This document is provided only on the basis of being an aid to understanding tax and levy issues. Vendors do not undertake or guarantee this material is a complete solution to all or any issues encountered by the purchaser. Users of this material are expected to seek professional advice before acting on anything they read below. The Small Business Institute Limited and the author of this material accept no responsibility to anyone using it for its accuracy or validity or any consequences flowing from them.
These notes were prepared in January 2010 and were current at that time.
These notes will help you save money in the following areas:
• Accident Compensation
• Fringe Benefit Tax
• Gift Duty
• Income Tax
• Rental Property
Starting in business or changing to a company
Be careful if you are starting in business or changing your business from a self employed person into a limited liability company. The ACC rules governing your entitlement are contained in Sections 37 to 40 of the first schedule to the Injury Prevention Rehabilitation and Compensation Act.
There can be risks of getting a low ACC pay out, if you have an accident, in the first year or two. This is in spite of your previous income being quite high. Get us to check the current law and , if needed, consider applying to ACC for CoverPlus Extra – see next article.
You are not bound to accept ACC as it is. You may negotiate your own deal by choosing CoverPlus Extra. Here are some of the advantages
1. By nominating the required amount of weekly compensation, instead of basing insurance on prior-year earnings, you get certainty of income.
2. There is no need to prove loss if you have an accident as ACC has accepted your cover.
3. No reduction of compensation if the business profits fall during period of your claim.
4. CoverPlus Extra can start at any time. A credit will be issued for unused levies invoiced.
5. You receive 100 per cent compensation until you go back to fulltime work. There is no reduction if you go back part-time.
6. You can nominate incomes for spouses even though profits may be split between a company and shareholders or between partners in a partnership to provide the best tax outcome. Thus if H and W are marriage partners and H gets $40,000, W gets $12000 and the company gets $3000, CoverPlus Extra allows you to insure for the whole $55,000. Ordinary ACC would insure H for only $40,000. If he had an accident the pay out would be based on $40,000 whereas the real income loss is $55,000 because W and the company are dependent on H working to earn their incomes. Further, ordinary ACC pays out on 80 per cent of the $40,000. CoverPlus Extra pays out 100 per cent of $55,000.
7. The ordinary ACC cover for shareholders of new companies is only $400 before tax per week. Could you survive for the rest of your working life on this income?
Extra on CoverPlus Extra BUT
Did you know you can reduce the costs of ACC by means of CoverPlus Extra? You do not have to insure for the full amount of your shareholder remuneration or business profit.
There are two situations:-
Starting in business
Three or more years of recorded liable earnings
Starting in business
You can go straight to the minimum threshold of $19968. You will probably find you can stay on the minimum for some years.
Three or more years of recorded liable earnings
The minimum threshold is 50 per cent of the average of the last three years liable earnings or $19,968 whichever is the greater. If you are in partnership or are a shareholder/employee in a company the minimum threshold is 40 per cent.
Remember though your ACC cover will be less than it would have been using Cover Plus. Does this suit you? Could you get a top up of cover from an insurance company, perhaps as part of a sickness policy?
ACC’s risk for accidents to those approaching 65 or over is quite low. These people could consider the option of carrying the risk themselves and switching to CoverPlus Extra’s minimum cover to save premiums.
ACC and Tax
A word of warning, however, if you have a company! ACC premiums are in two parts. They are called the Earner Premium and the Employer Premium. The first one is only tax deductible for self employed and partners. Earner Premium is a personal cost in a company.
ACC bills the shareholder instead of the company when they take out CoverPlus Extra. Thus the bill is no longer a company cost and the entire expense is now non tax deductible. Likewise, no GST is claimable on the employer premium. Since the employer premium is often so much smaller than the Earner Premium, this may not concern you. From a claims point of view it makes no difference. The income is taxable under both schemes.
Had a bad year?
This comment applies to companies. It would be unfortunate if you were to have an accident shortly after a bad year. ACC would pay you based on the income for your last financial year. Low income equates to low ACC pay out. You should consider switching to CoverPlus Extra if your income falls.
If you are trading as a company and working full time, you would be entitled to nominate any salary for yourself you like. If you were to boost your personal income and the company were to make a loss as a consequence, you would also increase your ACC pay out. ACC would only be likely to challenge you if you had been unreasonable. The company could carry the loss forward or, if a Loss Attributing Qualifying Company, transfer it to shareholders.
One wonders whether some accountants might be tempted to hold back filing clients’ tax returns with IRD to the last moment, when their clients previous year’s income has been low, just in case an accident occurs late in the year.
Partnerships – classification rule can save money
The following rule is very restrictive. Partners may use ACC classifications relating to the work they do for the partnership. This change started from the year ended 31 March 2001. It applies:
• to the residual claims levy only;
• to partnerships only, not companies;
• where the person is in one partnership only.
A sleeping partner is not liable to pay any residual claims levy.
Salary reduction means reduced ACC claim
If you are a shareholder in a private company and limit your income to minimise tax at 38 per cent, you might also be limiting your ACC payout for an accident. We suggest you discuss this with your insurers or consider Cover Plus Extra.
Fringe Benefit Tax
Annual basis for FBT registration
If you are a small business having a payroll generating less than $500,000 PAYE deductions per year, you are entitled to register for paying Fringe Benefit Tax on an annual basis. There are rules to follow. We won’t go into those here.
Just be aware the $300 limit per quarter for providing fringe benefits of an unclassified nature like presents (not interest free loans, use of motor vehicles etc) to a staff member becomes $1200 limit per year.
If you gave a benefit in one quarter worth $350 and were registered on a quarterly basis, there would be no exemption. You would pay Fringe Benefits Tax on the whole $350. On the other hand, if you were on an annual basis and that were the only benefit for that employee, then the exemption would apply and you would pay no Fringe Benefits Tax.
If you employ staff, register with IRD to pay FBT annually, just in case you need that extra exemption. You can easily send a nil return in each year you don’t provide any benefits. Sometimes IRD cancels the annual basis if you are not paying any FBT. If this happens to you, request it be reinstated. You will need to insist the department back dates the reinstatement to when they cancelled it. If you don’t, the reinstatement will not apply until the beginning of the next year.
There is an over all limit of $22,500. The law says Fringe Benefits Tax is payable if “the total taxable value of all unclassified benefits provided in the last 4 quarters including the current quarter by the employer to all employees of the employer, whether accounted for on a quarterly or an income year basis, is more than $22,500.” You will notice the last 4 quarters can straddle two financial years.
Cost of a vehicle for FBT purposes
Cost includes the following. All figures are GST inclusive
• Purchase price of vehicle.
• Initial registration and licence plates.
• Accessories, components and equipment (other than business accessories) fitted to the vehicle.
• Sign writing.
• Painting the vehicle in company colours.
• Cost of transporting vehicle to place where it will be first used.
Cost does not include the annual vehicle re-licensing fee.
We suggest you note this list. Be sure to look out for these costs and account correctly.
Any car available for the private use and enjoyment of an employee or one of their relatives or associated persons is subject to Fringe Benefit Tax. So, if the company buys a car and makes it available to a shareholder who is also an employee of a company, a Fringe Benefit Tax liability arises. It is calculated based on the cost of the car, and sometimes the depreciated book value of the car. A low cost car generates a low tax.
Therefore, it makes no difference how much the car is used. The tax is the same whether the car travels 3000 km a year or 30,000 km per year. The more the car is used privately, the better deal you get.
For more information about cars and Fringe Benefit Tax see next article.
Company car continued
This is such a complicated subject. As many people have difficulty with it, we thought it would be helpful to provide you with a few comments.
If a company owns a car, which is available for the private use of an employee, Fringe Benefit Tax (FBT) is payable. The term employee includes you, if you are a working shareholder. Note the use of the word “available”. The vehicle does not have to be used privately for you to incur the tax.
The tax is calculated on 20 per cent of the original cost of the vehicle (including GST) or 36 per cent of the depreciated book value. If you or an associated person/close relative have owned the car within the last two years and it is sold to the company at its current market value, the original amount the vehicle cost you or the associated person/close relative is still used for the FBT calculation. This is to stop people transferring ownership of their private car to their company at today’s value to reduce this tax.
How do you minimise FBT?
The vehicle is a car, so the law assumes taking it home is private use. If you run your business from your home then you could argue you are garaging it at the company’s premises. You are not really taking it home. Now you have to prove, to IRD’s satisfaction, this is true. You can assist with this by getting another director/officer of the company to write a letter to you telling you, you cannot use the car privately. If there is only one officer of the company you will need to write the letter to yourself. As this doesn’t look good, you could consider getting your accountant to write the letter. IRD has set out the letter for you in its FBT booklet. Then you must go and check on your fellow director/yourself at least once a quarter to see they/you are not using the vehicle privately. Go out your front door, look in your carport or garage and then go back into your house and make a written note you have checked and ensured your vehicle is not available to be used for private purposes.
