When is limited liability not limited liability?

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Many business owners choose to operate as a limited liability company on the understanding that this offers protection from creditors in the event of business failure.  But is this completely correct?  The answer is both yes and no.  While limited liability companies do theoretically offer some protection, the fact is nobody would would want to do business or offer finance or credit to a company if this were completely true.

There are two mechanisms in place to protect banks, finance companies and suppliers offering goods or services on credit in the event of business failure:

  1. Sections 135 and 136 of the Companies Act 1993
  2. Directors guarantees

Section 135 of the Companies Act states that a director of a company must not allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

Section 136 states that a director must not agree to the company incurring an obligation unless the director believes at that time, on reasonable grounds, that the company will be able to perform the obligation.

Continuing to trade while insolvent can result in director(s) being prosecuted.  It is also possible for any dividends and some shareholder salaries or drawings paid while insolvent to be effectively clawed back on the grounds that they were awarded unlawfully.

To provide further protection, banks, finance companies and some suppliers only offer finance or credit to a limited liability company, if they receive a signed and witnessed director’s guarantee.  This means that the director(s) is(are) personally liable for the balance owing.

At the end of the day, we are all responsible for paying our debts – there is no guarantee of a free pass.  And I believe this is a good thing.

But then, why choose to operate as a company?  I will cover the pros and cons of limited liability companies briefly in a subsequent post.

 

The above information is current at the time of writing and is provided in general terms only, relevant to owner-operated businesses in New Zealand.  We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information.  If you have any queries about the topic, please feel free to contact me so I can take any subsequent legislative changes and your particular circumstances into account.  

 

Amanda Imms CA

Principal

AJ Accounting Limited

ph. 021 771 557

amanda@ajaccounting.co.nz

Drawings, Salaries and Dividends, Oh My!

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There are several options for drawing money from your owner-operated business and each has implications that are worth considering when weighing your options up.  Applied correctly, you could potentially spread your tax obligations across the year, thereby reducing end-of-year terminal tax and provisional taxes and improving your cash-flows.  Apply them incorrectly and you could get yourself into some trouble with the Companies Office or Inland Revenue.  So, here we look at each of the options and their pros, cons and other issues to be aware of.  As always, if you have any queries or need advice on the topic, please contact me.  The material below is intended to inform and educate and should not be taken as a replacement for professional advice tailored to your particular situation.

Drawings

During the year, sole-traders, partners or shareholders may choose to take drawings.  This is a cash transaction only and does not affect the business’s net profits. However, you need to be careful that you do not draw more than your share of net profit, otherwise this may put your equity or current account into an overdrawn situation.  This is especially a problem for companies.  Companies should consider charging interest on overdrawn current accounts, otherwise the company may become liable for Fringe Benefit Tax, or if the balance is long-outstanding or irrecoverable, there is a risk it could be deemed a dividend and taxed accordingly.

Shareholder Salary

Businesses generally allocate net profits to partners or shareholder salaries to shareholders.  This is done at the end of the year, once net profits are known.  For a company, a shareholder salary can assist you in legitimately reducing your overall taxes payable, as your personal tax rate (for the first $48k), will be lower than the company’s, and your personal tax rate on the first $70k is lower than the dividend tax rate.  Shareholder salaries must be reasonable and reflect actual expertise / work performed / risk / investment in the company etc.  Companies have a legal obligation to ensure the company continues to have positive equity, so the total of all shareholder salaries for the year should not normally exceed the net profits of the company.

