BUSINESS ADVICE • 18 FEBRUARY 2021 • 4 MIN READ
Business structures - what's best for you?
Making the right decision regarding your business structure in New Zealand can save you money and aggravation. This blog is designed to give you some background information on the common business structures in New Zealand.
You will probably have heard most of the common business structure types, and there are some general considerations to think about, but everyone will have a different situation.
Myths about being a company
I’ll save tax because the company tax rate is 28%
Having a company structure does not guarantee you’ll save on tax. If one shareholder performs most of the work, or the company has only one or two clients, we’re required to allocate all profit to the shareholder(s). This is called the Attribution Rule for Income from Personal Services. The shareholder includes this profit allocation in the individual tax return and pays tax at their personal rate.
The result is exactly the same as if you use the sole trader structure. Read more on frequently asked questions for being a sole trader.
With the top tax rate now being 39%, Inland Revenue is very much aware that individuals may change to a company structure for no other purpose than to reduce their tax bill. This could be considered tax avoidance.
My personal assets are protected
If you’re the size of a sole trader but operating as a company, and/or the company has few assets, lenders are likely to request a personal guaratee from the shareholder(s). By giving this personal guarantee, the shareholder(s) personal assets may be taken or liquidated to settle the debt.
Sole trader business structure is the easiest option for a startup. A sole trader is a person trading on their own.
The sole trader:
- Controls, manages and owns the business
- Is personally entitled to all profits
- Is personally liable for all business taxes and debts
As a sole trader, you can usually begin the business without following any formal or legal processes to establish it. You may employ other people to help run the business.
Quick and cheap to get going, just start trading in your own name and IRD number. You will need to register for GST if you earn more than $60,000 in any 12-month period.
You can’t split your income for tax purposes, which means that if you earn a reasonable amount, you’ll be exposed to the highest tax rates.
You also have no protection against creditors and other claims against you. If you also own your own home, then you place this at risk.
Partnership structure is often associated with professional practices and it's less common these days. In a partnership, two or more people run a business together.
- Shares responsibility for running the business
- Shares in any profit or loss equally, unless the partnership agreement states otherwise
- Is liable for any debt within the partnership
Many partnerships are established with a formal partnership agreement.
The partnership itself does not pay income tax. Instead, it distributes the partnership income to the partners. The partners then pay tax on their own share.
Income, tax credits, rebates, gains, expenditure or losses allocated to a partner in an income year will generally be allocated in proportion to each partner’s share in the partnership’s income under the partnership agreement.
A limited partnership exists as a formal and legal entity in its own right. It is separate from its partners.
Limited partnerships need to be registered with the Companies Office and cost $270 for registration along with an additional charge of $20pa for each Annual Return to keep the Ltd Pship registered.
Partnerships give certainty about what happens to the business profits. Profits are taxed according to individual circumstances as all profit is paid out to the partners and they pay their own tax.
There is no flexibility about the division of profits and tax is paid at the individual’s rate which can expose the partners to the highest tax rate, if profit is high.
In addition, most standard partnerships mean that all partners are jointly responsible – so again people can place their personal assets at risk. The limited partnership is designed to reduce this risk.
Company structure is the most 'commercial' entity. A company exists as a formal and legal entity in its own right. It is separate from its shareholder(s) or owner(s). The cost of registering a company is $150 and the annual return cost is $45.
Assets and liabilities
- Owns the assets and liabilities of the business
- Is responsible for any debts
The shareholders’ liability for losses is limited to their share of ownership of the company.
This is the most common trading entity so gives the business a more commercial look and feel, profits can be retained in the company or paid out to shareholders and therefore gives the tax flexibility, and liability is restricted. This provides business owners with some protection from creditors or other claims.
You have to pay to incorporate and you must produce a set of annual financial statements that comply with the company law. This generally adds a small amount to your compliance costs.
A trust is an entity that holds money or property for the benefit of its beneficiaries or for law purposes. A trust requires trustees, settlors and beneficiaries. The settlor sets up the trust, while the trustees manage the trust for the benefit of the selected people (the beneficiaries).
All trust needs a trust deed to hold all these relationships together and used as the operating manual for the trustees.
Trust is commonly used in NZ for the purpose to protect people’s personal assets and preserve wealth for future generations.
Trusts often have money or property that’s used for investment purposes and earn revenue. This revenue is taxable in the trust. Trust has the option to distribute to the beneficiaries. For any income not distributed to beneficiaries will be taxed at a trust rate 33%. And only profit can be distributed to beneficiaries, losses have to stay in the trust.
There are also new rules for certain trusts to disclose their financial information to IRD. Your accountant will look after that for you. But if you want to know more about it, please read this IRD's guide on additional reporting requirements for NZ domestic trusts.
Trusts protect your personal assets from the risks associated with a business. Trusts also protect your family's wealth for future generations.
There are increasing compliance rules around trusts. Plus, the time and cost to maintain trust increased over the years. Also, due to the change in the trust distribution rules, trusts are no longer tax efficient (the tax rate is 33%).
There’s no best business structure. The best business structure is the one that suits your needs. If you want a business that’s easy and has lower costs to get started, you can choose to be a sole trader. However, it’s worth remembering that this might put your personal assets at risk. If you operate through a company structure, there’re more tax requirements you need to meet.
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Sue de Bièvre
An intrepid entrepreneur and feminist with a penchant for disruption; spotting problems and rolling her sleeves up to fix them makes Sue tick.
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