Nonsense? You may think so, but this procedure may satisfy the master.
If you want to use the car say at weekends, you can give yourself written permission to do so and pay two-sevenths of the FBT. Similarly, you can apply to the fellow officer or yourself to use the car for your holiday and pay the FBT. IRD does not like you picking odd days here and there. For example, you choose either all weekends or none.
The law assumes we all need cars. If you say you will not use the car for private running, you had better have access to another vehicle. No one will believe you remain a hermit until the weekend!
Some people as an alternative to paying FBT pay their company for the value of the benefit, which we usually attend to by means of a book entry when preparing the company accounts.
There are other options. You can own the car yourself and charge your company mileage at IRD specified rates or you can use the AA rates, which are usually a better choice. An overall 5000 km limit can apply to mileage rates. Consult us for details.
Generally, FBT is not such a bad tax. It often works out to favour the taxpayer. The best deal is a low-cost car used for plenty of private running.
Many people who have family trusts overlook their annual gifting. There is no limit now on the amount a person can gift. There needs to be a Deed of Forgiveness of Debt. Large lump sum gifts are now allowed but careful consideration is needed before completion.
Avoiding GST registration until absolutely necessary
You must register for GST when your sales for any 12 month period (or less than 12 months) are expected to exceed $60,000. Anyone starting a business, who wishes to defer registering for GST as long as possible, could be better off by getting their customer to buy the materials and charge for labour only. This is particularly applicable to builders. Care is required however, as if you do exceed the threshold you will need to pay GST even if you haven’t charged it to your customer.
Buying real estate
If you buy a property for domestic rental, there is no GST involved. Residential rental accommodation has been specifically excluded from the GST net. This means you can’t claim GST when you buy and you can’t claim GST on rates, insurance and other expenses. Equally you don’t have to pay GST out of the rent you receive.
All other rental property is treated differently. If it will generate income of more than $60,000 per year, you must register for GST. If under $60,000 you may register if you choose.
Assume you would be entitled to claim the GST on the purchase price of the property. There are traps you must be aware of:
1. Payment has not been made until your solicitor hands over your money to the seller’s solicitor. Inland Revenue will penalise you for carelessness if you claim your GST back too soon.
Imagine you are registered for GST on a two-monthly basis. The solicitor receives payment from you and your bank on 27 May. Your GST period ends on 31 May. Settlement is due on 30 May. Your lawyer is sick so he or she doesn’t actually pay the money over until 3 June. You believe you have paid for the property before 31 May. Your solicitor doesn’t think to ring you, not realising the GST implications. If you claim GST in the 31 May GST return, you may be charged a hefty penalty even though IRD has not even paid you your GST refund.
2. We have also struck cases where properties have been registered in the wrong name. A client bought a commercial property for his company but the registered owner of the land was showing as him and not his company. The company claimed the GST. It was disallowed. The IRD did not impose a penalty but they might in the future.
3. Cases have also occurred where the tax invoice is made out to the wrong party. For example a contract was signed in one name then an associated party, say a trust, actually completed the contract.
Going concern becomes a GST concern
When a business changes hands as a “going concern” the transaction may be zero rated. This means no GST is paid by the seller or claimed by the buyer.
The advantage of zero rating is to minimise the money the buyer needs to pay out. Without zero rating, GST would be paid to IRD and then claimed back: a pointless exercise.
Arguments developed between buyers and sellers as to whether the business was a “going concern”, so the law was changed to require a written agreement confirming this. In addition, both parties must be registered for GST.
Recently, a property was sold to a buyer (or nominee) and the agreement contained the words “as a going concern”. The seller expected the buyer would be GST registered and assumed there would be no GST to pay. However the substitute buyer (the nominee) was not actually registered for GST. The buyer subsequently registered for GST and made a second-hand goods claim.
In the case I’m telling you about, the buyer claimed the refund. IRD then claimed GST from the seller, who, in turn, sued the buyer. The seller lost the case under section 78E (Goods and Services Tax Act 1985) which gives a right of recovery, because the contract stated that the price was “GST inclusive”.
You should also be aware there is still a common-law right to nominate another buyer and a “novation” agreement may need to be used, even though the agreement may not have the words “or nominee” in it. If zero rating, make sure the contract reads “plus GST if any”.
At the time of writing, it looks as though the law will be changed to remove some of these problems.
Hire purchase type agreements
Be sure you really have a hire purchase contract or a contract under which you acquire the asset at the end of the lease and not just an agreement for spread payments. It must be written in the contract. Claim GST on the full cost of the item excluding all finance charges. Make your claim in full when you buy. Do not claim any GST when you pay the instalments.
Tax invoices for petrol
Those little chits you receive when you buy petrol are not always tax invoices. As I write this, I am looking at a petrol station chit. It shows the date, how paid and records purchases and the amount. It is not clear the purchases were petrol and the document is certainly not a tax invoice. You must hold a tax invoice for purchases over $50. It will include the words “Tax Invoice” and the supplier’s GST number as well as other data.
Tax invoices – make sure you have them all
If there is a GST inspection, the first thing the inspector will look for is tax invoices. Can you answer yes to these questions?
• Do you have a current tax invoice for your rent?
• Do you always get a tax invoice when you buy postage stamps, costing more than $50 at one time?
• Do you ever check for missing tax invoices?
For amounts in excess of $1000, do you make sure all the details are on the tax invoice? Do you know what these are?
Tax invoices for more than $1000 must show name and address of the buyer, name and GST registration number of the seller, the words “Tax Invoice” in a prominent place, quantity and description of goods or services supplied, amount charged plus GST or statement GST is included.
• Do you make sure you have a proper tax invoice when you buy a car – if buying from a non registered person, keep a record similar to that needed for a tax invoice, but excluding GST number, of course, because the seller won’t have one.
1882 style tax
When Dr Arthur Conan Doyle put in his first tax return showing a very low income and no tax to pay, the IRD wrote across his tax assessment notice “most unsatisfactory”. He apparently responded by writing back to them agreeing. It was Victorian times. IRD was not amused and called for an explanation.
80 per cent Attribution Rule
Does the 80 per cent rule apply to you? If your partnership, company or trust has business income, derived from personal services, of more than $70,000 and 80 per cent comes from one source, then this law might affect you. If your income is coming from related businesses, they will probably be deemed to be one source for tax purposes.
People in the software industry, couriers, truck drivers and doctors are among those who should read on.
IRD ignores the partnership, company or trust and treats their income, for the purposes of assessing tax, as your income. This means you pay 38 per cent tax instead of company tax at 30 per cent or trust tax at 33 per cent.
The law has been difficult to put together because it has had to cater for exceptions.
Suppose a truck driver has a vehicle worth $200,000. Part of the income is a return on investment in the truck. The lawmakers decided any asset costing $75,000 or more would entitle the owner to an exemption from this rule so long as the asset is a necessary part of the business structure that is used to derive the total income from personal services.
Next they decided the $75,000 was too arbitrary, so they added “or costing more than 25 per cent of gross income”.
Then someone started worrying about the asset being used privately. This gap was stopped by insisting private use be less than 20 per cent.
How do people avoid this legislation?
• They ensure their income in any financial year comes from more than one source, no one of which totals 80 per cent of earnings. Those whose situation is marginal could be better off taking a holiday!
• They buy more expensive assets to exceed one of the two thresholds.
• They arrange their private use of assets so they do not reach the 20 per cent limit.
Your income sources are not obvious to us when we prepare your accounts. Please be sure to tell us if you think the attribution rule may apply to you.
American way (Guilty until proven innocent)
In New Zealand the taxpayer has to prove he/she is right. Many people believe the traditional approach to the law is followed: The IRD has to prove its case. This is not so unless IRD alleges tax fraud.
Here are a few suggestions:-
1. Document to absurdity. Try and record your reasons for any action which might be challenged by IRD. For example, if you travel overseas keep comprehensive records of who you visited and what you discussed and when you called. Keep notes of your preparation for the trip and your follow up afterwards. If you took your spouse and are attempting to claim costs then record your justification. Take some professional advice because IRD has a pretty negative attitude to allowing your partner’s expenses.
2. Dot your i’s and cross your t’s. If you sell your vehicle to your own company, for example, actually sell it. Minute the transaction and get the company to pay for it, if possible. An accounting book entry will also suffice. The vehicle should be sold at market value. Get a written valuation. If you are not inclined to do this, at least keep clippings from the newspaper to support your valuation. The onus is on you.
