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Optimising Business Structures for Taxation Purposes
Part of my role in advising clients, is attempting to optimise their structures for taxation purposes – less tax paid for a profitable business should naturally correlate to more cash in the pocket (one would hope!). The following issues are some common themes in this regard:
Initial Structuring versus Restructuring
Getting good structuring advice at the outset is a prudent decision for any business, particularly if you do not want to be one of the 25% who fail to survive more than three years per the stats presented in a recent MBIE article.
Structuring risks from a taxation perspective are also greatly reduced if good advice is obtained at the outset, firstly because tax savings are realised at the earliest possible stage in the business lifecycle, and secondly (and more importantly in my view) due to the existence of anti-avoidance rules contained in the various tax Acts.
It is well publicised that Government expects IRD to provide a return on investment in excess of $7 per $1 spent on audit activities, and a useful tool in IRD’s arsenal, is to consider whether any restructure undertaken by a taxpayer has tax avoidance as one of its purposes or effects, provided that purpose or effect is not merely incidental. In this respect, IRD is on the lookout for “arrangements” the taxpayer has “entered into” – difficult to establish however, where a particular structure has been in place from the outset.
Company Tax Rate Benefit
A common mistake is the belief that using a company structure will cap your effective tax rate at 28%, thereby avoiding exposure to the top personal marginal tax rate of 33%, had a sole trader or general partnership business structure have been used instead. However the benefit is usually only a timing one, as often the shareholders (themselves on 33% rates due to earning more than $70,000 per annum in their personal capacities) want to get their hands on the cash sooner, rather than later, which is achieved (usually) by the company paying them a dividend. Enter the dividend withholding tax (DWT) of at least 5% required to be paid by the company to IRD the month following the dividend payment month, and you are back at 33%.
No Magical Deductions
Another common misunderstanding is the belief that use of a company structure will somehow create numerous additional tax deductions that you would not have been entitled to under other business structure scenarios. Not so, there are no special expense deductions suddenly created due to the use of a corporate business structure. Usually you have to spend hard cold cash (or at least incur an obligation to spend) to get a deduction in the first instance, and $1 of hard cold cash equates to $1 of hard cold cash irrespective of business structure (although the tax benefit of the deduction itself may be different depending on type of business structure used).
Personal Attribution Rules
Often forgot about because the rules were introduced when we had a top personal tax rate of 39% some years back, however there was no repeal of the regime when the rate subsequently dropped to 33%.
The rules were introduced to counter providers of essentially personal services from inserting an inter-posed entity (company/trust) between themselves and their customer, to take advantage of the lower tax rate of the inter-posed entity.
So take note – where more than 80% of your income comes from the one customer (related customers treated as one), you do more than 80% of the work, and you do not use “major assets” in the course of providing your personal services, then your inter-posed will essentially be looked-through for tax purposes, with the profit attributed to the personal service providers directly and taxed accordingly.
Tax Benefits of Trusts
While use of a trust structure certainly facilitates the ability to shift income to a greater number of family members, long gone are the days where allocating large sums of income to your two year-old would provide a tax benefit. The advent of the minor beneficiary rule resulted in allocations of income to persons under 16 years of age, still being treated as income of the trustees for a particular income year, and subject to a 33% tax rate.
Trusts do still have some advantages in my view however, for those aged 16 and over, still deriving less than $70,000 of annual taxable income. Taxation of trust income works on the basis that the income is only taxed at the trustee tax rate of 33%, to the extent it has not been allocated as beneficiary income (with such distributions taxed at the beneficiaries marginal tax rate, subject to the minor beneficiary rules). So each year you have the option to make beneficiary distributions where your family circumstances offer a potential benefit in doing so. However do not overlook the risks of potential exposure to your 19 year-old, who on becoming aware the trustees owe them monies for distributions previously made on paper so not yet paid (and perhaps never intended to be in the short term), and decides to sue the trustees for payment.
Use of Look Through Companies (LTC’s)
Simply an ordinary company from a common law perspective, which obtains certain tax benefits by registering under the LTC regime. Probably more advantages than disadvantages under the regime, however most importantly once again, is obtaining good professional advice at the outset.
A good opportunity to reduce your tax cost when looking to trade on the ground in overseas jurisdictions (from 53c per $1 to 33c per $1 in an Australian scenario for example, where using an LTC versus a vanilla parent/subsidiary type structure), or as an investment vehicle for multiple property investments to avoid getting locked in capital gains which can occur with a non-LTC structure.
There are others….
The above are just a taste of the various tax related considerations one should take into account when determining an optimal tax structure. However most importantly, structuring should always be undertaken with a more holistic view of one’s world in which you are about to operate, taxation just being one part of the structuring puzzle.
Please do not hesitate to contact me should you like additional information with respect to any of the comments I have made throughout the article.