Tax structures in New Zealand

If you are a migrant looking at starting a new business in New Zealand, it makes sense to start looking at the country’s choices in regard to different tax structures:

Sole trader

A sole trader is defined as a person trading on their own. From a compliance perspective this is a cheaper option, because you don’t have to complete full financial statements annually. You need to maintain all financial records, though, and collate a financial summary at the end of the tax year. This doesn’t leave room for tax planning: sole traders pay most of their tax at the highest personal rate.

Partnership

Partnerships are less common today due to the limited protection offered to partners and the possible risk of exposure from the other partners. The tax impacts are similar to that of a sole trader.

Trading through a company with limited liability protection

This means a company is a legal entity in its own right, separate from its shareholders and with its own unique tax obligations. While the company tax rate this year has moved from 33% to a more appealing-sounding 30%, all this really means is that, in the absence of a trust arrangement, one is simply delaying one’s tax liability at the top rate. In other words, you will be paying 38% on all income over $70,000 (see the attribution rule below).

Company with a trust ownership

This structure primarily provides for asset protection and wealth creation. It offers a number of benefits, including tax minimisation — a secondary advantage, to be sure, but one that can be rewarding, and with income-splitting opportunities), a 33% tax rate, and a structure that’s usable for other business ventures.

Limited liability partnership

A new structure legislated only last year (2008) and still largely untried. The initial setup is expensive, making this option possibly more feasible for large businesses or for the purpose of large financial transactions. It provides the same benefits as the partnership structure with the additional protection of limited liability.

Complicating factors?

One is the attribution rule. The attribution rule is one of the more subtle areas that often trips up new ventures in New Zealand, especially contractors. What it means is that if 80% or more of your income is earned from one source (business or public sector entity) during a financial year, then all of your profit is attributed to you personally.

And that usually means paying the biggest chunk of your tax at the highest personal tax rate of 38%.

Let’s look at a simplified example of what all this might mean if a business trading through a company earns $180,000 profit and, with a trust structure effective tax liability, enjoys an annual tax liability of approximately $52,500.

The same business trading as sole trader or company without a trust is going to be looking at a tax liability of around $58,000.

That represents a saving of approximately $5500 in tax each year on top of the benefits of asset protection and wealth creation that a trust provides.

But it pays to tread carefully. If tax is the primary (or only) motivation for setting up a company with a trust ownership, the IRD (Inland Revenue Department) will act and that will cost you a lot more than any tax you intended to save. It’s always crucial to seek out a professional, especially in these interesting economic times.

Stephen Nicholas, a chartered accountant, is CEO of Openside, freephone 0800 322 268, one of New Zealand's fastest-growing accounting consulting firms. He has held senior positions with Fairfax Media, AMP Financial Services, AXA Funds Management and Citicorp Private Banking, and has a passion for making an impact on the performance of businesses.