3. Transactions which reduce tax should have commercial reality. If you pay your spouse a director’s fee be sure you can justify this. Obviously, the person should be a director. What do directors do? They attend directors’ meetings, minutes are kept and so on. There is no objection to making the minutes very brief such as recording decisions and the duration of the meeting. Many fire side chats between marriage partners about the development of the business are in the nature of directors’ meetings.
Asking the tax department – Don’t
The Dominion Post newspaper dated 24 August 2002 reported that, of the answers to taxpayer enquiries supplied by the IRD, nearly a quarter are wrong and more than half those dealing with GST are incorrect.
The Department is not responsible for its mistakes. You are expected to find the right answers and to seek expert advice if needed.
It is no use saying an IRD staff member told you, even if you can quote the person’s name and the date you were advised.
This was the lead story in the Dominion Post on that day. If you have a tax problem, consult us: if we do not know the answer immediately we can find it.
A few days after this news item, IRD claimed their May 2002 survey showed 99 per cent of taxpayer calls are answered correctly.
A few years ago a client told her accountant how she solved her tax problems. She would ring three branches of the IRD with her question. She would compare the answers and if there was one which suited her, she would accept it and make her tax claim accordingly. She figured if she were ever challenged she could always say she was advised by the IRD and followed this.
The IRD has a big staff and it would be impractical for the Department to train all its employees, to the level of a tax consultant. Tax law is vast and it requires considerable experience to understand the nuances.
An example is the fine line between personal and business expenditure. Why, for example, if I have to have a car for work should the costs of running it between work and home not be tax deductible? If I need reading glasses to do my job, why should I not be able to claim them as a business cost? If I meet regularly with friends for a drink and I do business with them, why is this considered a personal cost? At other times, having a drink with business associates can be accepted as a business entertainment cost. We should not expect IRD staff to have such a detailed knowledge.
Tax law is built up from a mixture of statutes and case law. Every year there are acts of parliament and regulations which change tax law and there are cases decided in the courts which also change the law.
If you seek the advice of an officer of the IRD, you do so at your peril. The Department will not stand by the advice given by one of its staff. Some years ago a company called New Zealand Geothermal wanted to know if employees engaged on an overseas contract and working outside New Zealand would be subject to New Zealand tax. In spite of having disclosed fully all information and having received a letter confirming there would be no need to deduct any PAYE, two years later the Department changed its mind and demanded the tax. New Zealand Geothermal pointed to the letter and claimed payment of the PAYE at this stage, would be disastrous for the company. The matter went to court. Fortunately, in this case, the Judge found the IRD’s original ruling to be correct and New Zealand Geothermal lived on. It does not always go that way.
Avoid ringing IRD for advice. If you are tempted, do not rely on the answer you receive. You could still be up for any short paid tax plus interest and a penalty. IRD could say you should have sought professional advice. IRD advice is not considered to be professional advice.
If you want to be safe, you can obtain a “binding ruling”. You would pay for this. Commonly they cost about $6,000 and upwards, and if IRD is not happy it sometimes refuses to rule.
Borrowing for your company
Small companies are often financed with substantial loans from shareholders. This does not have to be the case. Shareholders can arrange for the company to borrow and repay money owing to them. They will probably have to offer their home as security but this does not make the loan a personal one.
The use to which the money is put determines the tax deductibility. If the company borrows money to refinance its debt to shareholders, the money is being used for the business. The interest is tax deductible.
Many clients overlook this opportunity. They will use hire purchase to buy themselves a new car when they could have got their company to borrow the money and enjoyed a tax deduction of the interest. When a shareholder rearranges finance so the company borrows the money, we recommend there is a letter from the shareholder to the company demanding repayment of the current account.
As usual, it pays to check with us before proceeding.
Builders and Developers
Tax law is complicated for anyone involved in property development. Your home and rental properties can get caught in the tax net. Your relatives, particularly your spouse, can also find themselves similarly caught. Check carefully with us if you are contemplating any property development.
Buying a business
Most people pay for the following:-
• Furniture and Fittings
• Stock at valuation
Usually the seller retains the accounts receivable, accounts payable, bank accounts and often, particularly in the case of very small businesses, the vehicle(s).
IRD does not usually interfere with prices set between buyers and sellers so long as the transaction is at “arms length”. However if the prices paid are silly they can and have successfully used the anti avoidance provision to upset the arrangement. “Arms length” means the buyer and seller are strangers.
At the time of writing, it appears IRD is putting this one in the too hard basket. You are supposed to adjust for the private use of your cell phone but we have never been told how this can be done. Inland Revenue have indicated they may waive any adjustment for private use where it is merely incidental.
For employees and shareholder employees providing the cellphone is primarily for business purposes, no FBT is required to be charged in respect of private use
No, no, no. There are no circumstances allowing you to claim for someone to look after your children, as a business expense. This even applies if you have to travel away from home on business. Child care is a personal cost. You can claim a rebate. Use form IR 526
Claiming expenses for income tax deduction
Income tax rules are slightly different from GST. You don’t have to be able to produce a Tax Invoice to comply with Income Tax law. All you have to be able to show is the money was spent for the business and it was a proper business cost. Whose name appears on the invoice may not be important for Income Tax law purposes as long as the expense belongs to the company. You don’t really have to have an invoice. The trouble is if you don’t, how do you prove you are right?
A client was being inspected by IRD. The inspector looked at his entertainment expenses. There were some bills missing. The client appealed to the inspector to allow the costs anyway. He explained as no discrepancies had been found, it was unlikely the entertainment expenses were false. The inspector agreed and accepted the claims.
Most companies have a small share capital. This usually means the owners have to lend money to the company for it to operate.
If in doubt, keep your share capital small. If it was big and you wanted to get some of your money out, you might find yourself borrowing back the share capital. Money you borrow from the company will give rise to a liability to pay Fringe Benefit Tax, unless you pay an adequate rate of interest for the loan. Share capital can be repaid but this has a high administrative cost
You can run up business costs on your personal credit card. The invoices should be made out to your business. If ever they are not, you may still be able to claim GST by treating the payments as a reimbursement of an employee (you).
At the time of writing, the air points you derive from your personal credit card are not taxable.
Depreciation - Appreciating the effects of
I have often been told a business, particularly a new one, is not making a profit because the expenditure matches the income. The client gets a shock when I disagree and demonstrate there is a profit and hence some tax to pay.
The difference between my way of calculating the profit and my client’s often arises from the client including equipment as part of the expenses. It can also occur because the client is looking at his bank transactions and overlooks money earned but not yet in the bank (his or her debtors or work in progress).
The machines, furnishings, etc you need to run a business, are called assets. They differ from other expenses such as telephone and power costs because they can be used for several years. Accountants attribute a proportion of the cost to each year and call this depreciation.
Do not let anyone tell you depreciation is not an expense. This has never been more important than when you are buying a business. In fact, you will often find, in a well established business, the annual expenditure on equipment is similar to the depreciation.
If you have one major asset, such as a truck, you need to try and save as much as you can of the annual depreciation. If you can achieve this, you are likely to have most of the money when replacement is needed. If not, you will continue to be paying a large part of your profits to a finance company.
You must get depreciation right. If you under claim, you are deemed to have made the claim but cannot get a deduction for it. Don’t forget new assets (excluding some buildings) are depreciated at a faster rate than second-hand ones.
Directors’ fees – companies only
If your spouse’s income is taxed at a lower rate than yours, you may be able to save some tax by paying a director’s fee as well as for work done for the company.
There are statutory responsibilities imposed on directors. Also, you probably discuss the business regularly. Therefore, if your spouse is a company director, you may wish to pay for the service.
If you want to be particularly smart, make brief notes of every informal discussion. Treat these as minutes of directors’ meetings. You don’t need to record much. The duration of each meeting would be useful.
If your company has retained some of the business profit for the year, you may need to pay a dividend. This will affect only those whose company has been subject to income tax.
Our concern relates to your shareholders’ accounts in the company books. You are an employee of your company. If you draw out more money than the balance owing to you, Fringe Benefit Tax (FBT) becomes payable. If a family trust owns some of the company shares, it is an “associated person” and is treated the same way. It cannot be credited with any money until there is a formal declaration of a dividend. Therefore it is not entitled to any drawings.
Many small business owners draw most of their profits every year. This seldom generates a problem so long as all the profit is credited to them as directors/shareholders, at the end of each year and none to their company. However, as soon as some of the income goes to the company, these people may have an FBT problem unless they declare a dividend and rearrange their drawings.
Declaring a dividend requires compliance with company law as well as tax law. Directors must show the company can pass the solvency test. They must sign a certificate to this effect, as well as resolving to declare the dividend. The solvency test requires them to show the company can pay all its bills, after the dividend has been declared, as they fall due. It also requires them to be able to show the company assets are worth more than its liabilities, including contingent (often related to a dispute) liabilities, after the dividend has been paid or credited.