Wage/Salary

Partners/shareholders can choose to take a wage or salary during the year.  This may replace, or partly replace drawings.  As PAYE is being deducted from your wage/salary, this reduces your year-end taxes, and also reduces (or in some cases, eliminates) provisional tax.  This can be an excellent solution for managing taxes and cash-flows.  However, there are several issues to be aware of:

  1. You should have a formal written employment contract in place.  Even if this means that you sign it both as employer/director/partner and also as employee.  This provides evidence of the arrangement and sets out the terms and remuneration.
  2. You need to complete and sign an IR330 (tax code declaration).
  3. The wage/salary should be realistic.  It cannot be much higher or lower than you would expect to earn doing the same work for someone else.
  4. The wage/salary cannot normally be increased or decreased in line with profits.  However, I see no issues with building a quarterly or annual bonus into the agreement, so that if you are performing well (and therefore profits are higher than expected), you can take a bonus.  The amount and frequency of the bonus and the conditions to be met should be stated in the employment agreement.
  5. Your wage/salary (plus any drawings taken on top of this) should not normally exceed your share of net profits for the year.
  6. You (or your accountant) need to keep records of wage calculations, any bonuses, deductions, payments etc.
  7. You (or your accountant) need to file monthly PAYE returns with IRD and pay the PAYE due.

For these reasons, paying yourself a PAYE-deducted wage or salary can work extremely well if your business generates relatively stable, consistent net profits, if you are comfortable with calculating wages and PAYE and if you are happy with the level of documentation you need to have in place.  It can however be quite risky for businesses with fluctuating performance or for businesses whose net profits are on the decline. 

If you go to the trouble of calculating a wage or salary and deducting and paying PAYE, you might just as well join Kiwisaver while you’re at it.  Although there is no longer the $1,000 kick-start payment, you will still receive employer contributions and the annual member tax credit.  You would need to complete and sign a KS2 and calculate Kiwisaver deductions and contributions when you calculate your wage/salary and include employee deductions and employer contributions in your PAYE returns.   

Dividends

Dividends are taxed at the flat rate of 33%, which is also the highest individual tax rate, so there is no overall tax benefit to issuing dividends, compared to a wage, salary or shareholder salary.  However, they may be appropriate if your company has net profits from previous years not yet allocated to shareholders and therefore also a balance in its imputation credit account (ie taxes paid by the company on profits not yet allocated to shareholders).

In practice, this generally involves the company paying the company tax rate of 28% on net profits, then issuing a dividend to shareholders with imputation credits attached (resulting from the 28% tax paid) and then the company pays a further 5% resident witholding tax (to bring tax paid on the dividend up to 33%).  Dividend witholding tax must be paid to Inland Revenue by the 20th of the following month. 

Although the recipient shareholder will not have to pay further taxes on a “fully imputed” dividend, the credits cannot however be used to reduce your overall individual income tax liability (ie, they cannot be applied to other taxable income), however the dividend witholding tax can.

There is no ACC earner levy on dividends, whereas there is on a wage, salary or shareholder salary, which means that while you won’t be paying the ACC earner levy on this income, it also means that this portion of your income will not be covered in the event of an ACC claim.

Imputation credits cannot be carried forward (or applied to a dividend) if shareholder continuity is less than 66% from the time the company taxes were paid until the time the taxes (imputation credits) were attached to the dividend.  If you have a balance in your imputation credit account and anticipate making significant changes in the company’s shareholding, it may be worth considering issuing a dividend to get the full benefit of the credits first.  

It is worth noting that in order to issue a dividend, you must be sure that the company will be solvent both before and after the issue and the directors must complete and sign a Certificate of Solvency to this effect.

Summary

Profit allocations, shareholder salaries and dividends are determined or declared after net profits are calculated.  They essentially (or hopefully…) cover any drawings taken during the period. 

Profit allocations and shareholder salaries are not taxed until after your income tax returns are filed, however provisional tax (or an IRD assessment if you filed late) may be payable in the mean time.

Profit allocations and shareholder salaries are included in your individual income tax return and taxed at your marginal rate, which for the first $48k is lower than the company tax rate and for the first $70k, is lower than the dividend rate.

Company dividends provide a nice bonus in that the company pays the tax (terminal and possibly provisional tax), but the shareholders get the benefit of the company taxes paid in their individual tax returns.  You cannot have the imputation credits refunded or offset against tax liabilities arising from other income, but you can with the dividend RWT.  Dividends are not worth considering if your individual taxable income is $48k or less for this reason.

