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buying a business?

Valuation of assets, stock & goodwill

Conflict of interest - The vendor and the purchaser have to agree on the allocation of values for goodwill and other assets.

Goodwill - is normally non assessable to the vendor and non deductible to the purchaser.

Vendor's view - The vendor wants low value for stock and fixed assets and high value for goodwill.

The vendor would prefer to load the value of goodwill of the business at the expense of the stock and assets: the price received for stock represents taxable income to the vendor.

The price agreed for fixed assets if above book values and below original cost, will incur depreciation recoveries in the year of disposal, (depreciation recovered treated as taxable income).

Purchaser's view - The purchaser prefers a higher price allocated to stock and assets; and a lower value of goodwill.

The cost of stock is allowable as a deduction.

Depreciation is allowable on the cost price of the fixed assets.

Debtors - Be careful! If debtors are taken over by the purchaser, they represent a capital asset. Therefore if any of these debtors don't pay the loss is a capital loss and not deductible for tax.

Potential tax liability- Be careful when purchasing a company by buying the shares that you do not inherit a tax liability due to incorrect previous tax returns.

buying property

It is a good idea to add into the sale and purchase agreement a suitable "due diligence" clause that will enable you as a purchaser to cancel the contract if the conditions aren't met.

Due Diligence Clause
Courtesy of Tony Steindle (Property Law - A NZ Investor's Guide)

"This agreement is conditional for ten working days on the purchaser undertaking and being satisfied, in the sole discretion of the purchaser, with a 'due diligence' investigation in respect of the property including all commercial and conveyancing aspects of the purchase and the merit of purchasing. This clause is inserted for the benefit of the purchaser and if it is not satisfied, the purchaser shall not be obliged to state any reason."

business structures

Some of the structures used for business in New Zealand are:

sole trader

No separation between individual and business (taxed at individual rates)
Simple, easy to operate, low cost
No FBT (exception paye employees)
GST when income above threshold $60,000 p.a.
Liability exposure from legal claims.

partnership

Suggest a partnership agreement is used to guide management and document agreement for profit sharing between partners.

Confidential ownership.
Tax flows through to partners.

limited partnership

Limited partners have liability exposure limited to the amount of their investment.
Confidential ownership.
Tax flows through to partners.
Limitations on tax losses.
General Partners do the day to day business and are the same as partners in an ordinary partnership. The general partner is jointly and severally liable for the debts of the partnership. General Partners can be a company to achieve limited liability.
This entity was designed to encourage more investment.

company - overall comments

Suggest a shareholders agreement is used.

Shares in a company can be sold to transfer ownership, and the company structure can continue to operate.

Tax Losses can be carried forward to next year if shareholder continuity maintained.

Imputation credits may be lost if shareholder continuity is not maintained.

Companies have obligations to file an annual return with the companies office.

close company (small private company)

May elect to become a QC or LAQC

5 or less people (associated shareholders count as 1) control more than 50% of the company.

Qualifying company - qc status

Dividends paid by a QC must be fully imputed to the extent that imputation credits and dividend withholding payment credits are available. To the extent that these credits are not available, the dividends are exempt. This means that dividends can be distributed tax free to shareholders.

Capital gains can be distributed tax free to shareholders without winding up the company.

Existing companies wanting QC have to pay an entry tax called qualifying company election tax. Existing companys also forfeit brought forward losses
Limit of $10,000 foreign non dividend income
Shareholders are personally responsible for the company tax if the company doesn't pay it.
Time limit for new companies to elect to become a QC or LAQC
Rules regarding QC's and LAQC's changing this year.

Qualifying company - laqc status

This means losses can be passed to shareholders to then offset personal income.

The LAQC status will be revoked this year and replaced by the LTC entity.

Look through company

The LTC is being proposed by Government to replace the LAQC. The idea behind the change is to ring fence losses on rental properties to carry forward for offset against future profits.

LTC maintain limited liability like an ordinary company.