Tax law requires you to have sufficient company tax paid by 31 March, known as Imputation Credits, to cover all dividends paid. If you think you may not have paid enough tax by this deadline, don’t wait until April 7 to pay your company tax. It is safer to send the money to Inland Revenue by March 31.
Shareholder salaries are deemed credited as at the beginning of the year. This helps make sure shareholder accounts with the company remain in credit. Dividends, however, are normally not credited until they are declared. The Companies Act requires you to apply the solvency test at the time the dividend is paid out, so it is good practice to pay the dividends as soon as they are declared. If you cannot make this payment and need to leave the dividend as a debt owing to the shareholder, you will have to apply the solvency test and sign a solvency certificate again, when you have the cash to pay out the money.
There is now no limit on the level of donations that may be made by a company except where the level exceeds the amount of profit of the company. The donations cannot make the company go into loss otherwise the loss is non tax deductible.
You can make the donations yourself and claim a personal rebate. Donations you make are limited to your taxable income. The tax credit is 33 1/3rd of the amount paid.
Employees on PAYE can make donations through the payroll system and receive the tax credit off their PAYE.
Having trouble deciding which expenses are 50 per cent deductible and which 100 per cent? Here are a few guidelines. It pays to check the detail in the IRD publication IR268, which can be downloaded from the internet, or by ringing us.
50 per cent deductible
Presents to customers which are food or drink.
Entertaining customers or staff at your office.
The corporate box at a sports venue.
Travelling expenses for getting to and from a staff party.
Food and drink when out of town but entertaining a client.
All business lunches for clients.
100 per cent deductible
All expenditure incurred overseas.
Food and drink for your staff either as normal morning or afternoon teas or working lunches.
Food and drink for employees while travelling on business.
Employee or contractor?
IRD gets upset when people claim to be self-employed to avoid having tax deducted from their income.
Registering for GST and providing invoices is not enough. Mostly, being self-employed is self-evident. However, there are grey areas.
IRD has produced a pamphlet to help you. It is the IR336.
An “employee” who gets it wrong will have expenses disallowed and face possible penalties and interest going back for at least four years.
IRD publication IR336 sets out the criteria IRD uses for determining whether a person is an employee or in business.
Some people think if they register for GST they can call themselves contractors. Be very careful as this is a trap for employers. Be guided by the publication IR336. It is no defence to say the person working for you is registered for GST. That has nothing to do with whether or not PAYE deductions should have occurred. The employee could also be in trouble. IRD could cancel back-year expense claims and may be able to charge Use of Money Interest as employees are not allowed to claim any expenses. Some of the factors the Department considers in relation to the “employee” are:
• Does the employer control the “employee” e.g. the hours of work and when holidays are taken?
• The risk taken e.g. Use of own equipment (not just small tools) and who takes responsibility for losses.
• Who provides training?
• Can that person employ others to do the work?
• Freedom to do work for others.
Employing the family
It is acceptable to employ both your spouse and your children. If a sole trader employs his/her wife/husband, he or she must obtain prior approval from the IRD. Wages paid to a spouse will only be recognised as a tax deductible cost from the time approval has been granted. The Department requires specific information.
The prior approval rule applies only to sole traders. Partners have to enter into a written contract which has a minimum period of three years and companies are merely required to show they can justify their salary decisions, if called upon to do so.
If you pay your children, be sure to deduct tax if their annual income is going to exceed $2340. The tax paid wages should be lodged into a bank account in their name or paid to them. Parents can be trustees for their children and apply the money in accordance with trustee law, but the money can never be used for the children’s “necessities of life” as that is the parents’ responsibility and the courts will disallow the tax deduction. Be sure you can justify the amount of wages you pay to your children. You do not require prior IRD approval.
Estimating your tax
It is often tempting, when you expect a low income year, to reduce your provisional tax by estimating it. Be very careful if you do this. You must ensure you have sufficient paid at each instalment date or you will be charged Use of Money Interest on under payments.
For example: You estimate your tax at $6000 and pay three instalments of $2000 each on time. When your tax is calculated, some time after the end of the tax year, it works out to $10,500. You have short paid $1500 at each instalment date and will have to pay Use of Money interest. By estimating, you have put yourself into the interest regime. Your alternative would have been to have paid the tax based on the previous year and waited for your refund at the end of the year.
Evasion, Tax Avoidance and Acceptable Planning
Most people prefer to pay as little tax as possible. This article will explain when it is OK to minimise your tax and when not.
The Oxford Dictionary shows the words avoidance and evasion as having the same meaning. Not so with taxation. Evasion means deliberate illegal ways of dodging tax. Avoidance involves legal ways to minimise tax but can be upset by the IRD.
Acceptable Planning is using the law in a way which was intended by the Government. You must be able to prove the government intended you be able to get the advantage you are seeking. For example, investing through a PIE can mean your maximum tax rate on your income from that investment is 30 per cent instead of 38 per cent. The Government intended to make this tax saving opportunity available.
This is the deliberate action of either failing to declare income or the deliberate inclusion of expenses which are not tax deductible. The emphasis is on the word deliberate. If you can convince a judge you did not realise you were erring, you will not be guilty of evasion. You might still have tax and penalties to pay but IRD will not be able to impose the highest penalties reserved for tax evasion.
Tax avoidance is becoming a difficult area of tax law. While it may be legal, it is increasing coming under the IRD microscope.
Tax avoidance refers to tax only. Rearrangements to avoid Use of Money Interest cannot be upset by IRD.
Tax deductibility depends on the nature of the expense. If the fee is for rights limited to a specified time within your contract then the fee may be claimed as a tax deductible cost over the period for which you have that license. When negotiating, ensure, as much as possible of the expense is tax deductible. Get advice.
Government stock and other bonds
The difference between the cost of bonds and the amount you sell them for, or you receive on maturity, is taxable. Please contact us if you think this affects you.
From April 2007 the law allows people to pay provisional tax with GST. Those entities which have less than $150,000 of Residual Income Tax, are GST registered and pay tax with GST, will not have to pay UOMI provided they pay their tax on time.
Applications to use the GST ratio have to be lodged with IRD before the tax year starts.
Interest on money borrowed for your business is not always tax deductible. Beware when borrowing for your company. If you borrow the money and on lend it to the business, the interest is being incurred by you so is not a company cost. It is far better for the company to borrow the money, perhaps using your home as security for the bank.
Suppose you have borrowed the money yourself. Don’t worry. You can on lend it to the company and charge interest. Be sure you make a small profit. If you borrow at 7 per cent on lend at say 7.5 per cent. Record the small profit in your personal tax return.
This is important. You will find if you look at the heading Company Shares, I have recommended you keep your share capital small and make up the rest of the money you need, by making a loan to your company. If you want to borrow money for personal purposes, have a look at how much your company owes you, first. If the sum is large enough, you could tell your company, if it had ears, to borrow the money so it can repay the debt to you. There is no reason why you should have to fund your company. Let the bank do it. The interest will be tax deductible. Important? A client came in for some advice on saving tax. His company accounts showed the company owed him about a quarter of a million dollars. He was moving house and needed to raise a $200,000 mortgage. He could have made all the interest tax deductible by following the advice I have just given you. By the time he had come in for the consultation he had completed the deal a mere three days previously. He had borrowed the money himself and the interest was not deductible. It could have been if he had sought help just a few days earlier. Ow!
Circumstances of each case can differ. Definitely seek advice before repaying yourself.
Downloading intellectual property from the internet may make the supplier subject to non resident withholding tax. It is the New Zealand resident’s obligation to deduct this tax from the grossed up payment. Be careful when buying software from overseas. Under IRD’s current interpretation packaged copies that many people purchase are OK. E. G. windows, anti virus software, etc. One off type software may be subject to the tax though.
Grossed up means you find out the figure which, when you deduct the tax, gives you the amount of the remittance.
Investing - claims for expenses
You can make a tax claim for monitoring fees of a financial institution if they are directly related to deriving income. Money borrowed to buy shares which will yield dividends can be claimed. However, normally, you cannot claim expenses relating directly to dividends, such as attending an AGM.
There are some common myths in the IRD:-
1. You have to have a room set aside for business in order to claim for the use of your home.
This matter was settled against the IRD about 40 years ago. A solicitor claimed for costs relating to 1/3rd of his dining room because he used the dining room 1/3rd of the time for business. You merely have to take the proportion of the house or room used for business.
2. If you are trading as a company or trust, you have to have a tax invoice made out to that entity.
It can be made out in your name if you are working for the business. If you pay the bill and the company pays you, this is an employee reimbursement, which is permitted for GST purposes.
3. A company car has to be registered in the name of the company.
Motor vehicle registration is not conclusive evidence of ownership. If the business has paid for the car and, if there is also a company minute supporting this, there is pretty conclusive evidence of who owns the car.