If you can handle the paper-work and record-keeping (or if you are happy to pay someone to do it, or perhaps you already employ staff anyway), and your business has relatively stable, consistent income, paying yourself a PAYE-deducted wage or salary can ease cash-flows and reduce your terminal and provisional tax liabilities.  Any net profits left after the wage or salary is deducted will still be allocated to partners, or be available to distribute as shareholder salaries or dividends.

 

The above information is current at the time of writing and is provided in general terms only, relevant to owner-operated businesses in New Zealand.  We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information.  If you have any queries about the tax implications of your drawings, distributions or profit allocations, please feel free to contact me so I can take any subsequent legislative changes and your particular circumstances into account.  

 

Amanda Imms CA

Principal

AJ Accounting Limited

ph. 021 771 557

amanda@ajaccounting.co.nz

 

Your Guide to Good Record Keeping

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hWhile it’s generally accepted that keeping good records is an important part of running a business, putting this into practice isn’t always as straight forward as it sounds, and exactly what records do you need to keep anyway?

 

Let’s start by looking at the benefits you can gain from keeping good records:

  • If your records are complete and organised logically, it makes it quick and easy to find what you’re looking for later
  • Having a consistent, reliable filing system makes it easier when multiple people use or need access to the documents
  • Inland Revenue requires taxpayers to keep all financial records for seven years
  • The Companies Office requires companies to keep all financial records for ten years
  • You will be well prepared for any audits and won’t need to stress as much

What records should you be keeping?  Here are the items many businesses and other taxpayers would be expected to keep, though some items will apply in some cases and not others.  The item most frequently missed by clients are details of any second hand purchases.     

  • bank statements
  • bank reconciliations
  • supplier invoices and credit notes
  • supplier statements
  • donations receipts
  • customer invoices and credit notes issued
  • bank deposit details
  • details of all cash receipts and bank deposits
  • details of all cash payments
  • details of all cash reconciliations
  • cheque book stubs (each one complete with date, payee and amount)
  • details of parties you have purchased second hand goods from in the normal course of business
    • in order to claim a second hands good credit where a tax invoice was not issued, you will need to retain the following details of the purchase:
      • name of the supplier
      • address of the supplier
      • date of purchase
      • description of the goods
      • quantity or volume
      • consideration given
      • any documentation
  • Vehicle log book(s)
  • RWT (interest) certificates
  • NRWT certificates
  • Dividend certificates
  • Investment statements
  • Rental statements from your rental property manager
  • Hire purchase agreements
  • Loan agreements
  • Loan statements
  • Lease agreements
  • Insurance documents
  • Stock take records
  • GST returns
  • FBT returns
  • PAYE returns
  • Income Tax Returns
  • GST, FBT and income tax calculations (your accountant may retain these for you)
  • IRD statements and notices (if your accountant is your tax agent, they may retain these for you)
  • ACC statements
  • Management accounts
  • Depreciation schedules
  • Tax accounts
  • Shareholder resolutions (if your accountant acts as your registered office, they may retain these for you)
  • Company minutes (if your accountant acts as your registered office, they may retain these for you)
  • Company registers (if your accountant acts as your registered office, they may maintain these on your behalf)
  • Details of dividends issued
  • Trustee resolutions
  • Trustee minutes
  • Staff records
  • Payroll calculations
  • Grant / funding applications and agreements

That is potentially a lot of documentation to keep track of.  In my next post, I will look at some of the options available for storing and managing your records, including several electronic methods.  Electronic filing is very topical with several popular accounting solutions now allowing you to store (or store a link to) supplier invoices and other documents with the transaction.

 

The above information is current at the time of writing and is provided in general terms relevant to New Zealand only.  We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information.  

 

Amanda Imms CA

Principal

AJ Accounting Limited

ph. 021 771 557

amanda@ajaccounting.co.nz

Are you eligible for a Donations Tax Credit?

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To continue on with our festive theme, let’s look at the tax effects of giving at Christmas time (and any other time of course). If you missed my last post, which covered the tax effects of Christmas socials, parties and other entertainment, you can view it here.  

