Different tax treatments
Some structures have very little legal requirement while others have to follow regulations and be accountable to government departments. The structure you use will be based on factors such as the number of owners in your business, the desire to limit your exposure to liabilities of the business and the need for tax savings.
There are 5 types of business structures that you can use and all have different tax treatments.
- Sole Traders: One person controls, manages and owns the business.
- Partnerships: Two or more people run the business together with other partners.
- Companies (Limited Liability): This structure is a legal entity and is recognised as a legal ‘person’ in the eyes of the law.
- Trusts.
- Non- profit Organisations.
Tax on sole traders
The simplest form of business structure is that of a sole trader. This is where you trade on your own account as a self-employed person. A sole trader usually has no formal or legal processes to set up the business. The owner/manager is personally entitled to all profits, but is also personally liable for all business taxes and debts. A sole trader is a person trading on their own. They control, manage and own the business.
A sole trader usually has no formal or legal processes to set up the business. The owner/manager is personally entitled to all profits, but is also personally liable for all business taxes and debts. If you are a sole trader you’re probably not paying yourself a wage, but simply taking money from the business when you need it for personal use. These takings are called “drawings”. Drawings are not a deductible business expense when calculating your profit.
Drawings are a part of your profit and you are personally taxed on those profits accordingly.
A sole trader is taxed at the individual rates as shown below.
These individual rates apply for the tax year 2016-2017
Each rate is for every $1 of taxable income excl ACC earner’s levy
- $0 – $14,000 – 10.5 cents
- $14,001 – $48,000 – 17.5 cents
- $48,001 – $70,000 – 30 cents
- $70,001 and over – 33 cents
- No Notification rate – 45 cents
Tax on partnerships
A partnership is defined as a “relationship between two or more people who are in business together with a common view of making a profit”. A written partnership agreement is not necessary because the existence of a partnership can be determined from the circumstances surrounding each particular business case.
In a partnership all the costs, expenses and profits are shared equally amongst the partners involved and any variation should be set out clearly in the partnership agreement.
Partners share responsibility for running the business, and share the profits and losses equally, unless the agreement says otherwise. They share the assets as well as the liabilities. The taxation is similar to sole proprietorship.
That is, the profit is divided amongst the partners who each pay personal taxation on the income while the partnership itself is not taxed. When partnership profits or losses are distributed to a relative or an associated person and IRD consider the distribution to be excessive or unreasonable, IRD may reallocate the distribution for tax purposes.
The partnership itself does not pay income tax. It distributes the partnership income to the partners, who each pay tax on their own share.
- At the end of each year the net profit (without taking into account partners’ drawings) is distributed between each partner
- Each partner then pays income tax on their share of the profit in their individual tax return, along with any other income they may have received.
Tax on companies
A limited liability company is a separate entity which is for the purposes of law a separate legal personality from the people who own it. The owners are called shareholders and their liability for the debts of the Company is generally limited to the paid up value of the shares they own in the company. The benefit of a limited liability company is that the shareholders in the business do not have to pay any more than they owe on their unpaid shares (if they are unpaid) in the event of the company failing.
The limited company is treated as a person in law, so it is responsible for its own debts. Creditors can claim the assets owned by the limited liability company, but not the assets of the officers of the company, nor its shareholders. Only the property of the limited liability company can be used to clear the debts if it becomes insolvent and eventually wound up.
The officers and shareholders of the company, employees and investors in the company cannot be made to contribute to the debts (including Tax) of the company.
Companies can distribute money in 3 ways:
- Shareholder-employees can periodically draw money from the company. At the end of the year, the company calculates a salary amount on which the shareholder will have to pay income tax.
- Shareholders who are also employees of the company can be paid a salary with PAYE taken out in the normal way. These salaries are deductible as a business expense for the company.
- The company can pay dividends to shareholders out of the profits that remain after tax. It may also attach tax credits to these dividends called imputation credits. Profits derived by a company are taxed at the current 2016 /2017 year company tax rate of 28 cents in the dollar.
- In the case of a company a flat rate system is employed. This means that the tax is imposed at the one current rate of 28 cents in the dollar no matter how big or small the company’s taxable profit.
Tax on trusts
A trust is a flexible structure, which has been used for hundreds of years for various purposes. Many find it better to run business and non-business activities through a trust, rather than a company.
Many people see a trust as only a tax dodge, or as something used by the wealthy to retain ownership of property so it is kept away from people they owe money to (creditors). Most people’s knowledge of trusts is vague. While a properly constructed trust provides advantage to beneficiaries and others involved in the structure, trusts continue to be a legal means of protecting assets belonging to the family. They also benefit members of the family.
It is more than a tax saving device, although it is acknowledged that tax saving can be achieved through proper management and allocation of profits made by the trust. A trading trust may be used as an alternative to other business structures such as the traditional limited liability company. A trading trust is one that carries on a business.
In general tax treatment of trusts are as follows:
- The initial amount of money you put into a trust is not taxed, although you may need to pay gift duty
- Any income the trust earns (e.g., through investment or business income) that it doesn’t distribute to its beneficiaries is taxed at a current 2016/2017 year flat rate of 33 cents in the dollar. The trustee is liable for paying this income tax regardless of where they live in the world.
- Distributions to beneficiaries of the trust are taxed at the rate of tax applicable to each beneficiary as an individual.
Tax on non-profit organisation
A non-profit organisation is any society, association or organisation that:
- Is not carried on for the profit or gain of any member and
- Have rules that do not allow money, property or any other benefits to be distributed to any of its members.
If the organisation has profit-making activities, it must pay income tax.
All New Zealand clubs and societies must file a tax return each year unless they derive only exempt income.
If your organisation has a certificate of exemption from resident withholding tax on interest and dividends this does not mean your income is exempt income.
Non-profit organisations that are registered and incorporated under the Incorporated Societies Act 1908 are taxed at the rate of 28 cents in the dollar.
Unincorporated organisations are taxed at the same rate as individuals.
A deduction of up to $1,000 per year is available for some non-profit organisations. By deducting this amount from the organisation’s net income you reduce the amount of tax to pay.
There are a number of income tax exemptions your organisation may be entitled to, as long as none of its income or funds can be distributed to any of its members. The organisation’s main aims and activities must meet the requirements of the particular exemption.