Keep good records – the onus is on you
Keeping good records is very important for tax purposes. It is your responsibility to justify your claims for expenditure, if called upon to do so. Therefore, the more documentary evidence you keep the better. Sometimes copies of the bills are either not available or are insufficient evidence.
If you go overseas, keep a diary as evidence of your business activity.
A way to keep a reasonable record of casual, low-cost entertaining, such as a coffee shop lunch, is to keep a notebook of the date, cost, who was entertained and a brief note of what was discussed.
Car parking presents a problem. Meters do not provide receipts. You can only do your best. One way of accounting is to put, say, $20 of small change in the car and each time you top it up with another $20 of your own money, draw a cheque or make an internet transfer to reimburse.
Those who take a work-related vehicle home should be familiar with the IRD requirement for the employer to write to the employee prohibiting its private use. Also, get the employee to sign this letter agreeing to the arrangement.
The employer must check at least once every three months to see the employee is obeying. Do you do this? Do you write a diary note of the date and time of inspection?
The same rules apply if you are the sole shareholder/employee of your own company. You could write yourself a letter etc. – see Company car continued in the FBT section. A judge has recently commented doing that, isn’t enough, that perhaps the company’s accountant should write the letter to the sole director. Have a pile of blank forms to record you have carried out the inspection and fill them in once a quarter to show you have complied. If there is more than one director, get another to write the letter etc.
If your company borrows money, make sure the documents you sign are on behalf of the company. Banks or lawyers have been known to get this wrong, particularly if the money will be used to buy you a new home. This error can prove expensive.
IRD selected a family trust for a thorough examination. The first thing they asked for was the trust minute book. Are you keeping good trustee minutes?
Be very careful with your paper work especially for major transactions and most especially if you have a family trust.
Look Through Companies
Look through companies replaced LAQC(Loss Attributing Qualifying Companies) on 1 April 2011.
Their operation is similar to LAQC’s in the sense that the losses are attributed to the shareholders in line with their shareholding.
They vary from LAQC’s in that profits are also attributed to shareholders. The reason both profits and losses are attributed to shareholders is that the underlying assets and liabilities are, for tax purposes, treated as being owned by the shareholders as a partnership.
From a trading point of view the look through company is treated as a normal company with limited liability.
Shareholders can be paid a PAYE salary if they work for the company.
Look through companies may still be an appropriate entity for rental properties where they are negatively geared, particularly where there is proportional ownership of the property such as two families involved, but each case must be reviewed on it’s own merits.
Leasing a car
There are two types of lease for tax purposes:
The operating lease is the normal concept of a lease whereby you never own the car. The maximum time you can lease a car on this basis is 45 months. The payments are treated as an expense. It is important you or any associated person have no written rights to buy the vehicle and it must be returned to the supplier at the end of the lease.
The finance lease is one where you really own the car, or will own it and the vendor is spreading out the payments for you. If the lease lasts for more than 45 months it is a finance lease regardless of whether you will ultimately own it.
Finance leases, for tax purposes, are treated in the same way as hire purchase. The car is treated as an asset of the business and the debt to the seller or finance company is recorded. You can claim depreciation on the car and the interest content of your instalment payments. The debt repayment element of your payments is not tax deductible.
Letter from the IRD
If you ever receive any correspondence from the IRD indicating some action is required, contact us immediately. Ensure you get follow-up action before the deadline stated in IRD correspondence.
Failing to meet deadlines can be disastrous. If they write to you instead of us, the fact the letter was sent to the wrong place is no defence against missing the deadline.
Loan from spouse
Please read Tax Planning for the future, which appears below.
Loans to staff
If you lend money to your staff, you are providing a fringe benefit unless you charge IRD’s specified interest rate. If you provide an advance on salaries or wages, there is an interest free loan in existence for this short period of time. There is an exemption for small amounts up to $2,000
Some people try to get round this law by lending the money privately rather than through their business. Sorry, this is not allowed - the FBT tax laws apply even if the loan is private.
Log book – when did you last keep one?
If you are a sole trader or are in partnership and use a vehicle for both business and private running, you must keep a log book unless all the running is for business only. If there is only the one vehicle available for the business and family, the IRD will assume it is being used on occasions for private use.
The following has been copied from an Inland Revenue publication. These are the minimum logbook requirements:
Section DH 3 (2) requires that a logbook meets these conditions:
• It is kept for a period of not less than 90 consecutive days
• It records complete and accurate details of the reasons for and the distance of journeys undertaken for business purposes, and such other details as required by the Commissioner.
• It records the total distance travelled by the motor vehicle during the period the logbook is maintained.
• It is kept for a period that represents or is likely to represent the average business and private use of that vehicle over the three year logbook application period.
Inland Revenue requires that the following information be recorded in a logbook, in a legible and understandable format:
• the start date of the 90 day logbook test period
• the odometer reading at the start of the 90 day logbook test period
• the date of each business journey
• the starting odometer reading for each business journey
• the ending odometer reading for each business journey
• the origin and destination of each business journey
• the reason for each business journey
• the time of each business journey when the use of the vehicle is subject to time constraints;
• the end date of the 90 day log book test period
• the odometer reading at the end of the 90 day logbook test period.
If the proportion of business use changes more than 20 per cent, you must start another log book. Have you kept the required detail? Has your log book been brought up to date within the last three years? If not, start a new log book now.
If you have a family trust, use it to buy your Lotto tickets. If you win, wouldn’t you want the winnings to belong to the trust? Imagine trying to gift a $1 million to your trust at the maximum rate of $27,000 a year! You must be able to prove the trust bought the winning ticket. Do this by getting the trustees to pass a resolution to buy the tickets. It is best to draw a cheque (or make an internet money transfer) on the trust as well and pay it to yourself in advance for, say, a year. Don’t forget to keep the process going.
Major business decisions
Talk to us before implementing a major decision. A business property was being purchased by a married couple. Their business belonged to the husband only and only the husband was GST registered. Problem: As the wife owned a half share of the property and she was not registered – what about claiming GST? Getting the ownership wrong could lead to significant extra costs.
New businesses to get early payment discount
If you know anyone about to start in business, they might be glad to know the Government is prepared to reward them for paying their tax early. From 1 April 2005, new businesses will be able to claim a 6.7 per cent discount for paying their tax early. Here are the rules:
1. The discount applies only to sole traders or partnerships.
2. The discount will not be taxable income.
3. The tax has to be paid by the last day of the taxpayer’s financial year.
4. The income must be predominantly from business.
5. The maximum amount on which the interest is paid is 105 per cent of the final tax (known as Residual Income Tax).
6. Anyone restarting in business will not get the discount for a second time, unless there has been a gap of four years after the last year for which an interest payment was received.
7. Existing businesses can get the discount if they have never had to pay provisional tax.
Newspapers and magazines
If you need the daily newspaper for your business, you can claim this cost. You can’t buy part of a newspaper so the whole cost is tax deductible so long as the paper is a necessary cost. The same rationale goes for magazines.
As a New Zealand resident you must pay tax on all your income, including any derived overseas. Depending on international agreements, you might be allowed to claim back some of the tax paid to another government. Swapping information between governments is becoming wide spread.
If you hold life insurance (taken out while overseas), annuities, shares in overseas companies and other types of overseas equity investments, consult us. The law has become complex and we will need full details of these investments.
If you pay interest to an overseas supplier, you may have to pay withholding tax. Always get advice if you are paying for overseas services or interest.
Partnerships - salary
If you form a partnership and wish to pay one of the partners a salary before profits are distributed, be sure to have a written partnership agreement. It must include an agreement to the salary lasting at least three years and PAYE must be deducted from the salary payments and remitted to the IRD.
It is sometimes desirable to have a husband/wife partnership. If one has a substantial salary from employment elsewhere, you might prefer to fix a salary for the other rather than rely only on profit share. For example W has a salary of $75,000 from her job as a teacher. H relies on the business for his income. A reasonable minimum salary for H might be $40,000 per year. You could have an agreement for H to be paid $40,000.
Partnership – profit share
You are not supposed to just guess a fair split of partnership profits. Income must take into account hours each partner has worked, their capital contributions to the partnership, each person’s skill levels and an allowance for management of the business. If you do guess, be ready to justify your decision, if called upon to do so.
Some people who trade through limited liability companies, prefer to pay tax as they go (PAYE) rather than being in the provisional tax system. Although the tax is paid earlier than it might have been, smoothing the payments is easier for them to handle. Sadly, there is no perfect solution.
When company shareholders put themselves on PAYE, the liability for provisional tax does not disappear. They must still pay tax on the remaining profit.
Switching to PAYE does not necessarily solve the problem of provisional tax; it only reduces it.