As you might expect, gifts to a charity generally provide tax benefits to the giver.  An individual will usually be eligible to claim a refundable tax credit of one third (or more precisely, 33.33%) of all charitable donations during the tax year.  The maximum you can claim in any one year is one third of your taxable income for that year, however, you can share your donations with your married, civil union or de facto partner (and vice versa), as long as your total combined claims are no more than one third of your combined taxable income for that year (assuming your combined claim is split 50/50).

In order to qualify for the credit, you must:

  • be an individual (ie the credit cannot be claimed by a company, trust etc)
  • have earned taxable income during the year in which the donation(s) was/were made
  • have been resident in New Zealand during the year in which the donation(s) was/were made
  • have made monetary donation(s) of over $5 to an approved organisation (a searchable database of approved organisations is available here)
  • have a valid receipt for each donation which meets Inland Revenue’s requirements (note that IRD has relaxed its requirements slightly in relation to donations for the Christchurch earthquake relief of up to $1,200)
  • file an IR526 within four years of the tax year in which the donation was made (the IR526 form for the year ended 31 March 2014 is available here.  The 2015 form will likely become available after 31 March 2015).  It can pay to attach your donation(s) receipts(s) to the claim form.
  • have filed your income tax return (IR3) for the year

Donations tax credits can be transferred to another tax type or to another taxpayer or refunded.  Note that if you made the donation through payroll giving, it will have already been applied as a reduction to your PAYE.

The above information is current at the time of writing and is provided in general terms relevant to New Zealand only.  We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information.  If you believe you may be eligible for a donations tax credit, please feel free to contact me so I can take any subsequent legislative changes and your particular circumstances into account. And remember to keep your receipts.

 

Amanda Imms CA

Principal

AJ Accounting Limited

ph. 021 771 557

amanda@ajaccounting.co.nz

Christmas Socials and Events

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It’s that time of year again.  If you are planning on holding a Christmas social, it pays to know the impact your event will have on your tax liability.  Most costs relating to a Christmas social for staff and/or customers will be 50% deductible under the limitation rules, and require a GST adjustment to limit the GST portion to 50% of the total GST on that expenditure.  Larger events which are open to the public are normally 100% deductible. There may also be potential FBT exposure in some cases.  Here is a quick summary.

 

The following events will normally be 50% tax deductible and require a GST adjustment:

  • expenditure relating to socials held off premises for staff and/or customers
  • expenditure related to socials held on business premises for staff and/or customers
  • corporate boxes and any associated expenditure on food, drink etc
  • accommodation in a holiday home or time-share apartment and any associated expenditure
  • hireage of a pleasure craft and any associated expenditure

 

The following will normally be 100% tax deductible:

  • light refreshments, provided to staff during the course of their normal employment, such as morning tea 
  • light refreshments served at a business meeting 
  • light refreshments served at an educational event such as a seminar or conference that lasts for at least four consecutive hours
  • expenditure on an event that is open to the public and is for charitable purposes
  • expenditure on an event or social that takes place off-shore

 

These events may give rise to Fringe Benefit Tax:

  • expenditure on an event or social that takes place off-shore
  • entertainment expenditure where employee(s) (including shareholder-employees) can choose to enjoy the entertainment at their discretion and outside of their employment
  • FBT may also be payable on some travel costs where the business pays for entertainment-related travel

 

So, if you want to gain maximum tax benefits from your Christmas event, support a local charity!   You can’t argue with Inland Revenue’s rationale on that one.

 

The above information is current at the date of writing and is provided in general terms relevant to New Zealand only.  We do not accept responsibility or liability for its accuracy or for the outcomes that may result from placing reliance on this information.  If you have any queries about the tax implications of your business social, party or event, please feel free to contact me so I can take any subsequent legislative changes and your particular circumstances into account.

 

Amanda Imms CA

Principal

AJ Accounting Limited

ph. 021 771 557

amanda@ajaccounting.co.nz