Only a natural person, trustee or another LTC may hold shares in an LTC. There is only one class of shares, with 5 or fewer shareholders who have the same rights and obligations.

Shareholders in a LTC will only be able to offset losses (against their personal income) to the extent that those losses represent their economic loss, i.e. your losses cannot exceed the amount of your investment into the company. You have two options here: 1. Provide a personal guarantee over the Bank Debt loaned to the company or 2. Inject cash into the company as equity capital. Both of these will increase your money at risk or investment in the company, thus enabling you to use losses.

Selling shares in a LTC is likely to trigger depreciation recoveries under the new rules taking effect from 1 April 2011.

trust

A trust is setup primarily for asset protection.

Trusts can last for up to 80 years, and are a good vehicle to pass on asset ownership to future generations.

Trusts cannot pass losses to beneficiaries. Any losses can be carried forward to offset against future profits.

Trustees of the trust must comply with the trust deed, the trustees act 1956, and trust case law (always changing).

trading trust

A trading trust is similar to a trust with the added clauses in the trust deed enabling a business to be conducted. It has the ability to make distributions at the discretion of the trustees.

This is a complex structure and needs considerable planning and professional advice.

things to consider when choosing your structure

For new business ventures starting from scratch why not take a low risk low cost approach, suggest start with a sole trader, partnership, or close company structure. You can always move to more complex structures as your business grows.

If you are intending on purchasing an already established business then it will make sense to consider setting up an appropriate structure before you purchase the business.
Ensure you do thorough due diligence on any potential business purchase. Take your time and ask for more than one opinion.

Arrange a meeting with your professional advisors (Lawyer, Accountant, Banker, Financial Planner). You can request that your accountant prepares a tax impact report of the structure changes.

Always take the time to review and update your will when changing structures.

Combinations of structures and entities are possible. Be careful if your only motive is to reduce tax. My advice is not to proceed with any structure until you have a good understanding of the tax implications of operating under the proposed structure and what the likely tax implications would be if you exit that structure.
Also consider the costs and time to administer the structure.

There are legitmate deductible costs between entities.
Examples are:

Rent for business premises and plant
Interest on loans (advances made to a company)
Directors Fees

tax and commercial - things to consider

How are profits allocated?
Ability to claim losses against personal income?
Complexity of obligations, necessary meetings, documentation of minutes & resolutions, compliance with laws
Limited Liability (for small companies this liability protection is reduced when personal guarantees are given, also Directors can be liable for breach of duties).
Business Continuity (transfer of ownship / control - exiting & succession plans are needed)
Asset Protection.
Confidentiality of owners
Tax obligations - GST - FBT
Insurance - Public Liability / Key person / Income Protection / Professional Indemnity.

what to do with LAQC??? - some options

1. Do nothing - LAQC will lose loss attribution status and effectively become a QC

or 2. Adopt the proposed LTC structure

or 3. Revoke QC status and become an ordinary company

or 4. Use the transition period to become either a partnership, limited partnership or sole trader.

Best get some good advice and act prudently. Keep an eye out for changes in dividend rules, which are under review.

When should we contemplate setting up a trust?

I would suggest when you have sufficient assets in your ownership that you would like to protect. Perhaps when you own the family home, shares in your company, life assurance policy.

Once the assets are owned by the trust and the corresponding debt has been forgiven, then that asset is fully protected by the trust. At present this process takes time as there are restrictions on the amounts that can be gifted annually. It is proposed that gift duty will be removed on 1st October 2011.

A period of 5 years after all the assets have been transferred to the trust is usually the timeframe that some Government departments will go back with respect to means testing for benefits, (no guarantees though).

Contact me if you would like to discuss your particular situation. You never know, I might just be able to help.

disclaimer

Ignorance is no excuse when it comes to tax. For your specific situation, you are best to consult your professional advisor. Comments made on this page are of a general nature and are not intended to convey specific advice for your particular situation. I will not accept any liability claim in any shape or form, whatsoever for any misfortune you may encounter from reading this information.

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