Further, there is a potential tax trap because company tax over $2500 has to be estimated and a low estimate will attract Use of Money Interest backdated to the first instalment of provisional tax, which can be more than a year earlier.
The salaries of shareholder employees do not normally have PAYE deducted. However, if clients decide to put themselves on to PAYE, they can pay extra salary to themselves after year end and claim the cost in the immediate preceding year. These payments have to be made within 63 days of the end of the financial year and PAYE must be deducted from them. The problem is most people do not know their company profit by the time the 63 days is up, so would have to guess the amount to pay.
If the amount of the payment is large enough (see note below), a shareholder employee can be credited with extra salary even though the 63 days has expired. This amount can be taken back into the previous year as though the payment had been made within the 63 days. The recipient now becomes a provisional taxpayer. A question then arises as to whether the PAYE payments were really in the nature of provisional tax payments.
Note: The formula for determining the minimum amount needing to be credited to a shareholder employee is a little difficult to explain. Therefore, please discuss the situation with us. The alternative is not to be a PAYE taxpayer.
Go to http://www.ird.govt.nz/calculators/keyword/paye. Choose PAYE calculator on left side of page. It is better than looking up tables.
Even better! IRD has produced a calculator for tax on holiday pay.
Full marks IRD.
Penalties and what to do
If the IRD considers you have been careless, it will charge you a 20 per cent or even a 40 per cent penalty. If you have had “good behaviour” in the past you can get a 50 per cent reduction on that.
If you can show you consulted us, the penalty could be reduced to nothing. Hopefully, you will not have been careless.
Another form of penalty is Use of Money Interest at a rate which is currently 8.91 per cent per annum. It is calculated from the time the tax should have been paid, which might be several years back. It can add 50 per cent to your tax bill. This interest can be deductible in a company, and sometimes for an individual and for a trust. It depends on the particular facts. Consulting your accountant gives no relief from this form of penalty. Your danger may not be so much the one-off error as being consistently wrong. One place where many people are vulnerable is GST. If you prepare your own returns, it may be worthwhile to get us to check your workings occasionally.
Penalties – if you forgot to pay be quick
From 1 April 2008, taxpayers will be notified the first time they make a late payment. A late payment penalty will only be imposed if payment is not made within one month of the notice. There will be a 1 per cent penalty to start. A further 4 per cent is charged if the amount remains outstanding after 7 days. Monthly incremental penalties are 1 per cent.
If you forget to pay your tax on time or pay the wrong amount, be quick with correcting the situation and save penalties.
If you have been short of money to pay your tax and receive money after the tax date but in time to avoid the full 5 per cent, get a payment into the mail or, better, make an internet payment. Payment occurs as soon as you put the letter in the post box. Be sure to catch the mail before the last clearance for the day. If you are too late, post the letter anyway, you might be lucky. There has been no change to Use of Money Interest which is charged in addition to penalties.
Profits have their price
If you leave a profit in your company to avoid paying the extra five cents tax on income over $70,000, you will need to make sure this does not leave your company loan account overdrawn.
1. You have made a profit of $95,000.
2. You want to leave $25,000 in your company.
3. You want to pay yourself a $70,000 salary.
4. The company owed you $2000 at the end of last year.
The maximum drawings you can have this year is the $2000 plus $70,000 salary. If you take out more than this, you will either have to pay interest to the company or pay Fringe Benefit Tax because you will be receiving a loan from the company.
You will also need to pay provisional tax for the company, early, to avoid Use of Money Interest on the tax applied to company profit.
At the time of writing, the Courts have yet to hear the IRD’s appeal against a decision involving insufficient salaries paid out. Depending on the outcome of this case, fixing an arbitrary $70,000 salary may not be acceptable, particularly if the profit is a lot more than $95,000. As usual, check with us.
Please also read the notes below entitled Shareholder Salary.
If your business is one in which there are retentions, don’t overlook deducting any retentions forming part of your debtors (accounts receivable - money owing to you) at the end of the year.
Suppose you are a builder owed $120,000 at the end of the year. Part of this sum is charges for which you will not be paid until the retention period has expired. Your year ends on 31 March but you cannot recover the retentions until mid May following. This debt is not enforceable at 31 March and can therefore be deducted from the debtors figure.
If you happen to be on an invoice basis for GST, you will find yourself paying GST on the retentions but not income tax.
Selling your business
There could be depreciation recovered on business assets at the time of sale. Timing could save you tax.
If you sell at the beginning of the year and expect a low income for that year, you might find depreciation recovered taxed at a lower rate than if you had sold late in the previous year, when your income was higher.
The selling price of a business comprises the sale of its assets and goodwill. Gain on goodwill is not usually taxable. It therefore pays, when apportioning the price to make the goodwill high and everything else low.
If you need to put a price on equipment, look to see if some of it is worth more than its original cost. If you sell it above cost, that excess is usually a non-taxable capital gain.
If you can agree to sell your equipment at its book value or less you will avoid being taxed on depreciation recovered.
Finally look at your stock. The higher the value of stock, the greater your income in the year of sale.
No law exists to determine what happens when buyer and seller do not specify the split of assets in the sale and purchase agreement, except the general anti avoidance provision, which could be used in fairly extreme cases. It follows each must make their own decision and be ready to justify their choice to IRD if called upon to do so.
You will have to pay GST on the selling price of the business unless it is sold as a “Going Concern”. Going Concern means you are selling a business that is capable of being operated by itself. For example: If a taxi driver sells her business and keeps the car, the business is not capable of being run without a car. She must sell the car as well for it to be capable of being operated both before and after the sale as an income earning unit. A written agreement between the buyer and seller must record the sale is as a Going Concern and both the buyer and seller must be registered for GST at the “time of supply”. This issue is causing technical problems and the government is looking at making it easier.
Company shareholders are permitted to determine their salaries after they have worked out their business profit. If you are paying tax at the top rate (at the time of writing 38 per cent), you may prefer to leave a profit in your company to be taxed at 30 per cent.
Your gains would be:
• Less tax to pay
• Maybe less ACC to pay (but lower cover as well)
Your losses would be:
• Use of Money Interest back dated, which can mount up.
• To get profits out of the company you would have to declare a dividend, which adds to your compliance cost.
• You might overdraw your account with the company and expose your company to an FBT charge.
If you leave a company profit up to $8330, there is no Use of Money Interest and you will reduce your personal liability for provisional tax.
Don’t be too greedy about avoiding the 38 per cent tax bracket. Inland Revenue could allege tax avoidance, if you leave too much profit in your company. Be ready to justify a low salary. Advice from an employment agent could help.
Starting in business
You may sell any equipment, stationery etc, you own when you start your business, to the business. The price is the lower of what it cost you or what it is worth now. What’s it worth now? It’s your job to find out. Try second hand dealers and look in the newspapers.
Sometimes people about to start in business buy things for it in anticipation. So long as the interval of time between the date of purchase and the date of starting your business is reasonable, you would be able to treat these purchases as being new goods and also claim GST. How long is reasonable? Well, with a company that has not been formed yet the law allows 6 months so this period should also be OK for non companies as well.
You can possibly claim back GST on goods you have owned prior to going into business. There is a condition, however. You must have paid GST when you bought the item and sometimes you can only claim it piece by piece. For example, if you bought a car from a second hand car dealer, there would have been GST in the purchase price unless the car is so old you bought it before GST came in back in 1986. If it is old and GST was only 10 per cent at the time, your claim is limited to 10 per cent.
If you have a low income year and you have a child who could claim a student allowance as a consequence, get the child to claim early. There is no retrospective right of application.
Tax planning for the future
Look ahead. Set up your structures to work for you later. Expect tax laws to change. Anticipate changes.
If you are starting a business and expecting a large income you should consider:-
1. Using a family trust to protect your assets.
2. How to minimise the incidence of the 38 per cent tax rate.
3. Investigating opportunities to share income which stand up to IRD scrutiny, such as:-
• Salaries for family members who help in the business
• Director’s fees
• Interest on loan from low income spouse.
4. Arranging company shareholding to best advantage before you start.
5. Is it better for you to have family cars owned by your company?
6. Would it be better to use borrowed money to fund your company instead of your own?
These issues need care. You should consider:
• If you use a family trust look at the administrative costs.
• Don’t be greedy about minimizing the 38 cents tax. IRD may challenge unreasonably low salaries.
• If you pay members of the family, for working in your business, be prepared for IRD to challenge unduly large payments. Justify salaries based on hours of work and skill needed. How much would you have to pay someone else to do the same job?
• If you are paying your children, pay them properly. Pay PAYE if required. If they are young, pay their wages into a savings account for them. You may use the money for their benefit, in your capacity as a trustee. However, the payments you make for your children must not be for the necessities of life. Their maintenance is their parents’ responsibility.
