a plan.

Business Risk

They know that business is risky and insurance won’t cover them for everything that may go wrong.

To protect themselves from potential liability to the business risks, they decide to form a company. They incorporate Clive’s Consulting Limited to own and run the business.

Clive and Carla are both shareholders (owners) of the company. As it is a limited liability company, the most they stand to lose is a nominal amount of, say, $100 they will pay for their shares. The company takes the risks, not the shareholders.

The company needs at least one director who will have responsibilities to manage the company and comply with company law. As Clive is primarily running the business, doing deals with clients etc., he will be the sole director. Directors can be personally prosecuted if they do something reckless, so they don’t see any need to expose Carla to those risks.

Protecting Personal Assets

They’re happy that the company will reasonably contain the business risks, but their biggest fear is losing their house. What if Clive is help personally liable for failing in his director’s duties and sued for millions?

Owning their home in their personal names is always going to leave it vulnerable to their personal risks which may or may not be related to the business. Personal disputes with neighbours or causing a forest fire could leave them with a liability they cannot pay.

They decide to form a trust and transfer the house into that. Once the house is owned by the trust, it is no longer in their ownership and so is out of reach of their potential creditors.

Confident Clive has plans to grow his new company into a high value investment that he can sell in the future to fund a comfortable retirement. As they now have a trust to protect their assets, they decide to put the company in their too.

On the advice of their accountant they form their company with 100 shares. 98 shares will be owned by the trust and one share each by Clive and Carla. Holding a share in each of their personal names gives them the flexibility to pay themselves shareholder salaries from the company without deducting PAYE.

Tax

Clive is confident he can generate fees of around $130K with business expenses of $30K, leaving $100K profit in his first year of business. So how will that be taxed?

A company is a flexible vehicle for managing income tax, splitting the $100,000 profit between the company, Clive and Carla.

Clive and Carla need money to live on. As shareholders, they can take money out of the company during the year to live on. They won’t pay PAYE on this as they will take it as drawings which is effectively a loan from the company. They will be taxed on their “shareholder salaries” determined at the end of the year.

Let’s assume Clive’s confidence is justified and he does make $100K profit in year one. Once the year has finished and the profit is calculated, shareholder salaries are worked out.

Carla’s Tax

Carla has worked a few hours a week. They have worked out a fair market value for this work is $20K. This becomes her shareholder salary which is an expense in the company accounts and income to Carla. The company deducts the salary expense reducing its profit to $80K. Carla’s tax return is filed, and she pays tax on her $20K income. Her tax is calculated at her individual tax rates being 10.5% for the first $14,000 of annual income and 17.5% on her next $6,000. Her tax on her $20K salary comes to $2,520.

 

 

 

 

 

 

 

Clive’s Tax

Clive has generated most of the profit through his personal efforts. His shareholder salary must reflect that, so they allocate him $70K. Clive pays tax of $14,020 on this, calculated at his individual tax rates as follows:

 

 

 

 

 

 

 

Clive’s Consulting Ltd’s Tax

After paying the shareholder salaries, the company is left with a taxable profit of $10,000 ($100K – $20K – $70K).

The company will pay tax of $2,800 being $10K times the company tax rate of 28%.

Tax Efficiency

Overall, they will pay $19,340 tax, an average rate of 19.34% on the $100K taxable income. They could save tax by paying a higher salary to Carla and less to Clive. Carla would pay 17.5% tax on additional income up to $48,000, while Clive would save 30% tax by reducing his income. However, if the shareholder salaries do not reflect the actual market values of the services provided, IRD could see it as tax avoidance and disallow the income split.

If Clive was operating as a sole-trader rather than through a company, he would be personally taxed on the whole business profit. At $100K, his tax would come to $23,920, an average rate of 23.92%. This is because any additional income over $70K is taxed at the top personal tax rate of 33%. With the company setup, this additional income is split between Carla’s tax rates of 10.5% and 17.5%, and the company rate of 28%.

Sole-Trader Tax Calculation

As a sole-trader, the business could still pay Carla some income. However, Clive would have to register as an employer and get permission from IRD to pay a wage based on the value of Carla’s work. The business would have to deduct and pay PAYE monthly.

Compared to a sole-trader setup, the company provides more flexibility and lower overall tax.

Cost and Complexity

Clive and Carla have a small business and a house. It doesn’t justify or require a large complex structure. What is involved in this structure.

Forming the Company

Incorporating a company in New Zealand is quick and cost-effective. Clive and Carla should be able to get an accountant to setup their company, including the required IRD registrations and preparing the initial company minutes and registers, for around $500.

Forming the Trust

Setting up a trust is more complicated. A trust deed will be drafted detailing who will manage the trust (the trustees), who will benefit from the trust’s assets (the beneficiaries), and the rules for running the trust. Presuming they use a lawyer to draft this deed, it may cost them between $1,200 and $2,400. Moving the house into the trust will incur some additional conveyancing fees of, say, a few hundred dollars.

Ongoing Requirements

Clive, as director of the company, must ensure it meets its statutory obligations. This includes preparing:

  • Annual financial statements
  • Income tax returns
  • Shareholder and director minutes

Generally, these will all be completed by an accountant as part of an annual compliance job. The business would require financial statements in some format whether it was owned by a company or not.

The ongoing trust management should require minimal work. The trust will only need to file a tax return if it receives taxable income from any source. Just owning the house and company shares will not require a tax return.

An annual trustee meeting and recording of minutes will normally suffice.

 

Registering your Business Name

Registering your Business Name

You don’t need to register your business name or trade name but you can apply to register a name with The Intellectual Property Office of New Zealand (IPONZ.govt.nz). Registering the name may help prevent others from using it and will assert your rights to the name if it is challenged by a competitor.

However, you can only register distinctive trade names or trademarks. For example, you could call your business “IT Professionals” but you would not be able to trademark the name. If you designed a unique logo using the words IT Professionals, then the logo could be trademarked as it would be distinctive enough that a competitor would have to copy it to use it, rather than inadvertently describing themselves as IT professionals.

If you trade through a company, no one else will be able to form a company with the identical, or nearly identical, name. You could call your company IT Professionals Limited, providing there is no other registered company in NZ with that name. A competitor cannot then call themselves IT Professionals Limited, but they could still describe themselves as IT professionals.

Most small businesses will choose a business name without registering it with IPONZ. However, it is worth checking the register at www.iponz.govt.nz to make sure you are not likely to be using a name protected by someone else in your industry or a related industry.

Another consideration is reserving the domain name for your business.

You can check whether a name is available as a company name, trade name and domain name by searching at https://www.business.govt.nz/onecheck/. The site also contains useful information on protecting your Intellectual Property.

Contact Robb with any questions.

Registering Your New Business with IRD

Registering your New Business with IRD

If you have decided to start a business, your first question may be whether you must register the business with IRD.

Let’s first clarify what a business is. A business is an activity carried on to make money. Your business will be owned and operated by a legal entity such as an individual (you) or a company. It is the legal entity operating the business that must be registered with IRD. The business activity itself cannot be separately registered as it is not a legal entity and therefore cannot form contracts in its own name.

If you start a business under your personal ownership, rather than using a separate entity, you are a sole-trader. You are the legal entity running the business and, so long as you have an IRD number, you are already registered with IRD.

If you form a new legal entity to run your business, such as a company, partnership or trust, that entity will need to register with IRD and get an IRD number.

If the legal entity is not already GST registered, and the new business is expected to sell more than $60,000 of goods or services per year, it will generally have to register for Goods and Services Tax (GST).

Contact Robb with any questions.

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.

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.