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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

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.

The NZ Tax Residency Trap

The NZ Tax Residency Trap

Professionals and skilled people in New Zealand enjoy enviable options with lucrative opportunities overseas and a quality lifestyle here. However, they also face a potentially expensive, and often overlooked or misunderstood, trap in unintended New Zealand tax residency. Many professionals who have left New Zealand could potentially still be a New Zealand tax resident without realising it, while others planning on moving to these shores may become one much earlier than they intend. In both cases, the financial impact can be far reaching.

In March 2014, the New Zealand Inland Revenue Department (IRD) released a new Interpretation Statement1 detailing how they determine whether someone is or isn’t a tax resident. While not a law change, it has widened the net for catching people within the New Zealand tax regime, effective from 1 April 2014.

The implication is that it is even more important to understand the rules and proactively manage your residency. You have to understand what actions may either trigger New Zealand tax residency or prevent you from terminating it.

Implications of Tax Residency

A New Zealand tax resident is taxed on all income, regardless of where in the world it is earned. A non-resident is only taxed on New Zealand sourced income. Therefore, if you are earning elsewhere in the world, the implications are vast.

Who is a New Zealand Tax Resident?

Tax residency is not the same as residency for immigration purposes. One does not imply the other. It is tax residency that we are referring to in this article.

Tax residence is determined by its own rules, involving two tests: the days present in New Zealand test and the permanent place of abode test.

Days Present in New Zealand

The first, a black and white test, is the number of days present in New Zealand. If you spend over 183 days in New Zealand during any twelve month period, you are deemed to be a tax resident. The 183 days do not have to be consecutive, and they do not have to be in the same financial year. If you can choose any two dates a year apart, and count more than 183 days between them when you were present in New Zealand, you will be deemed to become a tax resident from the first of those days. A part day counts as a full day, so the day of arrival and the day of departure are included.

The other arm to this rule is the 325 days absent rule. If you become a resident under the 183 day rule, you can subsequently terminate your residency by staying out of New Zealand for more than 325 days in a 12-month period. In this case, you will be a non-resident from the first of those 325 days. As with the 183 day rule, the days need not be consecutive.

Unfortunately it does not end there. As with much of New Zealand’s tax law, there are grey and subjective measures. Even without breaching the number of days present test, you will be a resident if you have a “permanent place of abode” in New Zealand.

What Constitutes a Permanent Place of Abode?

This second test for residency is not so clear cut and it is here that the IRD’s widened interpretation of residency bites.

This test comes down to an interpretation of each individual case. There are a number of factors to consider. No one factor alone will determine residency, but rather a weighing up of the individual factors. If, in considering the overall facts, you have accumulated enough ties with New Zealand, you will be considered to have a permanent place of abode here.

The first factor is whether you have a “place of abode”. That is, an abode in New Zealand available to live in. From 1 April 2014, even a rental property can be considered a place of abode because you could give your tenant notice and move in. However, IRD have stated that this will generally not be considered a permanent place of abode unless you have lived there previously. It seems the situation most at risk is where you leave New Zealand but keep your home and rent it out.

If you do have a place of abode, whether it is a permanent place of abode giving rise to tax residency is determined with reference to other factors. Among other things, connections of the following type with New Zealand will increase your chances of being a tax resident:

  • You intend to move to New Zealand in the future
  • You are a member of professional bodies, clubs
  • You have family based in New Zealand, and in particular a spouse and child/children
  • You frequently holiday in New Zealand
  • You have spent a lot of time in New Zealand
  • You have financial connections with New Zealand such as bank accounts, investments or superannuation schemes
  • You keep personal belongings in New Zealand. For example you have left New Zealand but stored your furniture in storage; or more likely, filled your parents’ garage.
  • You will be less likely to have a permanent place of abode if you minimise the above connections and have spent a long period overseas.

If you do have a permanent place of abode in New Zealand, also having an abode in another country does not change the fact. You can have a permanent place of abode in multiple countries.

Double Tax Agreements

A New Zealand tax resident can also be a tax resident elsewhere. Take the case of an IT professional who has moved from New Zealand to London. They could be living and working in the UK, and required to pay tax there on their worldwide income. If they haven’t broken their tax residency in New Zealand, they’re also required by NZ law to pay tax here on their worldwide income.

Fortunately, relief is available where the other country is one of the several2 that have a Double Tax Agreement (DTA) with New Zealand. A DTA serves several purposes including setting tie-breaker agreements for this dual residency situation. If you are a tax resident of both countries, the DTA rules determine which country can tax you as a resident, and which can only tax you as a non-resident. The tie-breaker rules compare your connections to each country using similar criteria as the permanent place of abode criteria above. It will usually be clear as to which country you have stronger ties, and will therefore be taxed as a resident. This relief is not available when residing in countries without a DTA with New Zealand.

Paying tax on all your income in two countries is a scary thought. Fortunately, in most cases you will receive a credit against your New Zealand tax for any tax paid overseas. If your overseas tax is lower than the tax levied on the income in New Zealand, then you will only pay the additional tax to get it up to the New Zealand level. The overseas tax paid is deducted from the New Zealand tax payable. Unfortunately, credits for overseas tax paid are limited to the amount of tax payable in New Zealand on that income. So if your overseas tax rate is higher than your New Zealand rate, IRD will not refund the difference and the excess tax credit is lost. So you effectively pay tax at the higher rate of the two countries.

A Planning Opportunity

Transitional Residence is an opportunity that New Zealand offers immigrants and returning residents who have been overseas for more than ten years. If you are eligible and choose to take this optional transitional residency, for the month you become a NZ tax resident and the 48 months following, you do not have to pay New Zealand tax on any overseas earnings other than from wages and personal services. I.e., any passive overseas income is not taxed here.

The benefit is you can move or return here and see how you settle into New Zealand life. Once you realise it really is God’s Own Country, you can start to move your investments across if and when suits. This obviously can be a significant benefit. The catch to avoid here is triggering your tax residency early which will compromise this opportunity.

It is quite possible to become a New Zealand tax resident by establishing ties to New Zealand prior to immigrating. You might take one or more extended holidays in New Zealand, form a firm intention to live here, open a New Zealand bank account, take out membership of the relevant local professional body or even buy a home. At some stage in this process, your ties may become such that you establish a permanent place of abode in New Zealand. Not only will this subject you to New Zealand tax on your salary or business income back home (subject to DTA relief as above), but your four year transitional residency will begin from the first month of your residency being triggered.

What you can do

The financial impact of your tax residency is clearly significant. The cumulative impact of penalties and interest for non-compliance can be devastating. Yet, there are many professionals, consultants and other skilled people plying their trade internationally quite possibly oblivious to their tax residency situation.

By knowing exactly how your residency is established, you can plan and manage your situation to avoid inadvertently triggering a tax residency issue.

Make sure you know your facts and manage your situation accordingly. Contact us for help managing your tax requirements.

Reference

1 Interpretation Statement: http://www.ird.govt.nz/technical-tax/interpretations/

2 Double Tax Agreements: http://www.ird.govt.nz/international/residency/dta/

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

Contact Robb for a free, no-obligation chat.

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.