• Do not pay a director’s fee unless the recipient is a director. Directors have statutory responsibilities. This is a justification for a fee to a spouse. For more information go to Directors Fees.
• Generally, the lower the cost of a car, when it was originally bought by a shareholder, a related person or a company, and the greater the private running, the more attractive it is for a company to own the family car.
• There is no reason why you must use your own money to fund your business. However, unless you are a company, rearranging finance will not help you and even then you need to be careful.
Here is something for those likely to have a lot of tax to pay. If you have under estimated your tax or cannot pay your provisional tax on time, you will probably be liable for Use of Money Interest – see paragraph on UOMI. There are businesses, which trade in tax. They can arrange money to cover your tax at rates significantly lower than the UOMI rates.
Thus if you have short paid your provisional tax a year ago, you can buy tax off one of these businesses.
If you need cash to pay your next instalment of provisional tax, again, these businesses can help reduce the UOMI cost.
If you use your telephone for both business and private use, IRD accepts a split of rental of 50 per cent to the business and 50 per cent private. You are expected to allocate toll calls on an actual basis.
When dealing with employees the law allows a 100 per cent deduction for cell phone charges so long as the cell phone is used primarily for business.
We are often asked: “What can I claim?” Here are some guidelines, which hopefully will help you. There are three situations:
Business is the prime purpose of the trip
The airfares are fully deductible. Apportion accommodation and food on the basis of the number of days engaged in business and the number of days engaged in holiday. You could have a situation where the prime purpose is business, but the holiday element is more than 50 per cent. Obviously, the greater the time you spend on holiday and the less on business the more the trip takes on a prime purpose of holiday.
The trip is partly business and partly holiday
In this case all the costs should be apportioned on a time basis, except the airfare Your objective should be to show your claims are fair and reasonable.
Prime purpose is holiday
In this case none of the air travel is claimable. Apportion accommodation and food based on the number of days on business compared with the number of days on holiday.
You have to be prepared to prove your case. While you are away, keep a diary with details of who you visited and approximately what happened.
The onus is on the taxpayer to prove the claim for travel costs is correct. This requires evidence. Was this really a business trip or is there an attempt to camouflage a holiday as though it were business? Telephone calls, e-mail messages, faxes and letters before the trip are strong evidence to support its business nature. Similarly, one would expect appointments made to meet people unless, of course, this happens to be a trip to a trade fair or conference. A diary of events is invaluable. What were you doing each day? Split your time fairly between business and pleasure and there should not be too much difficulty with the IRD.
You will have all sorts of expenses during the day and it will be hard to keep track of them. You should discipline yourself to record your expenses every evening. If you leave them, you will forget them.
As a cross check, try putting, say, $100 in one pocket and paying out your expenses only from there. At the end of the day, count the money you have left. The difference is the amount you need to account for. Don’t be surprised if it’s hard to remember where the money went.
Taking a spouse or partner with you
This is a tricky area. There are some conferences where it is expected you will take an accompanying person. In this case the partner’s expenses could be fully deductible. You should check with us in advance if you want a definitive answer.
Generally, taking a partner with you will not be tax deductible. Treat all the additional costs relating to that person as not tax deductible. Examples include air fares and food. Hotel accommodation will be incurred for business purposes whether or not there is an accompanying partner. If the cost would be the same with or without the extra person, it is unnecessary to make an apportionment.
Use of home
The standard claims are based on the proportion of the area of your home used for business. If 10 per cent of the house is really business premises then you can claim that share of the related costs.
Since IRD accepts claims based on area of the house used for business, don’t forget you might also be able to claim for a share of your garage. Take the share of the house plus garage as a percentage of the total area of building on your section.
Expenses could include:
• Interest on mortgage
• Repairs and Maintenance
If clients/customers come to your house regularly, you might also be able to justify a share of gardening and cleaning costs if you pay a gardener or cleaner.
If you are refinancing your house, you could include a share of the costs including:
• Legal fee
• Bank Fee
You can claim a share of GST on the expenses listed above, so long as they have GST in them, if you are a sole trader or in partnership. You can also claim in your company, so long as you treat this as a reimbursement to you, in your capacity as an employee. Companies can claim GST on reimbursements to employees but they must hold the original tax invoices.
Use of Money Interest
A couple of people who have been in business for some time, looked blankly when Use of Money Interest (UOMI) was mentioned. This makes me suspect there are other clients who do not understand the concept.
UOMI is an IRD charge which theoretically affects everyone, but there are exemptions. Until you have $50,000 of tax to pay in a year, this “interest” charge will not affect you. You, means you as a natural person. It does not mean a company or trust where the threshold is $2500.
Theoretically, this charge is to compensate the Government when a taxpayer has been late paying their tax, even though there is a legal entitlement not to have paid.
For example, if a company has paid three instalments of $5000 provisional tax, total $15,000, and the year end calculation shows a total tax liability of $24,000, UOMI is charged on the shortfall of $9000. The current rate is 8.91 per cent per annum.
UOMI illustrated for a natural person
Tax on all income, mostly business $49500
Tax already paid on dividends and interest $ 2750
Residual Income Tax (RIT) $46750
This person has RIT less than $50,000 and does not need to be concerned, yet, about UOMI. However, it would take only a small increase in the business income to push RIT over $50,000.
UOMI is calculated from the first instalment of provisional tax. For people with a 31 March 2010 balance date this is normally 28 August 2009 but can be 28 October 2009. By the time annual accounts and tax returns have been prepared for the 2010 year, UOMI may become quite a large sum.
If you are likely to be liable for UOMI, we depend on you to help us avoid it. One way of doing so is to monitor your income during the year. Draft accounts could be prepared on a regular basis. Clients often get these as a bi-product of GST returns. We would project your year end income every two months and see when to top up your tax payments.
If you are enjoying a good year, remember taxes are silently accumulating. We urge you to get in touch with us and give us a chance to help. Those who do nothing pay extra tax, needlessly.
If only it were just 8.91 per cent. If the interest is incurred by the business e.g. company or sole trader, the charge is tax deductible. That is a true 8.91 per cent. However, interest incurred by a shareholder is not tax deductible because the income is a salary and there are no expense deductions allowed against salaries and wages. As a non-deductible charge the interest is equivalent to about 14 per cent if it were tax deductible.
We do not like seeing our clients paying UOMI, particularly when we could have helped them avoid it had we been alerted. We cannot work magic some months after year-end when we do your accounts.
Another option which may be available to you - see the GST Ratio.
Wages paid to yourself and other misconceptions
Some people think they can reduce their tax by paying themselves for services to their own business. For example they paint their rooms instead of getting a painter to do the job. Even if you did pay yourself, which you cannot, you would not save tax because the money you received would be taxable income to you. By paying yourself, you could lose. If your work was creating an asset, like putting up partitions in your office, the cost would need to be added to the cost of the partitions and depreciated. If you paid yourself $1000 you would be taxed on this amount but only be able to claim, in your business, a small percentage of this amount, being the depreciation percentage applicable to partitions.
Tax is charged on your profit. This means sales less expenses. For a company, one of the expenses is your remuneration, which must also be taxed. This amount is therefore included in the expenses. We always aim to allocate the income of the business between you and your company so you pay the least tax, subject to your being able to justify the allocation. For example, tax might be minimised by paying $60,000 to a partner, who stays at home to look after your family. However it may be difficult to justify such a large sum. We would therefore consult with you to determine the maximum, which could be justified to IRD if you were called upon to do so.
I estimate 90 per cent of those new in business imagine they will be taxed only on the money they draw out of their business. I think the reason is they see the drawings as their wages and they compare this with working for a boss.
The cost of creating a website is a capital expense. It should be depreciated like any other software. Maintaining it is tax deductible. There are grey areas. Significant upgrading can be capital.
Certain businesses are seen as not full self employment. An example is a labour only contractor in the building industry. You are required to deduct Schedular Withholding Tax from your payments to these people and remit this as PAYE each month. Unfortunately, when the contractor is GST registered, the GST no longer works out at one-ninth of your payments. This is because GST has to be calculated on the payment before you deducted GST. You will find GST is 37/40ths of the net payment to the contractor when SWT is 20 per cent.
Year end accounts and preparing for them
Use of Money Interest
Have you paid sufficient provisional tax to avoid Use of Money Interest, which is charged at almost 9 per cent on company/trustee income tax in excess of $2500 or personal income tax over $50,000. If in doubt, calculate your expected taxable income for the year and call us. We will tell you how much tax this would attract. The sooner you pay your tax the sooner you stop the UOMI from running. It pays to monitor your tax liability continuously during the year.
Have you any bad debts? You must write them off before year end or you cannot claim them this year. Make sure you leave a trail so you can prove they were written off in time.
Are you planning to update any vehicles? Check their book value. Make your change before balance date only if you expect a loss will result from disposing of an old vehicle.
Stock and Work in Progress
You must count and value your trading stock at balance date, unless it will be worth less than $10,000. You must also keep sufficient records to show Inland Revenue if they ask for them.
Consider disposing of dead stock now (have a sale) as it must be valued at its cost, unless you can prove it has a lower market price. A guess is not acceptable. You have to find evidence to support the price. This can prove difficult to find.
Plant and Equipment
You are permitted to write off assets without having to dispose of them however the asset must no longer be used or be intended to be used by you or any associated person to derive income. The cost of disposal must exceed any payment you might get from its sale.
You cannot write down equipment by any more than its depreciation rate.
Carry out maintenance early to get the cost into the current year if you expect a high income.
Unused expenditure which can be fully claimed
Some expenditure can be incurred in advance and does not have to be adjusted for tax purposes. The items are contained in “Determination E11”. We can supply you with the full list on request. Here are three examples:
• Advance payments for travel.
• Stock which can be classed as consumable aids. If less than $58,000 it does not need to be included in your stock-take.
• Stationery is not part of stock.
It can be useful to pay dividends before 31 March. They carry tax credits of 33 per cent with them. From 1 April 2010, part of this is made up of a 3 cents withholding payment at the time the dividend is declared. Anyone whose income is less than $48,000 may find themselves with either less tax to pay or a refund. Also, if your family trust is a shareholder in your company, you may be able to pass the dividend through to one or more of the family. The maximum payment from a trust in any year to a beneficiary, who is under the age of 16 at the balance date of the trust, is $999.99. If this amount is exceeded, the distribution is taxed at the same rate as the trust. Currently this is 33 per cent. If in doubt, come and see us. Do not pay dividends in advance of declaring them or you could be liable for Fringe Benefit Tax.
If you want to pay any staff bonuses, they must be paid within 63 days of the end of the tax year, to get a tax deduction in that tax year. If the 63 days has elapsed, the tax deduction is claimable in the same year as the payment is made.
Buying a rental properties
When you buy a rental property and get a valuation for mortgage purposes, be sure to ask the valuer to provide you with a list of the chattels and a valuation for each.
IRD identifies 33 categories of chattels in a house. Each has its own depreciation rate, which is a great deal higher than the amount allowed on the building itself. Therefore, the better the chattels valuation the less tax you will pay. Further, an independent valuer’s opinion will be better recognised by IRD than your own, simply because it is independent.
Another practical tip: If you are buying a property put into the agreement “two keys must be supplied for all outside doors”. There is no obligation on the seller to supply you with any keys unless there is an agreement to do so or they have the keys in their possession.
There can be GST complications. See GST section article entitled buying real estate.
Inherited rental property
If you inherit rental property, it has cost you nothing. You are therefore unable to claim any depreciation. Worse, if it happens to be commercial or industrial and you are involved in GST, you have no claim for GST on the cost of the property, but you may pay GST at the time of sale.
There may be a solution. It will come down to the terms of the will. The executor may be able to sell the property to another entity, such as a company or family trust. Seek advice first because there are costs involved. The new entity may still be unable to claim GST input tax, but may be able to claim depreciation based on the amount it has paid for the property.
People ask what is negative gearing? Buying a rental property and making a tax loss is an example of negative gearing. Tax deductible expenses exceed income, creating negative profit (or loss if you prefer it). IRD sends you a tax refund, effectively subsidising your loss and helping you pay off your mortgage. You gain non-taxable capital growth.
Is it a good idea?
This is a matter of opinion. Robert Kiyosaki (Rich Dad Poor Dad) would say all property should have positive cash flow; money coming in exceeding money going out. Therefore, negative gearing would be good in his view so long as cash in is greater than cash out.
Beware being over-committed with mortgages in times of recession.
Losses due to negative gearing have come under the spotlight recently (December 2009). There may be changes in the wind.
Repairs and Maintenance
Major costs shortly after purchase may have to be added to the cost of the property. Interpretation of the law keeps changing. A claim for a deduction can only be made for what is actually repairing the property. Even if the work does not increase the value of the property, it can be capital or non tax deductible. It pays to check the latest interpretation of the law before proceeding.
Costs increasing value as opposed to restoring the building, like adding to floor area, add to cost of the house. Depreciation only can be claimed.
Do repairs while you still have a tenant or between tenants if you are thinking of moving into the house. Once the last tenant has vacated, the cost of repairs, even if major and caused by tenant destruction to your property, is NOT tax deductible.
Retaining your home for rental
At times, people are tempted to buy a new home and rent their old one. The interest on the borrowed money for the new home is not tax deductible.
When borrowing money, the law requires you to look at the use to which the money was actually put. Look directly, not obliquely.
If the money is borrowed to buy a home for you, the interest is not deductible. It is of no consequence, in law, that the borrowing enabled you to keep your old home for rental.
There may be a couple of ways around the problem.
One is to form a family trust and sell your old home to it. However, if you will be making losses, this is not particularly attractive because the losses cannot be claimed in your personal tax returns. They have to be carried forward until the trust starts to make profits. They can then be offset against those profits.
Another choice could be to sell your old home to a limited company and turn it into a loss attributing qualifying company (LAQC). You could then claim the losses in your personal tax returns. However, there is a significant risk IRD would see this as tax avoidance. The consequences could be unpleasant. Please read on.
There needs to be a good commercial reason, other than saving tax, to transfer a property to another entity. A transfer to reduce tax is not acceptable.
The department is widening its interpretation of what amounts to tax avoidance. The LAQC option, in particular, may be hard to justify.
Check the latest situation with us before finalising your decision. Tax law is constantly changing.
If you move and keep your old home for rental, the costs relating to it are tax deductible in the usual way. Depreciation is calculated on what you paid for the house even if it was bought many years ago. You can get chattels valued and claim depreciation on valuation or cost which ever is the lower.
Revolving credit is a way of financing property. It allows you to deposit and withdraw money freely up to a defined limit of borrowing.
It is ideal for property, particularly for home finance. The smart often arrange a fixed loan at a lower interest rate for part of the borrowing and revolving credit at a higher interest for the rest. The revolving part is designed so it will just about get down to zero when the loan is due to be refinanced.
The borrowers put all their salaries and any other receipts into the revolving credit account and pay their bills on the last day. In this way they minimise their borrowing and hence the interest to be charged on the loan.
The plan works nicely except for rental properties. Every time you put money into the account you reduce the original debt. So, if you borrowed $60,000 and have a tax paid salary of $50,000 per annum, you will be owing only $10,000 of the original debt at the end of the year.
Money drawn to pay your bills is for a private purpose and so IRD considers the interest incurred on it is not tax deductible. Each salary payment going into the bank reduces the interest bill, but each withdrawal increases the bill and the interest on it is a personal cost.
We may have a solution for you. If you want to buy a rental property and use revolving credit, let it be owned by a company. When you put your salary into the company bank account, you are lending to the company. When you take the money back for the groceries, you are merely getting your loan repaid; you are not borrowing. The company (not you) is borrowing from the bank. Make sure your shareholder current account is in credit the whole time.
Warning: A recent Australian case treated a situation like this as tax avoidance. The New Zealand courts could follow suit. Check with us before proceeding.
Selling your rental property
Do you realise when you sell your rental property you will probably have depreciation recovered on the building going back to the time you bought it? This often gives rise to an unpleasant surprise.
Depreciation recovered is income
Beware if you are changing a rental property ownership to a family trust. Again, you will have to consider depreciation recovered.
You do not have to claim
The law was amended recently to allow you not to claim depreciation if you choose. The advantage is clear. You will not strike this unpleasant surprise at a later date. However, should you happen to sell the property for less than you paid for it, you will not be able to claim the depreciation you might have been entitled to. For this reason, it is usual to make the claims and accept the medicine at a later date.
Depreciation recovered also applies if you have rented your home for a while, particularly while overseas.
If you were to die still owning the rental property there would be no depreciation recovered provided, under your will, the rental property passes to someone who is in 2 degrees of relationship to you. If the property passes to someone else then the death will trigger depreciation recovered
Transferring Rental property to a trust
There are two major disadvantages:-
1. If you have claimed depreciation on the building, you will probably have depreciation recovered and have to pay tax on it.
2. If there is a rental loss, there is no tax claim for the trust, unless it has other income to set off against the loss. The losses have to be carried forward to future years until there are profits.
You will not be permitted to claim depreciation on the price at which you transfer the property to the trust. You must use the original price you paid; UNLESS you wish to apply for permission to the IRD citing the Lys case. This is a case in which a judge ruled the taxpayer could use the price the trust paid. IRD have very strict criteria which must be met before granting their approval in terms of this case.